QF1100 (Week 1)

▶ Geometric Sequence

▶ Derivative

▶ Increasing/Decreasing Functions

▶ Accumulation Function

▶ Simple and Compound interest

Reference: Chapter 2 in Investment Sicence by David Luenberger

1/15
Geometric Sequence
A geometric sequence is a sequence of non-zero numbers of form
a, ar, ar2 , ar3 , . . . ,
where r ̸= 0 is called the common ratio and a is a scale factor.
Fact: The sum of the first n-terms of geometric sequence:
ar0 + ar + ar2 + ar3 + · · · + arn−1
n
X n−1
X
= ark−1 or ark
k=1 k=0
a(1 − rn )
= ,
1−r
where r ̸= 1.
Proof.
▶ 1st method: Mathematical induction (optional).
▶ 2nd method: Direct computation.
Hint: Show the identity
1 − rn = (1 − r)(1 + r + r2 + · · · + rn−1 ).
2/15
Proof
1−r n
Pn Pn
Pn
Because k=1 ark−1 = a rk−1 , by k=1 rk−1 =
k=1 1−r , we
obtain !
n n
X
k−1
X
k−1 a(1 − rn )
ar =a· r = .
1−r
k=1 k=1
Pn n
Hence, it suffices to show that k=1 rk−1 = 1−r1−r , i.e.,

1 − rn = (1 − r)(1 + r + r2 + · · · + rn−1 ).

In fact,

(1 − r)(1 + r + r2 + · · · + rn−1 )
=1 + r + r2 + · · · + rn−1
− (r + r2 + · · · + rn−1 + rn )
=1 − rn .

We are done.
3/15
Mathematical Induction (optional)
If r ∈ R, r ̸= 1, prove that for all n ∈ N, we have
1 − rn
1 + r + r2 + · · · + rn−1 = .
1−r

Proof: To prove this formula,

1
If n = 1, the statement is clearly true since 1 = 1−r
1−r .
If we now assume that the formula is true for n = k and add the term
rk+1−1 to both sides, we get

1 − rk
1 + r + r2 + · · · + rk−1 + rk+1−1 = + rk
1−r
1 − rk 1 − rk + rk − rk+1
= + rk =
1−r 1−r
1 − rk+1
=
1−r
Consequently, by the Principle, The inequality is valid for for all
n ∈ N.
4/15
Derivative
Define the derivative of f (x) with respect to x to be f ′ (x) by

f (x + h) − f (x)
f ′ (x) = lim .
h→0 h
Standard derivatives
▶ dxd
(f (x)n ) = nf ′ (x) · f (x)n−1 . e.g. dx
d n
x = nxn−1 for n ≥ 1.
▶ Chain Rule: dx d
(f ◦ g)(x) = f ′ (g(x)) · g ′ (x).
▶ Product Rule: d
dx (f (x) · g(x)) = f ′ (x) · g(x) + f (x) · g ′ (x).
f ′ (x)·g(x)−g ′ (x)·f (x)
 
d f (x)
▶ Quotient Rule: dx g(x) = (g(x))2 .
Example: Let f (x) = sin(x)2 + ex cos(x). Then

f ′ (x) = 2 cos(x) sin(x) + ex cos(x) − ex sin(x).

5/15
Increasing/Decreasing Functions
▶ f is (strictly) increasing on (a, b) if x1 < x2 ⇒ f (x1 ) < f (x2 )
for all x1 , x2 ∈ (a, b).
▶ f is (strictly) decreasing on (a, b) if x1 < x2 ⇒ f (x1 ) > f (x2 )
for all x1 , x2 ∈ (a, b).

Increasing/Decreasing Test
Let f be continuous on [a, b], differentiable on (a, b).
▶ If f ′ (x) > 0 for any x ∈ (a, b), then f is strictly increasing on
[a, b].
▶ If f ′ (x) < 0 for any x ∈ (a, b), then f is strictly decreasing on
[a, b]. 6/15
Example
Find the increasing/descreasing intervals of f (x) = x3 − x.

Solution: First, we compute its derivative and obtain f ′ (x) = 3x2 − 1.

Then its critical points (i.e., f ′ (x) = 0) are x = ± √13 ≈ ±0.58. It
follows that √ −1 √ −1
f ′ (x) = 3(x − 3 )(x + 3 ).
√ −1
Next, we have f ′ (x) > 0 when |x| > 3 and f ′ (x) < 0 when
√ −1
|x| < 3 .
Finally, by Increasing/Decreasing Test, f (x) is (strictly) increasing
√ −1 √ −1
when |x| > 3 and f (x) is (strictly) decreasing when |x| < 3 .

7/15
Exercise
200
X n
X
1. Compute ark and ark for n ≥ m.
k=100 k=m

2. Find the derivative of f (x) = 2x2 − 4x + 5.

3. Find the increasing/descreasing intervals of f (x) = 2x2 − 4x + 5.

Sketch its graph.

8/15
Accumulation Function
When a principal of $1 is deposited in an interest-paying account at
time t = 0, it earns some interest over the time interval [0, t]. The
accumulated value of $1 at time t, denoted by a(t), is known as the
accumulation function.
a(t) = principal + interest.
Clearly, a(0) = 1.

We use a diagram called cash flow to visualize a(t).

Example. The following is a cash flow for 6 months (=1/2 year)

deposit.

9/15
Simple Interest
Let r be the annual rate of interest.
Simple interest is calculated only on the principal amount.

Simple interest = # of years × annual rate × principal amount.

A principal of $1:
▶ After 1 year (i.e., t = 1), earn interest 1 × r and the accumulated
value a(1) = 1 + 1 × r × 1 = 1 + r;
▶ After 2 years (i.e., t = 2), earn interest 2 × r and the accumulated
value a(2) = 1 + 2 × r × 1 = 1 + 2r;
▶ After n years (i.e., t = n), earn interest n × r and the
accumulated value a(n) = 1 + n × r × 1 = 1 + nr.
Based on the simple-interest method of calculating interest,

a(t) = 1 + t × r × 1 = 1 × (1 + rt), for t ≥ 0.

10/15
Compound Interest

Let r be the annual rate of interest.

Compound interest earns interest on the interest.

A principal of $1:
▶ After 1 year (i.e., t = 1), the accumulated value
a(1) = 1 + 1 × r = 1 + r;
▶ After 2 years (i.e., t = 2), the accumulated value
a(2) = a(1) + a(1) × r = (1 + r) + (1 + r) × r = (1 + r)2 ;
▶ After n years (i.e., t = n), the accumulated value
a(n) = a(n − 1) + a(n − 1) × r = (1 + r)a(n − 1) = (1 + r)n .
If the compound-interest method is used,

a(t) = (1 + r)a(t − 1) = a(0) × (1 + r)t , for t ≥ 0.

11/15
Linear Growth vs Geometric Growth

Figure: Original principal of §100 and Interest rate of 10%

The seven-ten rule: Money invested at 7% per year doubles in

approximately 10 years. Also, money invested at 10% per year
doubles in approximately 7 years.
(Note that: (1 + 0.07)10 = 1.96715 and (1 + 0.1)7 = 1.94872) 12/15
Figures

Figure: Effective interest rates (Geometric Growth)

Figure: https://www.dbs.com.sg/personal/rates-online/
singapore-dollar-fixed-deposits.page 13/15
Example (Structured deposit)
A five-year structured deposit offers an effective annual rate of interest
of 3% for the first 3 years and 3.5% for the next two years.
If I invest $10, 000, how much will I receive at maturity if
(i) simple interest is paid
(ii) compound interest is paid.

14/15
Solution
Solution of (i). Suppose that simple interest is paid.
Note that a(0) = 10000 = 104 .
Since the interest rate for the first 3 years is 3%, we have
a(3) = a(0)(1 + 3% × 3) = 104 × (1 + 0.03 × 3) = 10, 900.
Since the interest rate for the next 2 years is 3.5%, we have

a(5) =a(3) + 3.5% × (5 − 3) × a(0)

=a(0)(1 + 3% × 3 + 3.5% × 2)
=1.16 × 104 .

Solution of (ii). Suppose that compound interest is paid.

We have
a(3) = a(0)(1 + 3%)3 ,
and

a(5) =a(3)(1 + 3.5%)5−3 × a(0)

=a(0)(1 + 3%)3 (1 + 3.5%)2
=1.17 × 104 .
15/15