Theory of Interest

MATH 253
By Daria Vyachkileva
Loans

Example. An 𝑛-year loan is repaid with equal payments made at the end of each year. The interest portion of the
payment made at time 𝑛 − 2 is equal to 0.5471 of the interest portion of the payment made at time 𝑛 − 5 and is also
equal to 0.2209 of the interest portion of the payment made at time 1. Calculate 𝑛.

Int+ = (1-vr-t +1) .

Pit

Intn-z =
(1-vx
-(n 2)-

+1) .
Pont = Pm+ (1 v3)
-

Intn-5 = Pm+ (1-v0

Int. = Pm+ (1 -

V")
In+ n.2
= 0.5471. Intn-5

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Loans

Example cont.

9(+ (1 -

w3) 0.5471.Pr/t(1 v)
=
-

v3
0.547)(1 v6)
=

x
1 - v =
-

v 0.9390
=

Intn-c = 0.2209 Int,

11-v3)Pmt 0.2209.
=

Pot (1-rY)
0.1722
0.2209(1- v)
=

v =

0.2205 =)n+ 205) 24

=

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Loans

Example. A 20-year loan of 𝐿 is repaid with level annual payments at the end of each year. The interest paid in the 1st year
is 4,316. The principal paid in the 11th year is 4,080. Calculate 𝐿.

&uestion 11.A7

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Loans

Example cont.

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Review

Example. An investor wishes to accumulate 8,000 in a fund at the end of 17 years. To accomplish this, she plans to make
equal deposits of 𝑋 at the end of each year for the first 7 years. The fund earns an annual effective rate of 4% for the first
7 years and 8% for the next 10 years. Calculate 𝑋.

8000: X.SE0.04 .
1.0g10

X 1.08'= 3000

X= 469.1b

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Review

Example. A deferred perpetuity-due begins making annual payments of 500 per year in 7 years. The annual interest rate
compounded monthly is 7%. Calculate the present value of the deferred perpetuity-due.

H+ i =(1 + it m
500
500

n
I
i
7

i5ris
. .

i 0.07229
=

6
500
v
PUo
-

0.07229

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Review

Example. The present value of a perpetuity paying 1 every three years, with the first payment due immediately, is 6.74 at
an annual effective rate of 𝑖. Another perpetuity pays 𝑋 every 4 years, with the first payment due at the beginning of year
2. This perpetuity has the same present value at an annual effective rate of 𝑖 + 0.01 . Calculate 𝑋.

↓ 1.5982
=

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Review

Example. A loan of 15,000 is repaid with 25 payments made at the end of each year for 25 years. The first payment is 100,
the second payment is 200, and so on until the tenth payment of 1,000, The final 15 payments are 𝑋 per year. The annual
effective interest rate is 3% per year. Calculate 𝑋.

15000 =

falo-Xap5.U"
↑ 4,483.8992
In
=

P= 100 100 (Ia(x =

(P. E(ax Ev
+

·
-

(100 3). Frost10

I =
100 - 10

- +

n 10
=

x 1,183.85
=

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Review

Example. A loan of 15,000 is repaid with 25 payments made at the end of each year for 25 years. The first payment is 100,
120
the second payment is 200, and so on until the tenth payment of 1,000, The final 15 payments are 𝑋 per year. The annual
-

effective interest rate is 3% per year. Calculate 𝑋.

15000 =
80a +20(Ia1o+...

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Review

Example. Doug buys a recreational vehicle and finances it with a loan of 30,000. The annual interest rate on the loan is
9% compounded monthly. Doug makes 22 monthly payments of 700. The first payment is made one month after
purchasing the recreational vehicle. Immediately after the 22nd payment, he refinances the loan with a new loan that
calls for him to make 30 monthly payments. The first of these payments is to be made one month later. The refinances
loan has a nominal interest rate of 6% compounded monthly. Calculate the amount of the new monthly payment.

Question 7.05

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Review e-5t
Example. A 10-year annuity makes continuous payments. At time t, the annuity pays at an annual rate of 30 − 3𝑡 . Time
is measured in years. The annual effective interest rate is 5%. Calculate the present value of the annuity.

Fordr
f dt
-

P
v = (e

at time
t
it

PV = 30ar-3(Iao =
30.Iv-sov
5 In/1.05)
=

PVo =128.31

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Review

Example. A borrower takes out a loan of 84,000 at an annual effective discount rate of 6%. The loan is to be repaid with
annual payments of 10,000. The first payment is due four years after the loan is taken out. Calculate the amount of the
drop payment.

Loan balance at 3:

84000
- =
101,133.6602
1 -
0.0)3
0.06
0.06383
-

F506
=
v =

n 16.7618
=

101, 133.6602 = 10,000. a

101, 133.6602 =

UF
=
10,000 9.p+-

Drop
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Review

Example. Keith borrows 20,000 for 20 years at an annual effective interest rate of 5%. He can repay his loan by making
level end-of-year payments of 1,604.85. Instead, Keith uses a sinking fund to retire the loan at the end of 20 years. Until
the loan is retired, he pays the interest on the loan to the lender at the end of each year and then deposits the reminder of
the 1,604.85 into a sinking fund that earn an annual effective rate of 6%. Calculate the balance remaining in the sinking
fund immediately after the loan is repaid.

2.249.76

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