Compound

Interest
•Compound Interest
• It is the sum by which the original
principal has been increased by the
end of the contract.
•Compound Amount
• The total accumulated amount at the
end of the period
• Formulas:

Where:
F – final amount/final value
m=1 Annually
P – principal amount m=2 Semi-Annually
r – rate (%) m=4 Quarterly
m – conversion period m = 12 Monthly
t – time (in years)
n – (m)(t)
 Finding the Compound Amount
Example:
1. Find the compound amount of ₱20,000
compounded semi-annually for 2 years at
12%.
Solution:
Example:
2. Accumulate ₱15,000 for 5 years at 6%
compounded quarterly.
Solution:
Finding the Compound Amount – When “n” is not
an Integer
Example:
1. Accumulate ₱6,500 for 4 years and 5 months at compounded
semi-annually.
Solution:
n=
n=
n=
Example:
2. Find the compound amount on ₱9,700 for 5 years and 3
months at 6% converted semi-annually.
Solution:
n=
n=
n=
 Finding the Interest Rate
Formula: Formula:
By Logarithmic Method By Exponential Method

Then,
r = (m)(i)
Example:
1. At what rate compounded quarterly will ₱7,000 become ₱18,500 at the
end of 11 years?
Solution:
Logarithmic Method

r = 4(0.022333481)
r = 0.089333924
r = 8.93%
Example:
1. At what rate compounded quarterly will ₱7,000 become
₱18,500 at the end of 11 years?
Solution:
Exponential Method
Finding the Time or Term of Investment
Formula:
By Logarithmic Method

or

Then,
Example:
1. On January 25, 2003, Mrs. Sally Lorenzo had ₱400,000 on a trust fund
which earns 14% converted quarterly. She plans to put up a cake and
pastry business as soon as the fund contains an amount of ₱500,000. On
what date will that amount be available?
Solution:
To get the exact
date:
1 year
(0.62161553)(12)
=7.45938636 or 7
Or Sept 8, 2004 months
(0.45938636)(30)
=14.24099266 or
14 days
Example:
1. How long will it take ₱5,000 to accumulate to ₱7,250 at 12%
compounded monthly?
Solution:

or 3.11 years
or 3 years and 1
month
NOMINAL RATE
EFFECTIVE
RATE
EQUIVALENT
RATE
 Equivalent rate
• Two interest rate are said to be equivalent if they
give equal compound amounts at the end of the
same term.
Example:
Nominal rate is equivalent to nominal rate if and
only if the accumulated value of any amount P at a
nominal rate is equal to the accumulated value of
the same amount P at nominal rate for equal
period of investment.
Example:
At and m = 4, if P = ₱1,000 and t = 2 yrs, then the accumulated value is

At and m = 2, if P = ₱1,000 and t = 2 yrs, then the accumulated value is

Nominal Rates/Stated interest rate
• Refers to the interest rate before taking
inflation into account
Formula:
 Effective rate
• The real return on a savings account or any
interest-paying investment when the effects
of compounding over time are taken into
account.
 Example:
Find the effective rate which is equivalent to a nominal
rate 8% compounded quarterly.

w = 0.0824
w = 8.24%
Example:
What nominal rate compounded quarterly is
equivalent to 8% compounded semi-annually?
j1 = ? m1 = 4 & j2 = 0.08 m2 = 2

• j1 = 0.07921561087
• j1 = 7.92%
 Example:
What rate converted monthly is equivalent to an
effective rate of 9%?
j1 = ? m1 = 12 & j2 = 0.09 m2 = 1

• j1 = 0.08648787979
• j1 = 8.65%
 Continuous Compounding
For any nominal rate j, as the conversion
period increases, the value of its equivalent
effective rate (w) also increases.
As m frequently increases (such as daily,
hourly, or even infinitely), the accumulation
factor approaches the value where
This is called compounded continuously
which is denoted as
 Accumulated Value
Force of interest
Formula:

Present Value
Formula:
 Effective rate for CC
𝑗𝑐
𝑤 =𝑒 − 1

Force of interest

or
 Example:
Find the accumulated value of ₱50,000 if it is
invested for 5 years at 10% interest compounded
continuously.
Solution:
Example:
Find the effective rate equivalent to converted
continuously.
Solution:
Let and w = ?
Then,
 Example:
Find the interest rate compounded continuously which is
equivalent to effective rate.
Solution:
Let and
Then,
log ⁡(1 .0825)
𝑗 𝑐=
or log ⁡(2.71828)
Equations Values
 Equation of Values
• A mathematical statement stating that the sum of
one set of values on a certain comparison date is
equal to the sum of another set of values on the
same comparison date.
• It is also effective on solving problems which involve
a set of new payments equated with each other.
Formula:
 Procedures:
Step 1: Represent the unknown with the letter x.
Step 2: Construct the Time Diagram
a. Locate the due amounts of the set
obligations on the upper part of the
diagram;
b. Locate the due amounts of the set of
new obligations on the lower part of the
diagram.
 Procedures:
Step 3: Select the most convenient Comparison
or Focal Date, FD. Draw arcs from each due
amount of the old and new obligations, all
arcs pointing towards the Focal Date.
Step 4: Prepare an equation of values by
adjusting the exponent of each accumulation
factor, , according to the chosen Focal
Date.
 Example:
A debtor owes ₱20,000 at the end of 2 years and ₱50,000 at the end of 8
years. If interest is at 7% effective rate, what single payment at the end of 6
years would liquidate both debts?
Solution:
Let x – be the single payment.
Solution:
New payment = Sum of old payments
 Example:
A Honda motorcycle was sold for a down payment of ₱10,000 and equal
payments of 5,000 each due at the end of each three months for one year. If
money is worth 8% compounded quarterly, what cash payment which is
payable now, is equivalent to these terms?
Solution:
Let x – be the single cash payment due at the present value.
Solution:
New payment = Sum of old obligations
 Example:
What three equal annual payments, the first due in two years, will discharge
an obligation of 10,000 due now when money is worth 10%?
Solution:
Let x – be the annual payment due at the end of 2, 3 and 4 years.
 Example:
Solution:
Old obligation= Sum of new payments

14,641 = 1.21x + 1.10x + x

x = 4,423.26
 Simple
Annuities
 Basic Concepts and Terminologies
Annuity
A sequence of payments, usually equal, made at regular
intervals.
It is divided into annuity certain and contingent annuity or
annuity certain.
Payment
The time between successive payments
Periodic Payment
The size of each payment
Term of Annuity
The time from the start of the first payment to the last
 Basic Concepts and Terminologies
Ordinary Annuity
One for which the periodic payments are made at the end of
each period.
Annuity Due
When the payments are made at the beginning of each
period.
Defined Annuity
One whose first payment is due at some later time.
Term of Annuity
The time from the start of the first payment to the last
 Symbols:
R
Periodic payment of the annuity
n
Total number of payments
i
Interest per conversion period
S
Amount of an annuity
A
Present value of an annuity
 Amount & Present Value of an Ordinary Annuity

and
or

Where,
A is the present value of S due in n periods
S is the amount of A for n periods/an ordinary annuity
R is the periodic payment
Example:
Consider an ordinary annuity of ₱10,000 per year payable
for 3 years with money worth 10%.
Year Computation Amount Year Computation Amount
0-3 10000 P10000 0-1 10000(1+0.10 P9100
0-2 10000(1+0.10 P11000 0-2 10000(1+0.10 P8300
0-1 10000(1+0.10 P12100 0-3 10000(1+0.10 P7500
Total: P33100 Total: P24900

Computation:
A = 33100(1+.10 S = A(1+.10
A = P24900 S = P33100
Example:
Find the amount and present value of an annuity of ₱1,500
payable for 2 years if the money is worth 10% compounded semi-
annually.
Solution:
 Periodic Payment of an Ordinary Annuity
a. Periodic payment of S

b. Periodic payment of A
Example:
In order to have ₱300,000 at the end of 15 years, how much must
be deposited in a fund every 3 months if money is worth 8%
compounded quarterly?
Solution:
Example:
Mr. Clark bought a refrigerator that costs ₱19,500. He paid ₱6,000
as down payment and the balance will be paid in 36 equal
monthly payments. Find the monthly payment if money is 15%
compounded monthly.
Solution:

monthly payment
 Finding the Interest Rate of an Ordinary Annuity

(n² - 1)i² - 6(n – 1)i + 12 (1 - = 0; and

(n² - 1)i² + 6(n + 1)i + 12 (1 - = 0

Note: The interest I is then solved by the quadratic formula.

Rules: (a) if both values of x are positive, we take the smaller
value
(b) if they have dissimilar sign, we take the positive value.
Example:
A refrigerator can be purchased for ₱9,000 cash or ₱900 down
and ₱630 a month for 18 months. Find the interest rate.
Solution:
A = 9000 – 900 = 8100 R = 630 n = 18
Since A is known,
(n² - 1)i² + 6(n + 1)i + 12 (1 - = 0
(18² - 1)i² + 6(18 + 1)i + 12 = 0
323i² + 114i – 4.8 = 0
Example:
To find i, we use the quadratic formula
a = 323 b = 114 c = -4.8

i = -0.3909526 or i = 0.03801146
i = 3.38%
Example:
Payments of ₱750 each are made every 6 months in 3 years. At
what rate compounded semi-annually will these payments
amount to ₱5,100?
Solution:
S = 5100 R = 750 n=6
Since S is known,
(n² - 1)i² - 6(n - 1)i + 12 (1 - = 0
(6² - 1)i² - 6(6 - 1)i + 12 = 0
35i² - 30i + = 0
Example:
To find i, we use the quadratic formula
a = 35 b = -30 c =

i = 0.8071706031 or i = 0.049972254
i = 5.00%
 The Term of an Ordinary Annuity
Formula when the future value is given,

Formula when the present value is given

Example:
How long will it take for annual year-end contributions of
₱57,000 to an educational Savings Pan to grow to ₱1,000,000 if
the Educational Savings Plan earns 13% annually?
Solution:
Solution:
Example:
Winston and Reina are discussing the terms of a ₱270,000 home
improvement loan with their bank’s lending officer. The interest
rate of the loan will be 18% compounded quarterly. How long will
it take to repay the loan if the quarterly payments are ₱25,000?
Solution:
Solution:
Simple Annuity
Due
A type of annuity where
payments are made at
the beginning of each
payment interval.
 Present Value of an Annuity Due
R
Periodic payment of the annuity due
n
Total number of payments
i
Interest per conversion period

Amount of an annuity due

Present value of an annuity due

 Present Value of an Annuity Due
Formulas
Example:
Marlon purchased a car. He paid ₱150,000 down payment and
₱10,500 payable at the beginning of each month for 5 years. If
money is worth 12% compounded monthly, what is the
equivalent cash price of the car?
Solution:
Solution:

Cash Equivalent = DP + Total Installment Payments

Cash Equivalent = 150,000 + 476,748.18
Cash Equivalent = 626,748.18
Example:
Ms. Coballes, a graduate school student of SPUP is granted a
scholarship which will pay ₱6,500 at the beginning of each month
for 4 years. If money is worth 18% compounded monthly, find the
present value of the scholarship.
Solution:
Solution:
R = ₱6,500 m = 12 t=4 r = 0.18
n= 48 i = 0.015
Amount of an Annuity Due

Formula
Example:
If ₱500 is deposited in a bank at the beginning of each 3 months
for 10 years and money is worth 8% compounded quarterly, how
much is in the fund at the end of 10 years?
Solution:
Solution:
R = ₱500 m=4 t = 10 r = 0.08
n= 40 i = 0.02
Periodic Payment R of an Annuity Due
Formula
Example:
What equal deposits should be placed in a fund at the beginning
of each year for 15 years in order to have ₱1,500,000 in the fund
at the end of 15 years, if money accumulates 12%?
Solution:
Solution:
= ₱1,500,000 m=1 t = 15 r = 0.12
n= 15 i = 0.12
Example:
Aaron agrees to make equal payments at the beginning of each 3
months for 10 years, to pay all interest and principal in
purchasing a house and lot worth ₱5,000,000 cash. If money is
worth 18% compounded quarterly, find the quarterly payment.
Solution:
Solution:
= ₱5,000,000 m=4 t = 10 r = 0.18
n= 40 i = 0.045
Deferred Annuity
• Deferred Annuity
It is an annuity whose term does not begin until the expiration of
specified time.
Formula:

Cash Price = Down payment +

• Deferment Period (d)

The length of time for which there are no payment
 Example:
A sequence of quarterly payments of ₱3,500 each, with the first one due at
the end of 3 years and the last at the end of 10 years. Find the present
value of the deferred annuity, if the money is worth 16% compounded
quarterly.

Let:
R = ₱3,500 r = 0.16 m=4 i = 0.04
First, solve for,
 Solution:
Let:
R = ₱3,500 r = 0.16 m=4 i = 0.04
First, solve for,
 Example:
Find the cash equivalent of an item that sells for ₱20,000 cash and 20
semi-annual payments of ₱5,500, the first is due at the end of 3 years, if
the money is worth 10% compounded semi-annually.

Let:
R = ₱5,500 r = 0.10 m=2 i = 0.05 DP = ₱20,000
First, solve for,
 Solution:
Let:
R = ₱5,500 r = 0.10 m=2 i = 0.05
DP = ₱20,000
First, solve for,

121,328.82
Periodic Payment R of Deferred Annuity
Formula
 Example:
Alex borrowed ₱100,000 with interest at the rate of 12% compounded
semi-annually. He agrees to discharge his obligation by paying a sequence
of 10 equal semi-annual payments, the first being due at the end of years.
Find the semi-annual payment

Let:
= ₱100,000 r = 0.12 m=2 i = 0.06
n = 10 d = 10
Solution:
= ₱100,000 r = 0.12 m=2 i = 0.06
n = 10 d = 10