SCOPE

Chapter 5: Mathematics of Finance

• Sec 5.5 Amortization of Loans

• Chapter 5 Review
• Explore & Extend
CONTENT

• Sec 5.5: Everything

• Chapter 5 Review

• Explore & Extend

PURPOSE
To understand the mathematics of finance which
will help make more informed decisions about
purchases and investments.

In this chapter we model selected topics in finance

that deal with the time value of money such as
investments, loans, and so on.
COMMENTS
• You must be able to solve any variable in any
one of the formulas used in this chapter.
• No formula sheet will be given!
• No financial calculators allowed
• An interest rate is always rounded off to 4
decimal places as a decimal, for example
0.1234 = 12.34%.
• We use a scientific calculator only at the final
calculation to avoid rounding mistakes.
STUDY TIP
• To summarise the whole Chapter 5, write down
all of the formulas used in this Chapter on a
piece of paper.
• As you practice questions, add notes to these
formulas such as when to use which formula
and how to solve certain variables.
• Remember to include the Comments and
Method on these slides onto your notes.
AMORTIZATION
• In this section we will discuss how repayments
on a loan works.
• As all of our regular repayments are the same,
and we are working with debt, we will always
use the present value formulas of an annuity:

𝟏− 𝟏+𝒓 −𝒏
• Ordinary: 𝑨=𝑹
𝒓

𝟏− 𝟏+𝒓 − 𝒏−𝟏
• Due: 𝑨 = 𝑹 𝟏 +
𝒓
AMORTIZATION
For example, we buy a house of R1 million on debt
by getting a loan from Bank Z. While we are living
in our house, we have to pay the loan back
monthly at 10% per year, compounded monthly, for
30 years.

Thus,
➢ 𝐴 = 1,000,000
➢ 𝑟 = 0.10
➢ 𝑚 = 12
➢ 𝑛 = 30 years
➢ 𝑅=?
AMORTIZATION
1 − 1 + 𝑟 −𝑛
𝐴=𝑅
𝑟
−30×12
0.10
1− 1+
1,000,000 = 𝑅 12
0.10
12

∴ 𝑅 ≈ 8,775.715701 …
∴ 𝑅 = 8,775.72

Hence, we have to pay back monthly R8,775.72

AMORTIZATION
Now, if we consider this monthly repayment of
R8,775.72, can you see that this amount consists
of two components:

1. The repayment of the original principal loaned.

PLUS
2. An interest component.
AMORTIZATION
• A very interesting remark we will see later on is
that in the first few repayments the principal
repaid is very small and the interest component
is very large.
• Towards the end, the situation changes around
and the principal repaid becomes very large
and the interest component becomes very
small.
• This is due to the fact that in the beginning we
owe a large amount of money while towards the
end we owe a smaller amount as we have
made payments in between.
AMORTIZATION SCHEDULE
An amortization schedule is a table that
summarizes:

• The repayments made at each period,

• The principal outstanding on the original loan at
each repayment,
• The interest component within each repayment,
• The principal repaid with each component.
AMORTIZATION SCHEDULE
• Regarding the schedule, some textbooks uses
a different labeling of the columns than the one
used in the textbook.
• In the assessments you will be given a blank
table, with no headings, and we will mark
according to your labeling.
• We will use the textbook’s labelling here.
AMORTIZATION SCHEDULE
Col 1 Col 2 Col 3 Col 4 Col 5
Principal outstanding Payment Principal
Interest
Period at beginning of at end of repaid at
for period
period period end of period
1 𝐴 𝐴×𝑟 𝑅 𝐶𝑜𝑙 4 − 𝐶𝑜𝑙 3
𝐴 − 𝐶𝑜𝑙 5
2 𝐶𝑜𝑙 2 × 𝑟 𝑅 𝐶𝑜𝑙 4 − 𝐶𝑜𝑙 3
(𝑝𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑟𝑜𝑤)
𝐶𝑜𝑙 2 − 𝐶𝑜𝑙 5
⋮ 𝐶𝑜𝑙 2 × 𝑟 𝑅 𝐶𝑜𝑙 4 − 𝐶𝑜𝑙 3
(𝑝𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑟𝑜𝑤)
𝑛 𝐶𝑜𝑙 2 − 𝐶𝑜𝑙 5
𝐶𝑜𝑙 2 × 𝑟 𝑅 𝐶𝑜𝑙 4 − 𝐶𝑜𝑙 3
𝑁𝑢𝑚𝑏𝑒𝑟 (𝑝𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑟𝑜𝑤)
𝑜𝑓 ⋮ ⋮ ⋮ ⋮
𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠 ⋮ ⋮ 𝑅 ± 𝑎𝑓𝑐 ⋮
Total 0 𝐧𝐑 − 𝐀 𝐧𝐑 𝐀

The few cents we add or subtract is to correct repetitive

rounding throughout the table. #afc = a few cents
EXAMPLE
Suppose that a bank lends a borrower $1500 and
charges interest at the nominal rate of 12%
compounded monthly. The $1500 plus interest is
to be repaid by equal payments of 𝑅 dollars at the
end of each month for three months.

The solution will be given in class.

EXAMPLE

Principal outstanding Payment

Interest Principal repaid at
Period at beginning of at end of
for period end of period
period period
1 1500 15 510.03 495.03
2 1004.97 10.05 510.03 499.98
3 504.99 5.05 510.04 504.99
Total - 30.10 1530.10 1500
AMORTIZATION FORMULAS
Sometimes we are only looking for a specific value
and not the full schedule. This is where the
amortization formulas comes in:

• Periodic repayment: (Col 4)

−𝑛
1− 1+𝑟
𝐴=𝑅
𝑟
• Principal outstanding at the beginning of the 𝑘 𝑡ℎ
period: (Col 2)
1− 1+𝑟 −𝑛+𝑘−1
=𝑅
𝑟
AMORTIZATION FORMULAS
• Interest in the 𝑘 𝑡ℎ payment: (Col 3)
1− 1+𝑟 −𝑛+𝑘−1
= 𝑅𝑟
𝑟

• Principal contained in 𝑘 𝑡ℎ payment: (Col 5)

1− 1+𝑟 −𝑛+𝑘−1
=𝑅 1−𝑟×
𝑟

• Total interest paid: (Total Col 3)

= 𝑛𝑅 − 𝐴
EXAMPLE
A borrower is repaying a R750,000 loan at 9.5%
per year, compounded monthly, with monthly
payments over 20 years.

1. Determine the monthly payment.

1 − 1 + 𝑟 −𝑛
𝐴=𝑅
𝑟
−20×12
0.095
1− 1+
12
750,000 = 𝑅
0.095
12
∴ 𝑅 = 6,990.98
EXAMPLE
A borrower is repaying a R750,000 loan at 9.5%
per year, compounded monthly, with monthly
payments over 20 years.

2. Determine the balance outstanding after the

70th payment.
1− 1+𝑟 −𝑛+𝑘−1
=𝑅
𝑟

0.095 −12×20+71−1
1− 1+
12
= 6,990.98 0.095
12

= 651,966.25
EXAMPLE
A borrower is repaying a R750,000 loan at 9.5%
per year, compounded monthly, with monthly
payments over 20 years.

3. Determine the interest contained in the 20th

payment.
1− 1+𝑟 −𝑛+𝑘−1
= 𝑅𝑟
𝑟

0.095 −12×20+20−1
0.095 1− 1+
12
= 6,990.98 × × 0.095
12
12

= 5,767.22
EXAMPLE
A borrower is repaying a R750,000 loan at 9.5%
per year, compounded monthly, with monthly
payments over 20 years.

4. Determine the principal contained in the 30th

payment.
1− 1+𝑟 −𝑛+𝑘−1
=𝑅 1−𝑟×
𝑟

0.095 −12×20+30−1
0.095 1− 1+
12
= 6,990.98 1 − × 0.095
12
12

= 1,324.16
EXAMPLE
A borrower is repaying a R750,000 loan at 9.5%
per year, compounded monthly, with monthly
payments over 20 years.

5. Determine the finance charge.

= 𝑛𝑅 − 𝐴
= 12 × 20 6,990.98 − 750,000
= 927,835.20