Financial Mathematics Chapter 05

CHAPTER -05

FINANCIAL MATHEMATICS

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 Financial Mathematics Chapter 05

Simple Interest:
The return the investor receives from using his money over a certain period of time.
S = P(1 + rn)
I = Prn
• S Future value of the Money.
• P Present value of the Money
• r/i rate of interest
• n/t Time period.
• I Amount of interest

Example 1: Mr. Ali borrowed Rs. 10,000 at 10% per annum. Find amount to be repaid after 3 years.
(13000)
Example 2: Find Future value of Rs. 1355 at 8% p.a simple interest for 5 years.
(1897)
Example 3: Mr. Ali invested Rs. 14000 at 2% p.a for 5 years. How much extra amount will he earn after
5 years? (1400)
Example 4: Find the present value of Rs. 1335 invested at 8% p.a for 5 years.
(953.5)
Example 5: A person borrows Rs. 20,000 from a bank at 12% p.a. In how many years will he owe
interest of Rs. 3600? (1.5)
Example 6: An amount of Rs. 20,000 is due in three months. Find the present value if it includes simple
interest at 8%. (19607.8)
Example 7: A sum of money which yields 6200 in 2 years and 7400 in 3 years. Find the rate of simple
interest and principal. (31.57%, 3800)
Example 8: A sum of money would double itself in 10 years. Find the number of years it would be four
times. (30)
Example 9: A total of Rs. 14000 is invested for a year. Some part of this investment at 5% and rest at
6%. If Rs. 740 is the total interest then find amount invested at 5%.
(10,000)
Example 10: A person borrows Rs.60, 000 at 8%. At the end of the loan he repays the loan in full with a
cash transfer of Rs.88, 800. What was the duration of the loan?
(6)

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 Financial Mathematics Chapter 05

Compound Interest:
Compound interest (or compounding interest) is interest calculated on the initial
principal and also on the accumulated interest of previous periods of a deposit or loan. Compound
Interest is also crucial to understanding Time Value of Money.
• S = P(1 + r)n
• C. I = S − P
• C. I = P(1 + r)n − P
• C. I = P((1 + r)n − 1)
Where,
• S Future value of the Money.
• P Present value of the Money
• r/i rate of interest
• n/t Time period.
• C.I Amount of interest

Example: Mr. Ali Invested Rs. 10,000 at C.I of 10% p.a for 3 years. Find Future value of the money.
(13310)
Compounding Frequency/ m-Factor:
r nm
• S = P (1 + m)
r nm
•
C. I = P (1 + m) − P
M represents parts in one year
Compounded Monthly m = 12
Compounded Semi-annually m=2
Compounded half yearly m=2
Compounded Quarterly m=4
Compounded Bi-Monthly m=6
Compounded Annually m=1

Example 1: If Rs. 1000 is invested at 5% p.a for 4 years. Find Compound Interest? (215.5)
Example 2: Find the Compound Interest on Rs. 16000 for 1.5 years at 10%p.a payable half yearly.
(2522)
Example 3: At what rate of interest compounded semi-annually will Rs. 6000 amount to Rs. 9630 in 8
years? (6%)
Example 4: The population of a country increases at the rate of 3%p.a. How many years will it take to
double itself? (23.45 years)

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 Financial Mathematics Chapter 05

Exponential Rate of Interest:

When a loan is compounded continuously, it means that interest is being calculated at
every smallest instance. Although continuous compounding plays significant role in financial
compounding, it is not considered realistic to have an infinite number of periods for interest
calculation.
𝐒 = 𝐏 × 𝐞𝐫𝐧

Example:
The population of a city was 8 million in January 2020. The population is growing at the
exponential rate of 2% p.a. What will be the population in January 2025? (8.84 million)

Effective Rate of Interest:

𝐫 𝐦
𝐄𝐑 = (𝟏 + 𝐦) − 𝟏
r Nominal rate of interest
E.R Effective Rate of Interest.
m Compounding Frequency

Example: Find effective rate of interest corresponding to a nominal rate of 3% p.a compounded half
yearly. (3.022%)
Example: An Investor earns 9.1% interest compounded semi-annually or 9% interest compounded
monthly. Which option he should prefer?

Find rate of Interest compounded quarterly which is same as 6% compounded bi-

monthly.
(6.01%)

Find rate of interest compounded half yearly that is same as 4% compounded

monthly. (4.033%)

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 Financial Mathematics Chapter 05

DISCOUNTING:
Discounting estimates the present day equivalent (present value which is usually abbreviated to
PV ) of an amount at a specified time in the future at a given rate of interest. Discounting is the
reverse of compounding.

Example: Calculate the present value of Rs 60,000 received in 4 years assuming a cost of capital of
7%.

Rate of Interest and Time are partitioned:

𝐒 = 𝐏(𝟏 + 𝐫)𝐧 (𝟏 + 𝐫)𝐧

Example 1: Mr. Ali Invested Rs. 100,000 in a Bank for 3 years. The Bank paid interest at the rate of 8%
p.a Compounded half yearly during the first year and at the rate of 12% p.a compounded
quarterly during last 2 years. Find its balance after 3 years.
(137013.85)
Example 2: Ali deposit 200,000 for seven years in an investment scheme and got 300,000 at the end of
maturity date. If he received 8% interest compounded monthly during the last three years, at
what rate of interest he required to balance the amount during first four years compounded
bi-monthly? (4.2%)

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 Financial Mathematics Chapter 05

Question 1: A three years investment yields a return of 25% over the period. Compute effective annual
rate of return.
Sol. S = 1.25x (7.72%)

Question 2: How would the future value of an amount invested today change in 8 years if the amount
is invested at the rate of 9% compounded monthly.
(2.04x = double)
Question 3: A sum of money invested at C.I amount to Rs. 4624 in 2 years and to Rs. 4913 in 3 years.
Find sum of money. (r = 0.0625, P = 4096)

Question 4: What will be the difference in the C.I on Rs. 50,000 at 12% for a year, when the interest
paid yearly and half yearly? (180)

Question 5: If annual rate falls from 12% to 8%p.a. How much more be deposited in an account to have
Rs. 600,000 in 5 years. If both rate are compounded semi-annually.
(P2 – P1)
Question 6: A firms’ Labour force is growing at the rate of 2% p.a. The firm now employs 500 people.
How many employs is it expected to hire during next 5 years?
(52)
Question 7: Mr. Talha invested Rs. 60,000 in a Company but found that his investment was dropping
down 6% of its value p.a. After 2 years he decided to pull out what was left of the
investment and placed at 4% compounded twice a year. In which year he would recover his
original investment?
(3.124years or 4th year)
Question 8: A Bank charges mark-up at Rs. 34.25/week per Rs. 10,000. Find rate of mark-up at percent
per annum. (17.81%)
Question 9: Sara took a loan of Rs. 1200 with simple interest for as many years as rate of interest. If
she paid Rs.432 as interest at the end of loan period, what was the rate of interest?
x
Sol. 432 = 1200 × 100 × x = ( 𝟔%)
Question 10: If the difference between simple and compound interest for 3 years at 5% is Rs.61. Find
P. (8000)
Question 11: A machine in a factory is purchased for Rs. 8500. After 8 years of useful life its scrap will
be of Rs. 3000. Find depreciation rate if interest is compounded monthly.
(12.9%)

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 Financial Mathematics Chapter 05

Question 12: The population of a small town is 100,000, which is growing exponentially at the rate of
6%p.a. What will be the population after 5 years?
(134985.88)
Question 13: Mr. Bean borrowed Rs. 5000 at 6% simple interest and invested the same amount at 6%
compounded semi-annually. What would he gain after 8.5 years?
(C.I- S.I= 714.238)
Question 14: If Rs. 200,000 is grown to Rs. 649,464 in 10 years, at what annual interest rate must it be
invested? What is effective rate of interest compounded semi-annually?
(12.5%, 12.89%)
Question 15: The discount factor for 3 years at 10% is:
(0.751)

Compromise for your Dream but NEVER Compromise on

your Dream.

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