General Mathematics

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Simple and Compound Interest and Simple and General Annuities - Part 001

Simple and Compound Interest and Simple and

General Annuities – Part 001

This module tackles topics on Simple and Compound Interest as well as

Simple and General Annuities.
Course Module Objectives:
At the end of this module, the learner should be able to:
1. Illustrate simple and compound interests
2. Distinguish between simple and compound interests
3. Compute interest, maturity value, future value, and present value in simple
interest and compound interest environment
4. Solve problems involving simple and compound interests
5. Illustrate simple and general annuities

Recall the time when you opened a savings account. Why did you start
saving? Why is it advisable to start saving early?

Simple and Compound Interest

Interest

What is Interest?

Interest, in business context, is a fraction or a percentage being imputed to a

sum of money. Simply put, interest is money that you earn after a certain
period of your money being in a bank for safekeeping.

Before going into further discussion, let us first know some basic
terminologies you will encounter during the course.

1. Principal – this is the original amount borrowed or invested.

2. Time / Term – the amount of time (normally in years) that the money
is borrowed or invested.

3. Rate – the interest rate that determines the amount of money the
money will earn.

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 4. Lender or Creditor – the person (or institution) who has money to
invest or make available to people who needs to borrow.

5. Borrower or Debtor – the person (or institution) who borrows money

or manages the investment of creditors.

There are two types of Interests that will be discussed in this module. The
Simple Interest and the Compound Interest.

Illustratively, one can see the difference between the two types by analyzing
the computed interest for the same principal amount.

Example 1: Suppose you want to borrow money from your friend to buy a gift
for your mother who is celebrating her birthday in a week. Your friend
agreed to lend you Php 3,000.00 payable in 3 months with 3% interest per
annum (Simple Interest).

After 3 months, you need to pay Php 3,022.50 to your friend. The interest for
the money is Php 22.50 for 3 months.
Example 2: Given the same situation with problem #1 but the rate is 3% per
annum compounded monthly.
After 3 months, you will need to pay your friend Php 3,022.56. (Check
computation below)

The two situations provide the same given except for the rate and type of
interest computation.

What is Simple Interest?

Simple interest is the amount of money imputed to a principal amount using

the formula:

where:

Going back to the first example, the computation is as follows:

Given:
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Simple and Compound Interest and Simple and General Annuities - Part 001

First thing to consider here is to make sure that the unit of the term and the
rate are the same. In this case, rate is in years and term is in months. You
need to convert one of the values first before you may use the values for
computation.

Converting 3 months to years:

( )

Plugging the values to the equation:

What is Compound Interest?

Compound interest is similar to the simple interest. The compound interest,

however, rolls over the interest earned or charge for the next cycle of
computation. In this regard, the principal amount grows as the interest
earned for previous cycle is added to the principal of the next.

Going back to previous example:

For the initial computation, you need to divide the annual rate of 3% by 12 to
obtain the interest rate per month. Interest rate is 0.25% per month. Using
this value, you may compute for the interest of the principal amount for the
first month. ( ) The interest Php 7.50 is
added to the principal for the second month so it becomes Php 3,007.50
( ). Interest is again computed using the new
principal amount. ( ). This cycle continues
until the end of the term.
A formula can be derived from how compounded interests are computed.
Compound interest can be computed as follows:

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 ( )
where:

Applying the formula to the given example:

Future value (FV) is the sum of the principal and the simple interests earned.

( )

For compound interest, we often encounter the idea of a nominal interest and
an effective interest. The nominal interest is the equivalent of a simple
interest computation for the interest rate given for compound interest
transactions. Effective interest, on the other hand, is the true percentage of
change based on the compounding nature of the loan / investment.

Maturity Value, Future Value, and Present Value

Maturity Value is the amount to be paid to the lender / creditor at the end of
the term.
Future Value is the sum to which the principal grows by a specified future
date.
Present Value refers to the value of the debt or investment at present day.
In business context, maturity value and future value are technically the same.
In most cases, maturity value is used in insurance and bonds while future
value is used for investments and deposits.

For Simple Interest

To compute for the Maturity, Future and Present Value of a loan or debt, you
need to use the formula:

where:
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Simple and Compound Interest and Simple and General Annuities - Part 001

The future value of the investment is the sum of the principal amount and the
simple interest.
Example 3: If you are targeting a total future value of Php 250,000.00, how
long should you invest Php 100,000.00 at 15% interest rate per annum?

For Compound Interest

The computation for maturity value, future value and present value is given
by the formula:

( )

where:

To compute for the present value of an investment / loan, you need to

manipulate the equation given to isolate P.

( )
Example 4: What should be the present value of an investment that is worth
Php 1,000,000.00 in 3 years in an interest rate of 3% per annum
compounded twice a year?

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Applying the formula:

( )

( )

Simple and General Annuities

What is Annuity?

Annuity refers to a deposit / investment agreement between a depositor and

a financial institution that promises to pay out a steady amount of money
over a term.
The term annuity was derived from the Latin word annuus meaning annual.
In the Philippines, annuity can be seen in different forms from the simple
agreement between friends to the complex transactions done in banks and
financial institutions.
Paluwagan is a simple concept of having payments made in a fixed term.
Depending on the agreements among members of the group, the paluwagan
may pay lump sums per month or per year. In some instances, Paluwagan
organizers pay twice a year.
There are two types of annuity:
1. Simple Annuity
2. General Annuity

Simple Annuity

Simple annuity is where compounding and payment period happen at the

same time.
A good example of a simple annuity is the paluwagan Filipinos are fond of
organizing.

General Annuity

General annuity is where the payment is not the same as the interest
compounding period.
An example of a general annuity is an life insurance policy availed by
individuals as investment for their retirement.
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Simple and Compound Interest and Simple and General Annuities - Part 001

Activities and Exercises

Interview your parents on investments they have made. Have them explain
to you what the terms of their investments are. Take note of the terms they
use and hold on to those information for further discussion in class.

References
Albay, Eduard M., et al., (2016). General Mathematics. Makati City: Diwa
Learning Systems, Inc.

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