MATH 1003

Calculus and Linear Algebra

01
Dr. Jing YAO

Department of Mathematics, HKUST

Dept. of Math, HKUST MATH 1003 - Calculus and Linear Algebra Jing YAO
 2.1 Simple Interest

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 2.1 Simple Interest

2
Mathematics of Finance

2.1 Simple Interest

2.2 Compound Interest

2.3 Future Value of an Annuity; Sinking Funds

2.4 Present Value of an Annuity; Amortization

 2.1 Simple Interest

2
Mathematics of Finance

2.1 Simple Interest

- The Simple Interest Formula

- Simple Interest and Investments (Examples)

 2.1 Simple Interest

Simple Interest
Definition
• Principal: a sum of money deposited in savings account or
borrowed from a lender.
• Interest: a fee charged for the money deposited/borrowed,
usually computed as a percentage (called annual (simple)
interest rate) of the principal over a given period of time
• Simple interest is 𝐼 = 𝑃𝑟𝑡, where
𝑃 = principal
𝑟 = annual simple interest rate (written as a decimal)
𝑡 = time in years
e.g., the interest on a loan of $100 at 12% for 9 months is:
𝐼 = 𝑃𝑟𝑡 = (100)(0.12)(0.75)= $9.
 2.1 Simple Interest

Simple Interest
Theorem (Amount formula)
Suppose we invest/borrow a sum of money 𝑃 through a certain financial
instrument, then after 𝑡 years, the amount you will receive/pay, 𝐴, is given by
𝐴 = 𝑃 + 𝐼 = 𝑃 + 𝑃𝑟𝑡 = 𝑃 1 + 𝑟𝑡 .
• 𝐼 = interest
• 𝐴= amount, or future value (the amount that can be taken back in the future)
• 𝑃= principal, or present value (the amount that is deposited now)
• 𝑟= annual simple interest rate (written as a decimal)
• 𝑡= time in years present future
value value
 2.1 Simple Interest

Simple Interest
Remarks
• Future value 𝑨 is the future worth of a present sum of money given a
specified rate of return (interest rate).
• For example, if the annual interest rate is 5%, then after one year, the
future value of $100 given to you now is worth
100(1 + 0.05) = $105.

• Present value 𝑷 is the present worth of a future sum of money given a

specified rate of return (interest rate).
• For example, if the annual interest rate is 5%, the present value of $100
given to you after one year is now worth
100 ÷ (1 + 0.05) = $95.24.
 2.1 Simple Interest

Example 1 (Total Amount Due on a Loan) 𝑨 = 𝑷(𝟏 + 𝒓𝒕)

Find the total amount due on a loan of $1,000 at 6% simple interest
rate at the end of
(1) 2 years;

Future value ($)

(2) 4 months.
Solution
(1) 𝐴 = 𝑃 1 + 𝑟𝑡
6
= 1,000(1 + × 2) = $1,120.
100
(2) 𝐴 = 𝑃 1 + 𝑟𝑡
Time (years)
6 4
= 1,000(1 + × ) = $1,020. For simple interest, the graph of future value
100 12
as a function of time is a straight line.
(Question: 𝑦-intercept? Slope?)
 2.1 Simple Interest

Example 2 (Present Value of an investment) 𝑨 = 𝑷(𝟏 + 𝒓𝒕)

If you want to earn an annual rate of 10% on your investments, how
much should you pay for a note that will be worth $5,000 in 9 months?

Solution Now we are interested in finding the principal 𝑃 (present

value), given 𝐴, 𝑟 and 𝑡.
10 9
5,000 = 𝑃(1 + × )
100 12
⟹ 𝑃 = $4,651.16
 2.1 Simple Interest

Example 3 (Interest Rate Earned on a Note) 𝑨 = 𝑷(𝟏 + 𝒓𝒕)

T-bills (Treasury bills) are one of the instruments the U.S.
If you buy a 180-day T-bill with a maturity value
Treasury Department uses to finance the public debt. of $10,000 for $9,800, what annual simple
interest rate you will earn?
Remark For the convenience of calculation,
here one year is “defined” to be 360 days
(called a banker’s year).
Solution
Now we are interested in finding 𝑟, given 𝑃, 𝐴
and 𝑡.
180
Notice that 𝐴=10,000, 𝑃=9,800 and 𝑡 = .
360
By substituting them into the equation, we have
180
https://en.wikipedia.org/wiki/United_States_Treasury_security 10,000 = 9,800 (1 + 𝑟 · )
360
⟹ 𝑟 = 0.0408 = 4.08%
 2.1 Simple Interest

Example 4 (Interest Rate Earned on an Investment)

You sell an old car to your friend and
accept a 270-day note for $3,500 at
10% simple interest rate as payment.
(Both principal and interest will be
paid at the end of 270 days.)
$3,500, 270-day, 10% rate
Sixty days later you find that you
need the money and sell the note to Sixty days later …
a third party for $3,550.
What annual interest rate will the
third party receive for the
investment? (Express the answer as a
percentage, correct to three decimal
places)
$3,550
 2.1 Simple Interest

Example 4 (Interest Rate Earned on an Investment)

For the third party, we have 𝐴 = 𝑃(1 + 𝑟𝑡) and we
paid: $3,550 know 𝑃 = 3,550.
Therefore, we need to calculate the future value 𝐴
and 𝑡 first.
hold:
$3,500(Day 0), 270-day, 10% rate 210 days

Day 0 Day 60 Day 270

Step 1 The future value of the 270-day note

270
𝐴 = 3,500 1 + 0.1 × = $3,762.50
360
The third party bought the note from you for $3,550 and then after 270 - 60 = 210 days,
he/she will obtain $3,762.50.
Step 2 Let 𝑟 be the annual interest rate for this investment. Then we have
210
3,762.50 = 3,550 1 + 𝑟 · ⟹ 𝑟 = 0.10262 = 10.262%
360
 2.1 Simple Interest

Example 5 (Stock Investments)

The brokerage firm charge commissions based on the amount of the trade.
The following table shows the commission schedule for one of these firms.

Transaction Size
Commission
(Principal) Piecewise-defined function

Commission($)
$0-$2,499 $29+1.6% of principal
$2,500-$9,999 $49+0.8% of principal
$10,000+ $99+0.3% of principal
Principal ($)
An investor purchases 50 shares of a stock at $47.52 per share.
After 200 days, the investor sells the stock for $52.19 per share.
Using the above commission schedule, find the annual rate of interest earned by this
investment.
 2.1 Simple Interest

Example 5 (Stock Investments) Transaction Size Commission

𝑷 = values of stocks + commission. $0-$2,499 $29+1.6% of principal

The values of 50 shares of stocks: 47.52×50 = $2,376. $2,500-$9,999 $49+0.8% of principal
The commission for buying those 50 shares of stocks: $10,000+ $99+0.3% of principal
29 + 2,376 × 1.6%= $67.02.
Therefore, the total amount of investment is 𝑨 = 𝑷(𝟏 + 𝒓𝒕)
𝑃 = 2,376 + 67.02 = $2,443.02.

𝑨 = future value of the stocks − commission. Let 𝑟 be the annual interest rate
The values of 50 shares of stocks after 200 days: 52.19×50= earned by this investment.
$2,609.50. Then we have
The commission for selling those 50 shares of stocks: 200
49 + 2,609.50 × 0.8%= $69.88. 2,539.62 = 2,443.02 (1 + 𝑟 · )
360
Therefore, the total amount of money obtained by selling Solving, we get
stocks is
𝑟 = 0.07117 = 7.117%.
𝐴 = 2,609.5 − 69.88 = $2,539.62.
 2.1 Simple Interest

Summary

Theorem (Amount formula)

Suppose we invest/borrow a sum of money 𝑃 through a certain financial
instrument, then after 𝑡 years, the amount you will receive/pay, 𝐴, is given by
𝐴 = 𝑃 + 𝐼 = 𝑃 + 𝑃𝑟𝑡 = 𝑃 1 + 𝑟𝑡 .