BATASAN HILLS NATIONAL HIGH SCHOOL

Math of
Investment

Name: Joana Lhyn A. Rudas

 Simple Interest
 Compound Interest
 Simple Annuity
 General Annuity
 Stocks & Bonds
 Simple Interest
Financial institutions borrow and lend money. When you deposit money into a savings account, you are lending the
financial institution money for a period of time. The financial institution pays you interest for borrowing your money. In
turn, the financial institution lends your money to individuals who need it. These individuals must pay interest for the
money they borrow. The interest rate they pay the financial institution is higher than the interest rate you receive from
the same institution. In this way, the financial institution earns a profit on these transactions.

Calculating Simple Interest

When you invest some money in a financial institution, the institution pays you interest for using your money. When you
borrow money from a financial institution, you pay interest to the institution. The mathematical formula for calculating
simple interest is:

I = Prt, where

I= interest
P= principal, which is the original amount invested or borrowed
r= annual (yearly) rate of interest expressed as a decimal
t= length of time expressed in years

Example #1:

Calculate the interest Olive will earn at the end of seven months.

Solution In the formula I= Prt, P = $1500, r = 4% or 0.04, and t = 7/12.

I=Prt

= 1500 x 0.04 x 7/12

=35

At the end of seven months, Olive will earn $35.

Using the Simple Interest Formula to find Principal, Rate, or Time

Not only can we use the formula I=Prt to calculate interest, but we can also use it to calculate the other variables in the
formula (principal, rate, and time). Using the Simple Interest Formula to find Principal, Rate, or Time Not only can we use
the formula I=Prt to calculate interest, but we can also use it to calculate the other variables in the formula (principal,
rate, and time).

To find the principal, divide the interest by the product of the rate and the time.
P = I / (r x t)

To find the rate, divide the interest by the product of the principal and time.
R=I/(Pxt)
 To find the time, divide the interest by the product of the principal and the time.
t=l/(Pxr)

Example #2:

Brooke Poole has $2400 to invest in a financial institution.

Calculate the annual rate of interest if she plans to earn $300 on her investment at the end of two years.

Solution I= $300, P = $2400, t = 2, r =?

r=1/(Pxt)

= 300 / (2400 X 2)

= 0.0625 or 6.25%

Brooke requires an annual rate of 6.25% if she wants to earn $300 on her investment at the end of two years.
 Compound Interest
An investment earns compound interest when the interest from each time period is added to the principal, and then
earns interest in the following time periods. As the principal grows, the rate at which you earn interest grows as well,
because you are earning "interest on interest." Compounding makes a significant difference in the final value of an
investment. Compounding increases the amount you earn when investing, but increases the costs when you borrow
money.

Comparing Simple Interest and Compound Interest

The following examples illustrate the difference between simple interest and compound interest. The first example
involves simple interest, whereas the second example involves compound interest.

Compound Interest Formula

Computing compound interest as you did in Example 2 is a lengthy procedure, especially as the length of time is
increased. You can set up a spreadsheet to do these calculations, but you may not always have access to a computer.
Fortunately, there is a formula for calculating compound interest, making the calculations less time-consuming.

The formula for computing compound interest is

Compound Interest Formula A =P(1 )11

where A = amount (original amount plus interest earned)

P = principal or amount invested in $ or the amount you are starting with

r = rate of interest in decimals (ex. 2% would be 0.02)

n = number of compounds per year (ex. how many times interest is calculated per year)

t = time in years the amount is left in the bank (ex. 6 months would be 0.5 years)

nt = n multiplied by t

Example :

Bry West invests $5000 in a financial institution at 6% per annum (simple interest).

Calculate his interest at the end of three years.

Solution In the formula 1= Prt, 1=?, P = $5000, r = 6% or 0.06, and t = 3.

I= Prt

= 5000 x 0.06 x 3

=900
At the end of three years, Miles earns $900 in interest.
 Simple Annuity
A simple annuity is defined as an investment vehicle designed to accept, grow and, upon annuitization, payout
a stream of income. Annuities are offered by insurance companies. The insurance company is in charge of
your money and is contractually obligated to see that you get paid the agreed upon amounts.

For you linguists out there the word annuity comes from the Medieval Latin word “annuitas,” meaning yearly or
year.

In short a specified amount of money that is paid during specific intervals. The amount depends on the type
of annuity and amount of funds you make available. Annuities are often a major part of retirement income
streams, providing dependable income.

You can receive a set monthly amount for the rest of your life if that is how you wish your annuity to be set up.
 General Annuity
A general annuity is an annuity where the payments do not coincide with the interest periods. You will be
able to see that it is very easy to deal with general annuities once an equivalent interest rate is determined
with that equivalent rate being compounded as often as the payments are made.
 Stocks & Bonds
Stocks Are Ownership Stakes; Bonds are Debt

Stocks and bonds represent two different ways for an entity to raise money to fund or expand their operations. When a
company issues stock, it is selling a piece of itself in exchange for cash. When an entity issues a bond, it is issuing debt
with the agreement to pay interest for the use of the money.

Stocks are simply shares of individual companies. Here’s how it works: say a company has made it through its start-up
phase and has become successful. The owners wish to expand, but they are unable to do so solely through the income
they earn through their operations. As a result, they can turn to the financial markets for additional financing. One way
to do this is to split the company up into “shares,” and then sell a portion of these shares on the open market in a
process known as an “initial public offering,” or IPO.

A person who buys a stock is, therefore, buying an actual share of the company, which makes him or her apart owner –
however small. It is why Stock is also referred to as “equity.”

Bonds, on the other hand, represent debt. A government, corporation, or other entity that needs to raise cash borrow
money in the public market and subsequently pays interest on that loan to investors. Each bond has a certain par value
(say, $1000) and pays a coupon to investors. For instance, a $1000 bond with a 4% coupon would pay $20 to the
investor twice a year ($40 annually) until it matures. Upon maturity, the investor is returned the full amount of his or her
original principal except for the rare occasion when a bond defaults (i.e., the issuer is unable to make the payment).