Simple and Compound Interest: Ryan Jeffrey P Curbano, PH.D

SIMPLE AND COMPOUND
INTEREST
Ryan Jeffrey P Curbano, Ph.D

Learning Objectives
• Perform calculations about interest rates.
• Calculate simple interest and compound
interest for one or more interest period.
INTEREST
• Interest – is the amount or money paid
for the use of borrowed capital.
– For the lender, interest is the income
produced by the money which he has lent.
• Simple Interest – interest on the
borrowed money, if the interest to be paid
is directly proportional to the length of
time the amount or principal is borrowed.
• Principal – is the amount of money
borrowed and on which interest is
charged.
• Rate of Interest – is the amount earned
by one unit of principal during a unit of
time.
Formula of Simple Interest
I = Pin
Where: I = total interest earned by the
principal.
P = amount of the principal
i = rate of interest expressed in
decimal form.
n = number of interest period.
• Total amount F to be repaid at the end of
the period
• Formula:
F=P+I
= P(1 + in)
Ordinary Simple Interest
• Ordinary simple interest – is computed

on the basis of one banker’s year, which is
1 banker’s year = 12 months, each
consisting of 30 days.
= 360 days
Exact Simple Interest
• Exact simple interest – is based on the
exact number of days, 365 for the
ordinary year and 366 days for the leap
year. The leap year are those which are
exactly divisible by 4 but excluding the
century years such as the years 1900,
2000
Formulas
• Ordinary Simple Interest
I = Pi (d/360)
• Exact Simple Interest
I = Pi(d/365) – ordinary year
I = Pi(d/366) – leap year
Where: d – is number of days
Example 1.0
• Determine the ordinary simple interest on
P10,000 for 9 months and 10 days if the
rate of interest is 12%
Example 2.0
• Determine the ordinary and exact interest
simple interest on P5,000 for the period
from Jan 15 to June 20, 1993, if the rate of
simple interest is 14%
Example 3.0
• Determine the exact and ordinary simple
interest on P1,200 for the period from Jan 16
to Nov. 26, 1992, if the rate of interest is
24%. Note the year 1992 is a leap year.
Example 4.0
• A P4,000 is borrowed for 75 days at 16%
per annum simple interest. How much will
be due at the end of 75 days?
Example 5.0
• A man deposit P 100,000 for one year which pays 6%
interest annually. He has a taxable income and the bank
charges a withholding tax of 20% incremental income tax
rate. Compute the after tax rate of return of his deposit.
Compound Interest
• Compound interest – interest earned by
the principal is not paid at the end of each
interest period, but is considered as added
to the principal and therefore will also earn
interest for the succeeding period
– Interest is much more than that earned by the
same principal when invested at simple
interest for the same period
Formulas
• Compound Interest, total amount paid at
the end of n period
n
F = P(1+i)
n
The factor (1+i) is called the “Single Payment
Compound Amount Factor” designated by
SPCAF = (F/P, i%, n)
Derivation of Formula of Future
Amount
Period Principa Interest Total Amount (Future)
l
1 P Pi P + Pi = P(1+i)
2 P(1+i) P(1+i) i P(1+i) + P(1+i) = P(1+i)²
3 P(1+i) ² P (1+i)² i P(1+i)²(1+i) = P(1+i)³

N P(1+i)ⁿ
• If r is the nominal annual interest rate and m
is the number of interest periods each year,
then the interest rate per interest period is
i = r/m, and the number of interest periods in
n years is mn
• Formula: Single payment compound amount
factor
mn
F = P(1 + r/m)
Continuous Compounding
• The number of interest period per year
without limit.
• Formula:
rn
F = Pe
where: e is the base of natural logarithm
Nominal Rate of Interest
• For the compound interest, the rate of
interest usually quoted is nominal rate if
interest which specifies the rate of interest
and the number of interest periods per
year.
• Example: a nominal rate of interest
compounded 8% quarterly, which means
rate per period is 8%/4 = 0.02
Effective Rate of Interest
• It is the actual rate of interest on the
principal for one year.
• It is equal to the nominal rate is interest is
compounded annually
• Greater than nominal rate if the number of
interest period per year exceeds one, such
as for interest compounded semi-annually,
quarterly or monthly
Formula
• Effective rate of interest
m
ER = (1 +i/m) - 1
r
ER = (e - 1)
Present Value
• Present value (P) is the amount which
when invested now will become F after n
periods.
• Formula:
P = F(1 + i) -or
n
= F or
(1+i) n
= F(P/F, i%, n)
Discount
• Discount on the negotiable paper is the
difference between what it is worth in the
future and its present worth.
Discount = Future value – Present
value
• Rate of discount (d)– is the discount on
one unit of principal per unit of time
DISCOUNT Formulas
• Rate of Discount (d)
d=1- 1 or i
1+i (1 + i)
• Rate of Interest given the discount
I= d
(1- d)
Example 1.0
• Find the present worth of the future
payment P300,000 to be made in 5 years
with an interest rate of 8% per annum
Example 2.0
• At certain interest rate compounded
quarterly, P1,000 will amount to P4,500 in
15 years. What is the amount at the end of
10 years?
Example 3.0
• Calculate the effective rate of interest corresponding to each of the
following rates.
– 9% compounded semi-annually
– 9% compounded quarterly
– 9% compounded bi-monthly
– 9% compounded monthly
– 9% compounded continously
Example 4.0
• An advertisement of an investment firm states that if you
invest P500 in their firm today you will get P1,000 at the
end of 4.5 years. What nominal rate is implied if interest
is compounded (a) quarterly (b) monthly? Determine also
the effective rate of interest in each case.
Example 5.0
• The present worth of several cash payments may be define as the
sum of the values of the future cash payment discounted at a given
rate for the corresponding period to the present. Find the present
value of installment payment of P1,000 now, P2,000 at the end of 1st
year, P3,000 at the end of 2nd year, P4,000 at the end of 3rd year
and P5,000 at the end of 4th year. Money is worth 10% compounded
annually.
Example 6.0
• How many years are required for P1,000 to
increase to P2,000 if invested at 9% per year
compounded (a) daily (b) continuously (c)
monthly
Example 7.0
• A man borrows money from the bank which uses a simple discount
rate of 14%. He signs a promissory note promising to pay P500 per
month at the end of 4th, 6th and 7th month respectively. Determine
the amount of money that he received from the bank?
Example 8.0
• Find the discount if P2,000 is discounted
for 6 months at 8% compounded quarterly.
Example 9.0
• A nominal interest of 3% compounded
continuously is given on the account. What is the
accumulated amount of P10,000 after 10 years?
Seatwork
• When will an amount be tripled with an interest
of 11.56%
• If P 5000 shall accumulate for 10 years at 8%
compounded quarterly. Find the compounded
interest at the end of 10 years
• P2000 was deposited on January 1, 2008 at an
interest rate of 24% compounded semi annually
How much would the sum be on Jan 1, 2013
• Convert 12% compounded semiannually to a
rate of compounded quarterly

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SIMPLE AND COMPOUND

Ryan Jeffrey P Curbano, Ph.D

• Ordinary simple interest – is computed

3 P(1+i) ² P (1+i)² i P(1+i)²(1+i) = P(1+i)³

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