Lesson III: Obligations and Equations of Values

Enriquez, Bernie Sean Carlo

Fernandez, Andre Anthony
Jose, Mark Eugene
Lozada, Abigail
Martinez, Bianca Nicole

II – STEM
 I. Deepen Your Understanding

Directions: Solve for the following problems completely.

1. On January 15, 2013, Fernando borrowed from Mark P25, 000 at 16%
compounded quarterly and promised to pay the amount at the end of three
years. On July 15, 2014, Mark sold the note to Fernando at 18% compounded
quarterly. How much did Mark receive from Fernando?

2. Garry Uy borrowed P3, 000 on May 15, 2000 and P2, 500 on January 15,
2002 at 10% compounded annually, He, then paid P500 on July 15, 2003, P600
on December 15, 2005, and P700 on March 15, 2008. What additional sum did
Garry pay on May 15, 2010 to discharge all the remaining liability?
 II. Analyze and Explore

The lesson introduces the concepts of discounting a future sum of money to

determine its current value. This ‘present value of a future cash flow’ is one of
the fundamental calculations underlying the mathematics of finance. This
lesson introduces the concept of the time value of money and equations of value,
which allows us to accumulate or discount a series of financial transactions and
are used to solve many problems in financial mathematics.

All financial decisions must take into account the basic idea that ‘money has
time value’. In other words, receiving P1, 000 today is not the same as receiving
P1, 000 one year ago, nor receiving P1, 000 one year from now. In a financial
transaction involving money due on different dates, every sum of money should
have an attached date, the date on which it falls due. That is, the mathematics
of finance deals with ‘dated values’. This is one of the most important facts in
the mathematics of finance.
 III. Summary of Key Ideas

1. The Values of Obligations are the set of specified sum of

payments on designated dates.
2. An equation of value is an equation stating the sum of values
received or borrowed and the sum of values of payments based
on a comparison date.
3. The comparison or focal date is the common date based on
the choice that will make the solution for the equation of values
convenient to solve.
 Values of Obligation

A set of specified sum of payments of designated dates is called values of

Obligations. If a sum is due on a certain date and another amount F is due on n
interest periods, then we refer to the two amounts as equivalent values. To
determine the value of an amount in the future, the process of accumulation will
be used. On the other hand, when asked for the present value of an amount,
discounting will be used. However, there are problems that ask for the most
valuable obligations. To do this, selecting a comparison date or focal date is
necessary. Tus, values of each financial obligation in the said focal date should be
computed to compare which is the most valuable.

The use of time diagram is necessary for easy reference for the processes of
accumulation and discounting. To use the diagram, whenever the obligation is to
the left of the focal date, its value should be computed through accumulation while
if it is to the right, its value should be computed through discounting. A sample
below illustrates the importance of time diagram.
Example 1

Julia owes P4, 500 due in one year at 9% compounded quarterly and
P8, 000 due in five years. She decides to settle her obligations by
giving a single payment on the fourth year. If the money is worth
12% compounded monthly, how much is the single payment.

Step 1. Identify the obligations.

P = P4, 500
M=4
R = 9% I = 0.0225
N=8 t=2
Step 2: Draw a time diagram. We choose the fourth year as the
focal date for the values.

Step 3. Bring all the dated values to the focal date using the
specified interest rate.

F1 = P5, 376.74 r = 12% F2 = P8, 000 r = 12%

M = 12 I = 0.01 M = 12 I = 0.01
N = 36 t=3 N = -12

F = P(1+i)n F = P(1+i)n

= P5, 376.74(1+0.01)36 = P8, 000(1+0.01)-12

 Equations of Values

An Equation of Value is an equation stating the sum of values received or

borrowed and the sum of values of payments based on a comparison date. The
comparison date should be based on the choice that will make the solution
convenient to solve.

Obligations = Payments

One of the most important problems in the mathematics of finance is the replacing
of a given set of payments by an equivalent set. We say that two sets of payments
are equivalent at a given simple interest rate if the dated values of the sets on a
common date are equal. An equation stating that the dated values on a common
date of two sets of payments are equal is called an equation of value or an equation
of equivalence. The date used is called the focal date or the comparison date or
the valuation date.
Example 1

If money is worth 14% compounded quarterly, which of the

following obligations is the most valuable?

A. P20, 000 due at the end of one year without interest

B. P25, 000 due at the end of three years at 10% simple interest

F = P (1+rt)
= P25, 000[1+(0.1)(3)]= P32, 500
C. P15, 000 due at the end of six years at 18%; m=12
F = P(1+i)n
= P15, 000(1+0.015)72 =P43, 817.37
Step 1. Identify the given information.

R = 14% m = 4 I = 0.035

Step 2. Choose any focal date and draw the time diagram. We shall use the 4th year as the
focal date.

Step 3. Accumulate or discount the given amounts depending on its location in the time
diagram.

Accumulate P20, 000 at Accumulate P32, 500 at Discount P43, 817.37 at

n = 12. n = 4. n = -8.
F = P(1+i)N F = P(1+i)n F = P(1+i)n
= P20, 000(1+0.035)12 = P32, 500(1+0.035)4 = P43, 817.37(1+0.035)-8
= P30, 221.37 = P37, 294.50 = P33, 275.42