Math 2701 - Week 1 - Simple and Compound Interest

Math2701:
Financial
Mathematics I
Ms Sekayi Campbell
Office: Math Dept, Room 10
Office Hours: Mon 4-5, Wed 1-2
Purpose of Course
Explore and apply selected mathematical
techniques that form the basis of Finance
Structure of Course
Date
Activity
September 3
Simple & Compound Interest/Discount
September 10
Present Value; Accumulated Value
September 17
Equivalent Interest Measures
September 24
Annuities Immediate/Due; Graded

Assignment (5%)
October 1
Deferred Annuities
October 8
Annuities Convertible m-thly
October 15
National Heroes Day - No lecture
October 22
Arithmetic/Geometric Annuities
October 29
Test (15%)
November 5
Loans
November 12
Stocks, Bonds
November 19
Revision
November 26
Revision; Graded Assignment

(5%)
Rules
To not disturb others, please:
Silence cell phones
Enter and leave the lecture theatre quietly,
especially if arriving after the session has begun.
Yield the floor to the speaker.
Interest
Interest is a compensation fee paid by a borrower
to the lender.
List a few reasons that a lender may demand this
compensation fee.
Interest
For todays lecture, let us assume that you are
investing money (perhaps in a bank account.)
Interest is paid to you once per year.
Simple Interest
Principal = A(0)
Interest rate charged each period = i
The interest rate is applied to the principal only
each period. Therefore the interest amount
earned each period = iA(0)
Simple Interest (Example)

You have invested $1000 for 5 years and are earning
4% simple interest. How much interest would be
earned each period? What will the amount in the
account grow to after 5 years?

Year
Interest
Amount
1,000

Year
Interest
Amount
1,000
4% * 1000 = 40 1,040
4% * 1000 = 40 1,040+40 =
1,080
4% * 1000 = 40 1,120
4% * 1000 = 40 1,160
4% * 1000 = 40 1,200
Simple Interest
At time t, the amount in the account will grow to
A(t) = A(0) (1 + it)
Compound Interest
Principal - P
Interest rate charged each period - i
The interest rate is applied to principal AND to the
interest earned up to that point. Therefore the
interest amount earned each period increases
over time.
Compound Interest
(Example)
You have invested $1000 for 5 years and are earning
4% compound interest. How much interest would be
earned each period? What will the amount in the
account grow to after 5 years?
Compound Interest
(Example)
Year
Interest
Amount
1,000
Compound Interest
(Example)
Year
Interest
Amount
1,000
4% * 1000.00 =
40
1,040
4% * 1040.00 =
41.60
1,040.00+41.60 =
1,081.60
4% * 1081.60 =
43.26
1,081.60+43.26=11
24.86
4% * 1124.86=
44.99
1,169.86
4% * 1169.86=
46.79
1,216.65
Compound Interest
At time t, the amount in the account will grow to
A(t) = A(0) (1 + i)t
Simple Interest vs Compound

Interest
In the previous examples, after 5 years the
amount in the account had grown to $1,200 under
simple interest and $1,216.65 under compound
interest.

Interest
If you intend to leave $1,000 in an account for 5
years, would you rather invest at 4% simple
interest or compound interest?
What about if you intended to leave the money in
the account for 1 year?
What about 6 months?

Interest
Under Simple
Interest,
A(t) = A(0)*(1 +
it)
Under Compound
Interest,
A(t) = A(0)*(1+i)t
5 years
1,200.00
1,216.65
1 year
1,040.00
1,040.00
6
months
1,020.00
1,019.80

Interest
Note that:
For periods less than 1 year, the accumulated value
in the account is higher under simple interest.
For periods greater than 1 year, the accumulated
value in the account is lower under compound
interest.
At 1 year, both values are the same.
Discount Rate
At times, a bank may quote a discount rate
instead of an interest rate.
Interest Rate vs Discount

Rate
10% interest
Now: deposit 1000
In 1 year: withdraw 1000 + 100 = 1100
(interest is paid at the end)
10% discount
Now: deposit 900
In 1 year: withdraw 1000
(interest is paid at the beginning)
Simple Discount
A(t) = A(0) (1 - dt)-1
Discount (Example)
You have invested $1000 for 5 years and are
earning 4% simple discount. What will this
amount accumulate to after 5 years?
Discount (Example)
A(t) = A(0) (1 - dt)
At time t = 5, the amount invested will accumulate
to
1000(1 5 * 0.04)-1 = 1000(1 0.20)-1 = 1,250.00
Compound Discount
A(t) = A(0) (1 - d)-t
Discount (Example)
You have invested $1000 for 5 years and are
earning 4% compound discount. What will this
amount accumulate to after 5 years?
Discount (Example)
A(t) = A(0) (1 - d)-t
At time t = 5, the amount invested will accumulate
to 1000(1 0.04)-5 = 1,226.43

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Math2701:

Simple & Compound Interest/Discount

Present Value; Accumulated Value

Equivalent Interest Measures

Annuities Immediate/Due; Graded

Annuities Convertible m-thly

National Heroes Day - No lecture

Revision; Graded Assignment

Simple Interest (Example)

Simple Interest (Example)

Simple Interest (Example)

Simple Interest vs Compound

Simple Interest vs Compound

Simple Interest vs Compound

Simple Interest vs Compound

Interest Rate vs Discount

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