DAVAO CENTRAL COLLEGE,

INC.
Juan dela Cruz Street, Toril, Davao City
Landline No. (082) 291 1882
Accredited by ACSCU-ACI

Week 11 – Mathematics in the Modern World

Unit 4: The Mathematics of Finance (Part II)

Topic: Interest and Maturity or Future Value

Learning Outcomes:
1. Calculate the compound interest and compound amount using
the multi-step method.
2. Calculate the compound amount using the compound interest
table.
3. Identify the nominal rate and effective rate and be able
to distinguish between them.

Concept Digest (Discussion)

Compound interest is a method of calculating interest
periodically on the sum of the principal and the accumulated
interest of previous periods. It means that the earned interest
will also earn interest.
Here is an illustration of a compound interest. Suppose you
deposit Php 5,000 in a savings account earning 3% interest,
compound annually.
During the first year, the interest is compound as follows:
I = Prt
I = (Php 5,000)(0.03)(1)
I = Php 150.00

After a year, the total amount in your account is:

A = P + I
A = Php 5,000 + Php 150
A = Php 5, 150

During the second year, the interest is computed using the

total amount in your account after a year.
I = Prt
I = (Php 5,150)(0.03)(1)
I = Php 154.50

The amount of interest earned on the first year and on the

second year are different. It is bigger on the second year
because the interest was computed based on the sum of the
principal and the interest earned during the first year.

At the end of the second year, the total amount in your account
is:
A = P + I
A = Php 5,150 + Php 154.50
A = Php 5,304.50

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 DAVAO CENTRAL COLLEGE,
INC.
Juan dela Cruz Street, Toril, Davao City
Landline No. (082) 291 1882
Accredited by ACSCU-ACI

To calculate the interest during the third year, we will use

the total amount in your account at the end of the second year.
I = Prt
I = (Php 5,304.50)(0.03)(1)
I = Php 159.14

You notice that the interest is increasing each year because

the amount in your account is also increasing every year.

The compounding period (n) of interest may not always be

annually. It may be any of the following below:
The number of
If interest is
N computation in a
compounded
year
Annually n = 1 Once
Semiannually n = 2 Twice
Quarterly n = 4 4 times
Bimonthly n = 6 6 times
Monthly n = 12 12 times
Daily n = 360 360 times

Now, if the Php 5,000 at 3% interest is compound quarterly,

there will be 4 compounding periods in a year.
The interest during the first quarter is:
I = Prt
3
I = (Php 5,000)(0.03)( )
12
I = Php 37.50
3
Note: t = since there are 3 months in on quarter.
12

The total amount in your account at the end of the first

quarter is:
A = P + I
A = Php 5,000 + Php 37.50
A = Php 5,037.50

During the second quarter, the interest is:

I = Prt
3
I = (Php 5,037.50)(0.03) ( )
12
I = Php 37.78

The total amount in your account at the end of the second

quarter is:
A = P + I
A = Php 5, 037.50 + Php 37.78
A = Php 5,075.28

During the third quarter, the interest is:

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 DAVAO CENTRAL COLLEGE,
INC.
Juan dela Cruz Street, Toril, Davao City
Landline No. (082) 291 1882
Accredited by ACSCU-ACI

I = Prt
3
I = (Php 5,075.28)(0.03) ( )
12
I = Php 38.06

The total amount in your account at the end of the third quarter
is:
A = P + I
A = Php 5,075.28 + Php 38.06
A = Php 5,113.34

During the fourth quarter, the interest is:

I = Prt
3
I = (Php 5,113.34)(0.03) ( )
12
I = Php 38.35

The total amount in your account at the end of the fourth quarter
is:
A = P + I
A = Php 5,113.34 + Php 38.35
A = Php 5,151.69

The Php 5,000 at 3% compounded quarterly earns Php 151.69

interest after 1 year, while the same amount of the same interest
but compounded annually earns an interest of Php 150 after a
year. This implies that more compounding periods in a year will
yield greater interest.

The Compound amount or Future-Value and Compound-Interest

Formulas

The compound amount can be calculated using the compound

amount or future-value formula,

r nt
A = P (1 + )
n

And for the compound interest, I = A – P

Where: A is the future value or compound amount
P is the original principal
r is the rate of interest
t is the time (duration of the loan/investment in
years
n is the number conversion periods per year
I is the compound interest

Example: How much interest is earned in 4 years on Php 12,000

deposited in an account paying 4% compounded semi-annually?

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 DAVAO CENTRAL COLLEGE,
INC.
Juan dela Cruz Street, Toril, Davao City
Landline No. (082) 291 1882
Accredited by ACSCU-ACI

Solution: We will calculate first the compound amount. Substitute

the following values in the formula: P = Php 12,000, r = 0.04, n
= 2, t = 4.

r nt
A = P (1 + )
n
0.04 (2)(4)
A = Php 12,000(1 + )
2
A = Php 12,000(1 + 0.02)8
A = Php 12,000(1.02)8
A = Php 12,000(1.1717)
A = Php 14,060.40

The earned interest after 4 years is:

I = A – P
I = Php 14,060.40 – Php 12,000
I = Php 2,060.40

The Present Value Formula

The present value is the original principal invested before
it earns interest; in the compound-amount formula, it is the (P).
Present value is the amount invested today and will have a
specific value in the future. The formula is:

A
nt
P = r
(1+ )
n

Where: P is the original principal invested

A is the compound amount
r is the rate
n is the number of compounding periods per year
t is the time or the duration of the investment

Example: How much money should you invest at an interest rate of

6% compounded monthly, to have Php 400,000 in 5 years?

Solution: Use the present value formula where A = Php 400,000, r

= 6%, n = 12 and t = 5.
A
P = r
nt
(1+ )
n
Php 400,000
P = 0.06 (12)(5)
(1+ )
12
Php 400,000
P = 60
(1+ 0.005)
Php 400,000
P = 60
(1.005)

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 DAVAO CENTRAL COLLEGE,
INC.
Juan dela Cruz Street, Toril, Davao City
Landline No. (082) 291 1882
Accredited by ACSCU-ACI

Php 400,000
P =
1.34885
P = Php 296,548.91

You need to invest Php 296,548.91 to have Php 400,000 in 5 years.

Example: With your 13th month pay of Php 25,000, you plan to buy
new laptop that costs exactly Php 25,000, but you have to decide
to invest the whole amount in an account that pays 4% compounded
monthly. After 1 year, what is the compounded amount?

Solution:
r nt
A = P (1 + )
n
0.04 (12)(1)
A = 25,000 (1 + )
12
A = 25,000 (1 + 0.00333)12
A = 25,000 (1.00333)12
A = 25,000 (1.0407)
A = 26,017.5

Is this amount more than enough to buy the laptop? It does

not follow that you have more than enough now to buy that laptop
because of the effect of inflation rate. The compound amount is
either less or more than the cost of the laptop.

Now, if the inflation rate is 5%, then the cost of the

laptop is:
25,000 + 5% of 25,000
25,000 + (0.05)(25,000)
25,000 + 1,250
26,250

After 1 year, your money is less than the cost of the

laptop, an indication that you have lost your purchasing power.
Your money has lost its value because it can now buy less
compared with that of a year ago.

Inflation
Inflation is an economic condition where there is an
increase in the cost of goods and services. It is expressed as a
percent.
The formula in calculating the effect of inflation is the
same as that in compound amount. Since inflation rate varies from
day-to-day, and month-to-month, we will use the average annual
inflation rate.

Example: You are just married and assume to have a college

student 18 years from now. If the annual tuition fee of a college

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 DAVAO CENTRAL COLLEGE,
INC.
Juan dela Cruz Street, Toril, Davao City
Landline No. (082) 291 1882
Accredited by ACSCU-ACI

student is Php 46,000, what would be the equivalent annual

tuition fee at the time you will have a college student, assuming
that the annual inflation rate is 7%.

Solution: We will subscribe the following values in the compound-

amount formula, P = Php 46,000, r = 7%, n = 1 (annual inflation)
and t = 18.

r nt
A = P (1 + )
n
0.07 (1)(18)
A = 46,000(1 + )
1
A = 46,000(1 + 0.07)18
A = 46,000(1.07)18
A = 46,000(3.3799)
A = 155,475.4

Eighteen years from now, the annual tuition fee of your college
student is Php 155,475.40.

Example: Suppose you purchase an insurance policy in 2016 that

will provide you Php 1,000,000 in 2046. If the annual inflation
rate is 8%, what will be the purchasing power of the Php
1,000,000 in 2046?

Solution: In this problem, calculate its purchasing power as

compared with that in 2016. We will use the present value
formula; substitute A = Php 1,000,000, r = 0.08, n = 1, and t =
30.

A
P = r
nt
(1+ )
n
1,000,000
P = 0.08 (1)(30)
(1+ )
1
1,000,000
P = 30
(1+0.08)
1,000,000
P = 30
(1.08)
1,000,000
P =
10.06
P = 99,403.57

In 2046, the purchasing power as compared with that in

2016. We will use the present value formula; substitute A = Php
1,000,000, r = 0.08, n = 1 and t = 30.

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 DAVAO CENTRAL COLLEGE,
INC.
Juan dela Cruz Street, Toril, Davao City
Landline No. (082) 291 1882
Accredited by ACSCU-ACI

Effective Interest Rate

The compounded annual interest rate is called nominal rate
while the simple interest rate that would yield the same amount
of interest after 1 year is effective rate. If a bank offers a
savings account that pays 3% compounded monthly and yielding
3.04%, the nominal interest rate is 3% and the effective rate is
3.04%

Example: A bank offers 4% compounded quarterly. What is the

effective rate?

Solution: We will calculate the compound amount of a certain

principal in 1 year with an interest rate of 4% compounded
quarterly. Assume, P = Php 100, r = 0.04, n = 4 and t = 1.

r nt
A = P (1 + )
n
0.04 (4)(1)
A = 100 (1 + )
4
0.04 (4)
A = 100 (1 + )
4
A = 100 (1 + 0.01)4
A = 100 (1.01)4
A = 100 (1.0406)
A = 104.06

To calculate for the effective rate, substitute I = 4.06, P

= Php 100, and t = 1 in the simple interest formula.

I = Prt
4.06 = (100)(r)(1)
4.06 (100)(r )
=
100 100
0.0406 = r
r = 4.06%

The interest rate of 4% compounded monthly will yield equal

an amount of interest for a simple interest rate of 4.06%

Example: Which investment has the higher annual yield, the one
that earns 4% compounded monthly or the one that earns 4.25%
compounded quarterly?

Solution: To compare the two investments, we compute for the

compound amount of Php 100 for each alternative.
4.25% COMPOUNDED
4% COMPOUNDED MONTHLY
QUARTERLY

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 DAVAO CENTRAL COLLEGE,
INC.
Juan dela Cruz Street, Toril, Davao City
Landline No. (082) 291 1882
Accredited by ACSCU-ACI

0.04 (12)(1) 0.0425 (4)(1)

A = 100 (1 + ) A = 100 (1 + )
12 4
A = 100 (1.0407) A = 100 (1.04032)
A = 104.07 A = 104.32

The compound amount for the 4.25% compounded quarterly has a

higher compound amount than the 4% compounded monthly; therefore,
the investment in 4.25% compounded quarterly will have a higher
annual yield.

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