MODULE WEEK NO.3 and NO.

Pamantasan ng Lungsod ng Maynila

Gen. Luna corner Muralla St., Intramuros, Manila
Philippines 1002
(+63 2) 8 643-2500

College/Department
COURSE CODE: Mathematics of Investment
Semester of A.Y. 2020-2021

Introduction

This module focuses on the important concepts of compound interest. Compound interest has its
own advantage especially on savings and investment while it can be a disadvantage when you pay
interest on a loan.

Rationale
COURSE MODULE

The purpose of this module is to prepare the students in understanding the importance and take
advantage of compound interest.

Intended Learning Outcomes

A. Explain the Basic Concept of Compound Interest

B. Use the Compound Interest formula to calculate the Present and Maturity Value
C. Use the Compound Interest formula to calculate Interest, Interest Rate, and Time Period
D. Differentiate Nominal and Effective Rates
E. Compute the economically equivalent payment or any value date, of a specified payment
given the interest rate that money can earn.
Activity

1. Quiz No. 2
2. Presentation of Module Week 3
3. Presentation of Module Week 4 and Chapter End Activities.

Discussion

Engage:

1. Who benefits from compounds interest?

2. Can compound interest make you rich?

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 MODULE WEEK NO.3 and NO.4

Explain:

3.1 The Basic Concept of Compound Interest

Sirug W. (2014). Compound Interest is the procedure in which interest is periodically calculated and
added to the principal. The time interval between succeeding interest calculations is called conversion
period (compounding period or interval period).

The interest earned during a period is “converted” to principal at the end of the period because the
principal and the interest are combined and treated as the new principal for the succeeding period. The
effect of converting interest to principal id that the interest earned in a period will also learned interest
in all succeeding periods.
COURSE MODULE

Borad S. (2020). Compound Interest is interest calculated on the amount that includes the principal
plus accumulated interest of the previous period. The interest calculation for the next period/new year
happens on the principal plus accrued interest until the beginning of the year/period. This process
continues until the tenure of the loan. It is also called as interest on interest because interest calculation
happens on compounded principal amount (principal + interest).

The compound frequency (conversion frequency) is the number of compounding that take place in a
year. The common compounding or conversion frequencies and the corresponding compounding or
conversion periods encountered are listed below.

Compounding or Conversion No. of Compounding or Compounding or Conversion

Frequency Conversions Per Year Periods
Annual 1 1 year
Semiannual 2 6 months
Quarterly 4 3 months
Bimonthly 6 2 months
Monthly 12 1 month

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 MODULE WEEK NO.3 and NO.4

The nominal interest is the stated annual interest rate on which the compound interest calculation is
based. The periodic interest rate is the rate of interest earned in one conversion period.

The following variables will be used in solving compound interest:

P = Principal amount loan or investment

j = Nominal interest rate
m = Number of conversions per year
t = Time period (term) of the loan or investment
i = Periodic interest rate
I = Amount of interest paid or received
COURSE MODULE

F = Maturity value of the loan or investment

The formula for the maturity value of a compound interest will be derived. The symbol P and F are
again used to represent the principal ad amount of maturity of loan or investment. The general problem
is to determine the maturity value at the end of n conversion periods if periodic interest at the rate i is
earned each period.

With the compound interest, interest is added to the principal at the end of each conversion period.
Therefore, we will obtain a larger principal at the beginning of every successive period. Our first
approach will be to work through the accumulation of principal and interest one period at a time.

Combined principal and interest at the end of any period becomes the new beginning principal for the
next period.

Maturity value (F1) after the first period, where P is the Principal:

F1 = P + I = P + iP = P (1+i)

Maturity value (F2) after the second period, where P + i or F1 is the new Principal:

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 MODULE WEEK NO.3 and NO.4

F2 = [P(1+i)] (1+i) = P (1+i)2

Maturity value (F3) after the second period, where P + i or F1 is the new Principal:

F3 = [P(1+i)]2 (1+i) = P (1+i)3

After all the conversions the maturity value will be:

Fn = [P(1+i)] n-1 (1+i) = P (1+i)n or simply F = P (1+i)

We can also view the derivation of the compound interest formula in a tabular presentation as shown
COURSE MODULE

below:

Period Present worth of the Future worth of the Maturity

Principal Amount (P) Value (F)
1 P P (1 + i)
2 P (1 + i) P (1 + i) (1 + i) = P (1 + i)2
3 P (1 + i)2 P (1 + i)2 (1 + i)1 = P (1 + i)3
4 P (1 + i)3 P (1 + i)3 (1 + i)1 = P (1 + i)4
n-1 P (1 + i)n-2 P (1 + i)n-2 (1 + i) = P (1 + i)n-1
n P (1 + i)n-1 P (1 + i)n-1 (1 + i) = P (1 + i)n

The following equation will be used in solving compound interest:

𝑭 = 𝑷 (𝟏 + 𝒊) 𝒏 Equation 3.1
𝑭
𝑷 = (𝟏+𝒊) 𝒏 or 𝑷 = 𝑭 (𝟏 + 𝒊)−𝒏 Equation 3.2

𝑰=𝑭− 𝑷 Equation 3.3

𝒏 𝑭
𝒋 = 𝒎 ( √𝑷 − 𝟏) Equation 3.4

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 MODULE WEEK NO.3 and NO.4

𝒍𝒐𝒈 𝑭/𝑷
𝒕= Equation 3.5
𝒎 [𝒍𝒐𝒈 (𝟏+𝒊)]

𝒋 m
𝒓 = (𝟏 + 𝒎
) -1 Equation 3.6

𝒎
𝒋 = 𝒎( √𝟏 + 𝒓 − 𝟏) Equation 3.7

P = Fe-jt Equation 3.8

F = Pejt Equation 3.9

COURSE MODULE

r = ej – 1 Equation 3.10

𝒍𝒐𝒈 (𝟏+𝒓)
𝒋= Equation 3.11
𝒍𝒐𝒈 𝒆

𝒍𝒐𝒈 𝑭/𝑷
𝒋= Equation 3.12
𝒕 𝒍𝒐𝒈 𝒆

𝒍𝒐𝒈 𝑭/𝑷
𝒕= Equation 3.13
𝒋 𝒍𝒐𝒈 𝒆

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 MODULE WEEK NO.3 and NO.4

Comparison between Simple and Compound Interest

Simple Interest Characteristics Compound Interest
✓ Principal ✓
Expressed in units of time Time Expressed as the number of
(days, months, or year) times that interest is calculated
Per unit of time Interest Rate Per calculation of interest
(days, months, or year)
At the end of the transaction’s When Interest is Placed into With every calculation of
time frame Account interest

3.2 Computing the Maturity Value

COURSE MODULE

In this section we will used the Equation 3.1 in computing maturity value.

Maturity Value F = P(1+i)n

Where:

F = maturity value of the loan or investment

P = principal amount of the loan or investment

t = time period (term) of the loan or investment

m = number of conversions per year

n = conversion period

j = nominal interest rate

i = periodic interest rate

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 MODULE WEEK NO.3 and NO.4

Example 1: What will be the maturity value of Php 12,000 invested for 4 years at 15%
compounded quarterly?

Solution: Given: P = Php 12,000 t = 4 years j = 15% or 0.15

m=4 n = tm = 4(4) = 16 i = j/m = 0.15/4 = 0.0375

𝑭 = 𝑷 (𝟏 + 𝒊) 𝒏
= 12,000 (1 + 0.0375)16
= 12,000 (1.0375)16
= 12,000 (1.802227807)
= Php 21,626.73368 or Php 21,626.73
COURSE MODULE

The investment will grow to Php 21,626.73 after 4 years.

Example 2: Determine the maturity value of Php 3,000 invested for 3 ½ years at 9.5%
compounded semiannually?

Solution: Given: P = Php 3,000 t = 3.5 years j = 9.5% or 0.095

m=2 n = tm = 3.5(2) = 7 i = j/m = 0.095/2 = 0.0475

𝑭 = 𝑷 (𝟏 + 𝒊) 𝒏
= 3,000 (1 + 0.0475)7
= 3,000 (1.0475)7
= 3,000 (1.383815598)
= Php 4,151.446793 or Php 4,151.45

The maturity value amount will be Php 4,151.45 after 3 ½ years.

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 MODULE WEEK NO.3 and NO.4

3.3 Computing the Principal Amount

In this section we will used the Equation 3.2 in computing the value of principal amount.

Principal Amount

𝑭
𝑷= or 𝑷 = 𝑭 (𝟏 + 𝒊)−𝒏
(𝟏+𝒊)𝒏
COURSE MODULE

Where:

P = principal amount of the loan or investment

F = maturity value of the loan or investment

t = time period (term) of the loan or investment

m = number of conversions per year

n = conversion period

j = nominal interest rate

i = periodic interest rate

i = periodic interest rate

Example 1: What amount must be invested now in a savings account earnings 9%

compounded quarterly to accumulate a total of Php 21,000 after 4 ¾ years?

Solution: Given: F = Php 21,000 t = 4.75 years j = 9% or 0.09

m=4 n = tm = 4.75(4) = 19 i = j/m = 0.09/4 = 0.0225

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 MODULE WEEK NO.3 and NO.4

𝑭
𝑷=
(𝟏+𝒊)𝒏
21,000
=
(1+0.0225)19
21,000
=
(1.0225)19
21,000
=
1.526170367
= 𝑷𝒉𝒑 𝟏𝟑, 𝟕𝟓𝟗. 𝟗𝟑𝟏𝟔𝟗𝟏 𝒐𝒓 𝑷𝒉𝒑 𝟏𝟑, 𝟕𝟓𝟗. 𝟗𝟑

A total of Php 13,759.93 must be invested now to accumulate Php 21,000 after 4 ¾ years.
COURSE MODULE

Example 2: Find the present value of Php 8,500 due in 5 years if money is worth 12%
compounded semiannually?

Solution: Given: F = Php 8,500 t = 5 years j = 12% or 0.12

m=2 n = tm = 5(2) = 10 i = j/m = 0.12/2 = 0.06

𝑷 = 𝑭 (𝟏 + 𝒊)−𝒏
= 8,500 (1 + 0.06)−10
= 8,500 (1.06)−10
= 8,500 (0.5583947769)
= 𝑷𝒉𝒑 𝟒, 𝟕𝟒𝟔. 𝟑𝟓𝟓𝟔𝟎𝟒 𝒐𝒓 𝑷𝒉𝒑 𝟒, 𝟕𝟒𝟔. 𝟑𝟔

The present value amount will be Php 4,746.36.

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 MODULE WEEK NO.3 and NO.4

3.4 Computing the Compound Interest

In this section we will used the Equation 3.1, and Equation 3.3 in computing the compound interest.

Future Value 𝑭 = 𝑷 (𝟏 + 𝒊)𝒏 and 𝑰 = 𝑭 − 𝑷

Where:
COURSE MODULE

I = amount of interest paid or received

F = maturity value of the loan or investment

P = principal amount of the loan or investment

t = time period (term) of the loan or investment

m = number of conversions per year

n = conversion period

j = nominal interest rate

i = periodic interest rate

Example 1: Find the interest earned at the end of 4 years if Php 36,700 is invested at 12%
compounded bimonthly?

Solution: Given: P = Php 36,700 t = 4 years j = 12% or 0.12

m=6 n = tm = 4(6) = 24 i = j/m = 0.12/6 = 0.02

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 MODULE WEEK NO.3 and NO.4

𝑭 = 𝑷 (𝟏 + 𝒊) 𝒏
= 36,700 (1 + 0.02)24
= 36,700 (1.02)24
= 36,700 (1.608437249)
= Php 59,029.64706 or Php 59,029.65

Then we can compute for the I using Equation 3.3

I=F-P
= 59,029.65 + 36,700
COURSE MODULE

= Php 22,329.65

The interest earned is Php 22,329.65.

Example 2: Denise paid Php 8,600 on a loan made 2 years before at 6% compounded
bimonthly, Find the interest generated?

Solution: Given: F = Php 8,600 t = 2 years j = 6% or 0.06

m=6 n = tm = 2(6) = 12 i = j/m = 0.06/6 = 0.01

𝑷 = 𝑭 (𝟏 + 𝒊) −𝒏
= 8,600 (1 + 0.01)-12
= 8,600 (1.01)-12
= 8,600 (0.8874492253)
= Php 7,632.063337 or Php 7,632.06

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 MODULE WEEK NO.3 and NO.4

Then we can compute for the I using Equation 3.3

I=F-P
= 8,600 - 7,632.06
= Php 967.9366627 or Php 967.94

Denise’s loan earned an interest of Php 967.94.

COURSE MODULE

3.5 Computing the Compound Interest Rate

In this section we will derive the formula of nominal rate j in the compound interest formula. We
will start the derivation using Equation 3.1 in computing the compound interest rate.

𝑭 = 𝑷 (𝟏 + 𝒊)𝒏
𝒋
𝑭 = 𝑷 (𝟏 + 𝒎)𝒏 replace i by j/m.
𝑭 𝒋
= (𝟏 + 𝒎)𝒏 divide both sides by P.
𝑷

𝒏 𝑭 𝒋
√ = (𝟏 + ) extract the n root of both sides.
𝑷 𝒎

𝒏 𝑭 𝒋
√ −𝟏= subtract both sides by 1.
𝑷 𝒎

𝒏 𝑭
𝒎 ( √𝑷 − 𝟏) = 𝒋 multiply both sides by m.

𝒏 𝑭
𝒋 = 𝒎 ( √ − 𝟏) Equation 3.4
𝑷

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 MODULE WEEK NO.3 and NO.4

Example 1: The maturity value of a five year, Php 7,000 compound-interest investment
certificate was Php 9,427.99. What quarterly compounded nominal interest rate did the
investment certificate earn?

Solution: Given: F = Php 9,427.99 P = Php 7,000 t=5 m=4 n = tm = 5(4) = 20

𝒏 𝑭
𝒋 = 𝒎 ( √𝑷 − 𝟏)

20 9,427.99
= 4( √ − 1)
7,000
COURSE MODULE

20
= 4 ( √1.346855714 − 1)

= 4 (1.015000027 − 1)
= 4 (0.01500002666)
= 𝟎. 𝟎𝟔 𝒐𝒓 𝟔%

The nominal rate is 6% compounded quarterly.

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 MODULE WEEK NO.3 and NO.4

Example 2: The maturity value of a six year, Php 16,000 compound-interest was 24,177.10.
What semiannually compounded rate of return will she earn on her investment?

Solution: Given: F = Php 24,177.10 P = Php 16,000 t=6 m=2 n = tm = 6(2) = 12

𝒏 𝑭
𝒋 = 𝒎 ( √ − 𝟏)
𝑷

12 24,177.10
= 2( √ − 1)
16,000
COURSE MODULE

12
= 2 ( √1.51106875 − 1)
= 2 (1.035000005) − 1
= 2 (0.03500000529)
= 𝟎. 𝟎𝟕 𝒐𝒓 𝟕%
The compounded rate is 7%.

3.6 Computing the Time Period

In this section we will derive the formula of time period t in the compound interest formula. We will
start the derivation using Equation 3.1 in computing the value of time period.

𝑭 = 𝑷 (𝟏 + 𝒊)𝒏
𝑭 = 𝑷 (𝟏 + 𝒊)𝒕𝒎 replace n by tm.
𝒍𝒐𝒈 𝑭 = 𝒍𝒐𝒈 (𝟏 + 𝒊)𝒕𝒎 apply the logarithm both sides.
𝒍𝒐𝒈 𝑭 = 𝒕𝒎 𝒍𝒐𝒈 (𝟏 + 𝒊) let tm be the base multiplier of log (1+i).
𝒍𝒐𝒈 𝑭
=𝒕 divide both sides by m log (1+i)
𝒎 𝒍𝒐𝒈 (𝟏+𝒊)

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 MODULE WEEK NO.3 and NO.4
𝒍𝒐𝒈 𝑭/𝑷
𝒕=
𝒎 [𝒍𝒐𝒈 (𝟏 + 𝒊)]

Example 1: How long will it take an investment earning 18% compounded monthly to double
in value?

Since the principal will be double in value after the investment period, we can say that P=1 and
F = 2.

Solution: Given: F=2 P=1 j = 18% or 0.18 m = 12 i = j/m = 0.18/12 = 0.015

𝒍𝒐𝒈 𝑭/𝑷
𝒕=
𝒎 [𝒍𝒐𝒈 (𝟏+𝒊)]
COURSE MODULE

log 2/1
=
12 [log (1+0.015)]
log 2
=
12 [log (1.015)]
0.3010229957
= 12 (0.006466042]

0.3010229957
= 0.07759250699
= 3.879536423 or 3.88 years

The total time is 3.88 years.

Example 2: When is Php 6,000 due if its present value of Php 5,000 is invested at 2%
compounded annually.

Solution: Given: F = Php 6,000 P = Php 5,000 j = 2% or 0.02

m=1 i = j/m = 0.02/1 = 0.02

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 MODULE WEEK NO.3 and NO.4

𝒍𝒐𝒈 𝑭/𝑷
𝒕=
𝒎 [𝒍𝒐𝒈 (𝟏+𝒊)]

log 6,000/5,000
=
1 [log (1+0.02)]
log 1.2
=
1 [log (1.02)]
0.07918124605
=
1 (0.008600171762)
0.07918124605
=
0.008600171762
= 9.20693775 𝑜𝑟 9.21 𝑦𝑒𝑎𝑟𝑠
COURSE MODULE

The amount will due after 9.21 years.

3.7 Computing the Comparison of Nominal and Effective Rates

Nominal interest rate is also defined as a stated interest rate. This interest works according to the
simple interest and does not take into account the compounding periods.

Effective interest rate is the one which caters the compounding periods during a payment plan. It is
used to compare the annual interest between loans with different compounding periods like week,

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 MODULE WEEK NO.3 and NO.4
month, year etc. In general, stated, or nominal interest rate is less than the effective one. And the later
depicts the true picture of financial payments.

Nominal interest rates are not comparable unless their compounding periods are the same; effective
interest rates correct for this by "converting" nominal rates into annual compound interest. In many
cases, depending on local regulations, interest rates as quoted by lenders and in advertisements are
based on nominal, not effective interest rates, and hence may understate the interest rate compared to
the equivalent effective annual rate.

Example 1: Find the effective rate equivalent to 17% compounded bimonthly?

Solution: Given: j = 17% or 0.17 m=6

𝒋 m
𝒓 = (𝟏 + ) - 1
COURSE MODULE

0.17 6
= (1 + 6
) - 1

= (1 + 0.028333333)6 - 1

= (1.028333333)6 - 1

= 1.182506351 - 1

= 0.182506351 or 18.25%

The effective interest rate is equivalent to 18.25% compounded bimonthly.

Example 2: Find the effective rate equivalent to 15% compounded quarterly?

Solution: Given: j = 15% or 0.15 m=4

𝒋 m
𝒓 = (𝟏 + 𝒎
) - 1

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 MODULE WEEK NO.3 and NO.4
0.15 4
= (1 + 4
) - 1

= (1 + 0.0375)4 - 1

= (1.0375)4 - 1

= 1.158650415 - 1

= 0.158650415 or 15.87%

The effective interest rate is equivalent to 15.87% compounded quarterly.

COURSE MODULE

Example 3: What rate converted bimonthly is equivalent to an effective rate of 11%?

Solution: Given: r = 11% or 0.11 m=6

𝒎
𝒋 = 𝒎( √𝟏 + 𝒓 − 𝟏)

6
= 6( √1 + 0.11 − 1)
6
= 6( √1.11 − 1)
= 6(1.017545481 − 1)
= 6(0.017545481)
= 0.1052728847 or 10.53%
Nominal rate of 10.53% converted bimonthly is equivalent to 17% effective rate.

Example 4: What rate converted semi-annually is equivalent to an effective rate of 7%?

Solution: Given: r = 7% or 0.07 m=2

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 MODULE WEEK NO.3 and NO.4
𝒎
= 𝒎( √𝟏 + 𝒓 − 𝟏)

2
= 2( √1 + 0.07 − 1)
2
= 2( √1.07 − 1)
= 2(1.034408043 − 1)
= 2(0.03440804328)
= 0.06881608656 or 6.88%

Nominal rate of 6.88% converted semi-annually is equivalent to 7% effective rate.

COURSE MODULE

3.8 Computing the Continuous Compounding

Continuously compounded interest is interest that is compounded an infinite number of times per
year on a particular investment for a specific number of years. This would mean that an investment
with an infinite number of compounding will produce an infinitely large balance at the end of the
investment period.

Example 1: To put a fund of Php 46,000 in 5 years and 3 months, how much must be invested
at 17% compounded continuously?

Solution: Given: F = Php 46,000 j = 17% or 0.17 t = 5 years and 3 months or 5.25

P = Fe-jt

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 MODULE WEEK NO.3 and NO.4
-0.17(5.25)
= 46,000e
= 46,000e-0.8925
= 46,000(0.4096303956)
= Php 18,842.9982 or 18,843

The investment should be Php 18,843.

Example 2: Danny deposited Php 6,300 in a commercial bank paying 12% compounded
continuously? How much would he have at the end of 5 years?

Solution: Given: P = Php 6,300 j = 12% or 0.12 t = 5 years

COURSE MODULE

F = Pejt
= 6,3000.12(5)
= 6,300e0.60
= 6,300(1.8221188)

= Php 11,479.34844 or 11,479.35

Danny will accumulate Php 11,479.35 after 5 years.

Example 3: What is the effective rate that corresponds to a nominal rate of 8.5% compounded
continuously?

Solution: Given: j = 8.5% or 0.085

r = ej – 1

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 MODULE WEEK NO.3 and NO.4
.0.085
=e -1
= 1.088717067 - 1
= 0.0887170667 or 8.87%

8.5% nominal rate is equivalent to 8.87% effective rate.

Example 4: Find the nominal rate compounded continuously which is equivalent to 15%
effective rate?

Solution: Given: r = 15% or 0.15

COURSE MODULE

𝒍𝒐𝒈 (𝟏+𝒓)
𝒋=
𝒍𝒐𝒈 𝒆
𝑙𝑜𝑔 (1+0.15)
=
𝑙𝑜𝑔 𝑒
log (1.15)
=
log e
log (1.15)
=
0.4342944819
0.06069784035
= 0.4342944819
= 0.1397619424 or 13.98%
The 15% effective rate is equivalent to 13.98% nominal rate.

Example 5: Find the nominal rate compounded continuously if Php 12,600 will amount to Php
25,400 in 4 years.

Solution: Given: P = Php 12,600 F = Php 25,400 t = 4 years

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 MODULE WEEK NO.3 and NO.4
𝒍𝒐𝒈 𝑭/𝑷
𝒋=
𝒕 𝒍𝒐𝒈 𝒆
𝑙𝑜𝑔 25,400/12,600
=
4 𝑙𝑜𝑔 𝑒
𝑙𝑜𝑔 2.015873016
=
4 (0.4342944819)
0.3044631715
=
1.737177928
= 0.17526309 𝑜𝑟 17.53%
The nominal rate is equivalent to 17.53%

Example 6: When will Php 15,700 increased by Php 3,400 if money is worth 17% compounded
continuously?
COURSE MODULE

Solution: Given: P = Php 15,700 I = Php 3,400 j = 17% or 0.17

F = P + I = 15,700 + 3,400 = 19,100

𝒍𝒐𝒈 𝑭/𝑷
𝒕=
𝒋 𝒍𝒐𝒈 𝒆
𝑙𝑜𝑔 19,100/15,700
=
0.17 𝑙𝑜𝑔 𝑒
𝑙𝑜𝑔 1.21656051
=
0.17 (0.4342944819)
0.0851337484
= 0.07383006192
= 1.153104118 𝑜𝑟 1.15 𝑦𝑒𝑎𝑟𝑠
It would need 1.15 years for Php 15,700 to increase by Php 3,400.

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