LESSON 9: INTEREST

Almost everyday money is borrowed and loaned in thousands of transactions

amounting, in total, to hundreds of millions of pesos. A bank is a financial institution which
is involved in borrowing and lending money. Banks take customer deposits in return for
paying customers an annual interest payment. The bank then uses the majority of these
deposits to lend to other customers for a variety of loans.
Borrowing and lending are two sides of the same transaction. To the lender loan
represents an investment in a debt obligation. The interest charged provides income form the
investment. The rate of return on the investment is equal to the rate of interest charged to the
customer.
In view of the fact that borrowing and lending are so central to our daily lives and in
the economic system, it is essential to familiarize with the definition of terms and learn the
computation of interest in borrowing/lending transactions.

At the end of the lesson, the student will be able to:

 explain the basic concepts of interest; and
 illustrate how interest is computed specifically as applied to mortgage, to
amortization, on services/utilities, and deposits and loans

Interest - money paid regularly at a particular rate for the use of money lent, or for
delaying the repayment of a debt.
Debt - something, typically money, that is owed or due.

Interest
People borrow or loan money for various reasons. A person may borrow money to pay
for unexpected expenses like hospital bills, take advantage of a midnight sale, purchase a new
gadget, buy a car, or finance travel expenses. A business owner may borrow money to meet his
or her future business pal of expansion, pay his or her business current expenses, take advantage
of cash or quantity discounts, and many more.
The charging of interest for the borrowed or loaned money can be justified from the
standpoint of the lender or the investor, as he or she foregoes the use of his or her money during

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the time it is borrowed and takes the risk of lending or investing it. Hence, for the lender, interest
is the amount or income he or she earns for lending or investing his or her money.
Simple Interest
Simple interest is the interest computed based on the principal only ( the amount of
money borrowed or invested ). It is usually used for short-term loans or investments.
Simple interest can be computed using the formula.
I= Prt
The maturity value (F) or the total amount the borrower has to repay is equal to the sum
of the principal plus the interest. It is also referred to as the future value.
F=P+I
F = P+ Prt
F = P (1+rt)
Example 1: What would be the interest Kaye has to pay if she borrowed P10,000 for 1 year with
an interest rate of 6% per annum?
Solution:
I= Prt
= (P10,000) (0.06) (1)
=P600
Example 2: What is the total amount that Kaye will pay at the end of 1 year?
Solution:
Use the formula for the maturity or future value.
F=P+I
F = P10,000 + P600
= P10,600
Example 3: If instead of paying P10,600 at the end of 1 year, Kaye was required by the lender to
pay P10,750, what is the rate of interest applied on the loan?
Solution:
Recall the formula for the maturity or future value.
F= P(1+rt)
P10,750= P10,000 [ 1+(r )(1) ]

10,750 10,000 [ 1+ r ]
=
10,000 10,000
1.075 = 1+r
r=1.075-1
= 0.075 or 7.5%
Example 4: How much should a father deposit in his savings account so that he will be able to
withdraw P100,000 after 3 years if the bank’s interest rate is 3%?

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Solution:
Use the formula for the future value for simple interest.
F=P(1+rt)
P100,000 = P [ 1+( 0.03)(3) ]

P100 000 = P (1+0.09)

P100 000 = P(1.09)
P (1.09) 100,000
=
1.09 1.09
P= 91 743.12
Example 5:
How long will it take for your money to double at 6.5% simple interest?
Solution:
Assume P=Php 1, Double means F=P2
Use the formula for the future value for simple interest
F= P(1+rt)
2= 1+ [ 1+( 0.065)(t )]
2 = 1 + 0.065t
2-1 = 0.065t
1= 0.065t
0.065t=1
0.065 t 1
=
0.065 0.065
t=15.38 years

LESSON 10. Compound Interest

INTRODUCTION
Compound Interest is computed based on the principal plus the accumulated interest.
This is the reason why compound interest is also known as the “interest on top of the interest”.
Unlike simple interest, compound interest allows interest to earn its own interest. Interest
is periodically computed and added to the principal. The combined amount of the original
principal and the interest then becomes the new beginning principal for the succeeding period.
The procedure is illustrated below.
Interest Principal (Amount at the Interest Future value (Amount Due at the End of
Period Beginning of the Period) earned the Interest Period)
during the
period

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 1 P Pi P+Pi (Factor the common
monomial factor P.)
=P(1+i)

2 P(1+i) = Amount at the P(1+i) P(1+i)+ P(1+i)i Factor the common

end of period 1 [ factor P(1+i) ]
= P(1+i) (1+i) ¿of exponent)

= P(1+i)2
3 P(1+i) = Amount at end P(1+i)2i P(1+i)2+ P(1+i)2i
Factor the common
of period 2
[ factor P (1+ i)2 ]
= P(1+i)2+ P(1+i) ¿of exponent)

= P(1+i)3
4 P(1+i)3 = Amount at the P(1+i)3i P(1+i)3+ P(1+i)3i
Factor the common
end of period 3
[ factor P (1+ i)3 ]
=P(1+i)3+ P(1+i) ¿of exponent)

= P(1+i)4

….. ……. ….. ….

N P(1+i)n-1= amount at the P(1+i)n-1i P(1+i)n-1
Factor the common
end of the previous
period n-1
+P(1+i)n-1i
[ factor P(1+i)
n−1
]
=P(1+i)n-1(1+i) ¿of exponent)

=P(1+i)n

The compound interest formulas are as follows:

F=P(1+i)n
mt
r
[ ]
F=P 1+
m

where
F= future value or accumulated value
P= principal
I = computed interest
r
i= = rate of interest per interest period
m
n = mt = number of compounding periods per year
t= time or term of investment (in years)
r = nominal rate of interest(in percent)

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Example 6: An amount of P100,000 is invested for 2 years at 6% interest compounded quarterly.
Is this a better investment compared to investing it at a simple interest of 6%?
Solution:
At compound interest:
mt
r
[ ]
F= P 1+
m
4(2)
0.06
[
= P100,000 1+
4 ]
=P 112,649.26
At simple interest:
F=P(1+i)n

= P100,00 [ 1+0.06 ( 2 ) ]

= P112,000
Yes, it is a better investment because it has a higher accumulated amount compared to that for
simple interest.
Example 7:
Kyle has to decide if he should deposit his P5000 in a savings account at a simple interest of 5%
for 5 years or invest it in his friend’s business which can potentially earn an interest of 5%
compounded monthly for 5 years. What should be his decision?
Solution:
Option 1 (Simple Interest):

F= P5 000 [ 1+0.05 ( 5 ) ] =P 6250

Option 2 (Compound interest):

mt
r
F=P 1+[ ] m
12(5)
0.05
[ ]
=P 5000 1+
12

= P6 416.79
Kyle should invest his money in his friend’s business.

1. If you are to invest your money, which should you choose- an investment that earns
simple interest or another investment that applies compound interest? Explain your
Answer.
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 2. Defines interest from the points of view of the borrower and the lender.

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3. Explain the difference between simple interest and compound interest.

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4. What is the rate of interest applied if an interest applied if an interest of 25,000 was paid
on a P75,000 simple interest loan after 5 years?

Solve the following problems and apply all the concepts learned in the examples.
1. Kaye’s housing loan worth P810,000 for 5 years was approved by the bank with an
interest rate of 8% per annum. How much will be her monthly amortization?

2. The company of Mr. Apsay has been audited last 30 July 2015 and an error of P12,000 in
his service tax payment due last March was detected. Because of this, he has to pay a
penalty of 20% of the amount owed. How much should he pay at the end of July?

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3. A loan of P250,000 was made for 75 days with an interest rate of 5 %. How much
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interest would be paid?

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REFERENCE:
Agcaoli, Zenaida A., et Al. Business Operations: Mathematics of investments.
Philippines: Mutya Publishing House, 2001
Picar, J . Worktext in General Mathematics for Grade 11: A Comprehensive Approach:
Dioscesan Printing Press and Publishing Inc.

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