Mathematics of Finance

Mathematics of Finance
Simple Interest and the future value
I = Pin
where, I = interest, in dollar
P = principal amount
i = interest rate
n = number of years
Find the interest on $1,460 for 72 days at 10% interest .
I = Pin
I=?
P = principal amount = $1,460
i = interest rate = 10% = 0.1
n = number of years = 72/360
I = $29.20
Future value: simple interest
F = P + Pin = P (1 + in)
Find the future value if $20,000 is invested at 6%

for 3 months.
F = 20,000 (1 + 0.6 x 0.25) = $20,300

here, i = 6/100 = 0.06, and n = 3/12 = 0.25
Present value: simple interest
we know, F = P + Pin = P (1 + in)

or, P = F / (1 + in)
Compound Interest
In general, FVn = PV (1 + i)n
Find the future value of $1000 at 7% per year for

10 years.
FV = 1000 ( 1 + 0.07) 10
= $1,967.15
FVn = PV (1 + i/m) n m
Find the future value of $500 at 8% compounded

quarterly for 10 years.
FVn = 500 (1 + 0.08/4)10 x 4
= $1,104.02
Finding the time and the interest rate:
At 8%compounded annually, how many years will it take

for $2000 to grow to $3000?
We know, FVn = PV (1 + i)n

i.e, 3000 = 2000 ( 1 + 0.08)n
or, 1.5 = ( 1 + 0.08)n
Taking log of both sides, Iog1.5 = Iog (1.08) n
Iog 1.5 = n (Iog1.08)
n = Iog 1.5 / Iog 1.08
n = 5.268
How many years will it take for $68.30 to grow to $100

at an interest rate of 10%?
Ans: 4 years
At what interest rate compounded annually will
a sum of money double in 10 years?
Let PV = $1, FV = $2
⇒ 2 = 1 (1+ i)10
⇒ 2 = (1+ i)10
⇒ 21/10 = 1 + i
⇒ 20.1 = 1 + i
⇒ 1.07177 = 1 + i
⇒ i = 0.07177 = 7.17%
What interest rate would cause $100 to grow to

$125.97 in 3 years?
Ans: 8%
Compound Discount, Present Value
As we know, FVn = PV (1 + i)n
⇒PV = FVn /(1 + i)n

What is the PV of $100 due in 3 years if

interest rate is 10%?
 1 
PV = $100  3
 (1.10) 
= $100(0.7513)= $75.13
Annuity: A series of payments of equal

amounts at fixed intervals for a specified
number of periods.
Ordinary (deferred) Annuity: An annuity

whose payments occur at the end of each
period.
Annuity Due: An annuity whose payments

occur at the beginning of each period.
Future value of an ordinary annuity
 n1 n  (1  i)n  1 
FVAn  PMT  (1  i)   PMT  
 t 0   i 
What’s the FV of a 3-year Ordinary Annuity

of $100 at 5%?
0 1 2 3
5%
100 100 100
105
110.25
FV = 315.25
 (1.05)  1 
3
FVA 3  $100 
 0.05 
 $100(3.15250)  $315.25
If $100 is deposited in an account at the end

of every quarter for the next five years, how
much will be in the account at the time of the
final deposit if interest rate is 8%
compounded quarterly?
Here, ‘i’ will be divided by 4 and ‘n’ will be

multiplied by 4.
 (1.02)  1 
20
FVA 5  $100 
 0.02 
 $100(24.29736982)  $2,429.74
Sinking fund
How much should be deposited in a sinking

fund at the end of each quarter for 5 years to
accumulate $10,000 if the fund earns 8%
compounded quarterly?
PMT = FVAn i / ((1 + i)n -1)
(Page 428)
Present value of an ordinary annuity
 n
1   1 - 1

PVAn  PMT  t
 PMT  (1 i) n

 t 1 (1  i)   i 
What is the PV of 3-year Ordinary

Annuity of $100 at 10%?
0 1 2 3
10%
100 100 100
90.91
82.64
75.13
248.69 = PV
1 - 1 3 
(1.10)
PVA 3  $100  
 0.10 
 
 $100(2.48685)  $248.69
Amortized Loans
• Amortized Loan: A loan that is repaid in equal

payments over its life
• Amortization tables are widely used for home

mortgages, auto loans, business loans, retirement
plans, and so forth to determine how much of
each payment represents principal repayment
and how much represents interest
As we know:
1 - (1 1i)n 
PVAn  PMT  
 i 
Or, PMT = PVAn i / 1- 1/ (1 + i)n

A company has borrowed $50,000 at 10%
compounded quarterly. The debt is to be
amortized by equal payments each quarter
over 15 years. Find the quarterly payment.
Page 435
Construct an amortization schedule for a

$1,000, 10 percent loan that requires
three equal annual payments.
YR Beg Bal PMT INT Prin PMT End Bal

1 $1000.00 $402.11 $100.00 $302.11 $697.89
2 697.89 402.11 69.79 332.32 365.57
3 365.57 402.11 36.56 365.55 0.02
Total 1,206.33 206.35 999.98 *

Mathematics of Finance

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Mathematics of Finance

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Mathematics of Finance

Simple Interest and the future value

Find the interest on $1,460 for 72 days at 10% interest .

Future value: simple interest

Find the future value if $20,000 is invested at 6%

F = 20,000 (1 + 0.6 x 0.25) = $20,300

Present value: simple interest

we know, F = P + Pin = P (1 + in)

In general, FVn = PV (1 + i)n

Find the future value of $1000 at 7% per year for

Find the future value of $500 at 8% compounded

FVn = 500 (1 + 0.08/4)10 x 4

Finding the time and the interest rate:

At 8%compounded annually, how many years will it take

We know, FVn = PV (1 + i)n

How many years will it take for $68.30 to grow to $100

What interest rate would cause $100 to grow to

Compound Discount, Present Value

As we know, FVn = PV (1 + i)n

⇒PV = FVn /(1 + i)n

What is the PV of $100 due in 3 years if

Annuity: A series of payments of equal

Ordinary (deferred) Annuity: An annuity

Annuity Due: An annuity whose payments

Future value of an ordinary annuity

What’s the FV of a 3-year Ordinary Annuity

100 100 100

If $100 is deposited in an account at the end

Here, ‘i’ will be divided by 4 and ‘n’ will be

How much should be deposited in a sinking

PMT = FVAn i / ((1 + i)n -1)

Present value of an ordinary annuity

What is the PV of 3-year Ordinary

100 100 100

• Amortized Loan: A loan that is repaid in equal

• Amortization tables are widely used for home

Or, PMT = PVAn i / 1- 1/ (1 + i)n

Construct an amortization schedule for a

YR Beg Bal PMT INT Prin PMT End Bal

2 697.89 402.11 69.79 332.32 365.57

3 365.57 402.11 36.56 365.55 0.02

Total 1,206.33 206.35 999.98 *

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