Chapter I

Mathematics of Finance
 I-1 Interest
I-1-01: Simple Interest
Let:
p = Principal in Riyals
r =Interest rate per year
t = number of years
→ The accumulated amount A after t years:
A = p + prt = p ( 1 + rt)
Graphing the straight line segment:
A(t) = p + prt ; t ≥ 0
 Example (1)
What are the interest and the total accumulated amount
after 10 years on a deposit of 2000 Riyals at a simple
interest rate of 1% per year?

Solution:
The accumulated amount A = p + prt
The interest paid I = prt
where p = 2000, r = 1/100 = 0.01 and t = 10.
A = 2000 + 2000(1/100)(10) = 2000 + 200 = 2200
I = prt = 200

Textbook: Example 1 page 186

 Graphing the straight line:
A(t) = 2000 + 2000(0.01)t ; t ≥ 0
 Homework
1.a. What are the interest I and the total accumulated amount A
after 2 years on a deposit of 500 Riyals at a simple interest rate of 8% per
year?
Answer: I = 80 Riyals and A = 580 Riyals

2.b.c. If the accumulated amount after 2 years on a deposit at a simple

interest rate of 8% per year is 580, then what’s the principal P (the
deposit)?
Answer: P = 500 Riyals

3.d. How many years t would it take a deposit of 500 Riyals at a simple interest
rate of 8% per year to grow to an accumulated amount of 580 Riyals?
Answer: t = 2 years

3.f. If a deposit of 500 Riyals grows to an accumulated amount of 580 Riyals in

2 years, then what’s the simple interest rate?
Answer: r = 0.08 (8% per year )
 Homework
2.a. What are the interest I and the total accumulated amount A
after 9 months on a deposit of 800 Riyals at a simple interest rate of 6% per
year?
Answer: I = 36 Riyals and A = 836 Riyals

2.b. If the accumulated amount after 9 months on a deposit at a simple

interest rate of 6% per year is 836, then what’s the principal P (the
deposit)?
Answer: P = 800 Riyals

3.c. How long would it take a deposit of 800 Riyals at a simple interest
rate of 6% per year to grow to an accumulated amount of 836 Riyals?
Answer: t = 0.75 year = (3/4)(12 months) = 9 months

3.d. If a deposit of 800 Riyals grows to an accumulated amount of 836 Riyals in

9 months, then what’s the simple interest rate?
Answer: r = 0.06 = 6% per year
 I-1-02: Compound Interest
Let:
p = Principal in Riyals
r =Interest rate per year
t = number of years
→
The accumulated amount A1 after 1 year:
A1 = p + pr(1) = p (1 + r)

The accumulated amount A2 after 2 years:

A2 = A1 + A1 r(1) = A1 (1 + r) = p(1 + r) (1 + r)= p(1 + r)2
The accumulated amount A3 after 3 years:
A3 = A2 + A2 r(1) = A2 (1 + r) = p(1 + r)2 (1 + r)=p (1 + r)3

The accumulated amount A after 4 years:

A4 = A3 + A3 r(1) = A3 (1 + r) = p(1 + r)3 (1 + r)= p(1 + r)4

We conclude that the accumulated amount after t years

At = p(1 + r)t
 Example (2)
What are the interest and the total accumulated amount
after 2 years on a deposit of 2000 Riyals at a compound
interest rate of 10% per year?

Solution:
The accumulated amount A = p(1+ r)t
The interest paid I = A – p
Where, p = 2000, r = 10/100 = 1 /10 = 0.1 and t = 2

A = 2000[1 + (1/10)]2

The interest paid = 2420 – 2000 = 420

I-1-03: Interest compounded m times a year
Let:
p = Principal in Riyals
r = Interest rate per year
m = number of times a year the interest is compounded
Conversion period = the period of time between successive
interest calculations
The interest rate per conversion period = i = r / m
t = the number of years (term)
n = Number of periods in t years = mt
→
The accumulated amount A1 after 1 period:
A1 = p + pi = p (1 + i)

The accumulated amount A2 after 2 periods:

A2 = A1 + A1 i = A1 (1 + i) = p(1 + i) (1 + i)= p(1 + i)2
The accumulated amount A3 after 3 periods:
A3 = A2 + A2 i = A2 (1 + i) = p(1 + i)2 (1 + i)=p (1 + i)3

The accumulated amount A after 4 periods:

A4 = A3 + A3 i = A3 (1 + i) = p(1 + i)3 (1 + i)= p(1 + i)4

We conclude that the accumulated amount after n periods

An = p(1 + i)n = p (1+i)mt = p (1 + r/m )mt

Where,
p = the principal
r = the interest per year
m = the number of times (periods) in a year the interest is
compounded
 Example (3)
What is the total accumulated amount after 3 years on a
deposit of1000 Riyals at interest rate of 10% per year
compounded:
1. semiannually ( 2 periods in a year)
2. quarterly ( 4 periods in a year )
3. monthly ( 12 periods in a year)
4. daily ( 365 periods in a year)
5. every 4 months ( 3 periods in a year )
6. every two months ( 6 periods in a year )
7. annually

Solution:
In all of these cases, we use the formula
An = p(1 + i)n = p (1+i)mt = p (1 + r/m )mt
1. semiannually ( 2 periods in a year)
A = 1000[1 + (0.1)/2 ]2(3

2. quarterly ( 4 periods in a year )

A = 1000[1 + (0.1)/4 ]4(3)

3. monthly ( 12 periods in a year)

A = 1000[1 + (0.1)/12 ]12(3)
4. daily ( 365 periods in a year)
A = 1000[1 + (0.1)/365 ]365(3)

5. every 4 months ( 3 periods in a year )

A = 1000[1 + (0.1)/3 ]3(3)

6. every two months ( 6 periods in a year )

A = 1000[1 + (0.1)/6 ]6(3)

7. annually ( 1 periods in a year )

A = 1000[1 + 0.1 ]3
Textbook: Example 3 page 189
 Homework
What is the total accumulated amount after t years on a deposit of P
Riyals at interest rate of r per year, compounded:

1. annually, if P= QR1000, t = 8 years and r = 7%

Answer: A = QR 1718.19

2. quarterly , if P= QR12000, t = 10.5 years and r = 8%

Answer: A = QR 27566.93

3. monthly , if P= QR150000, t = 4 years and r = 14%

Answer: A = QR 261751.04

4. daily , if P= QR150000, t = 3 years and r = 12%

Answer: A = QR 214986.69

4. semiannually, if P= QR2500, t = 10 years and r = 7%

Answer: A = QR 4974.47
 Homework
What is the total accumulated amount after t years on a deposit of P
Riyals at interest rate of r per year, compounded:

1. annually, if P= QR1000, t = 8 years and r = 7%

Answer: A = QR 1718.19

2. quarterly , if P= QR12000, t = 10.5 years and r = 8%

Answer: A = QR 27566.93

3. monthly , if P= QR150000, t = 4 years and r = 14%

Answer: A = QR 261751.04

4. daily , if P= QR150000, t = 3 years and r = 12%

Answer: A = QR 214986.69

4. semiannually, if P= QR2500, t = 10 years and r = 7%

Answer: A = QR 4974.47
 I-1-04: Continuous Compounding of Interest
”“ If the interest is compounded more and more frequently
We have:
A = p (1 + r/m )mt
= p (1 + r/m )\(m/r) rt
= p [1 + (1/u)]u(rt) , by letting m/r = u and so r/m = 1/u

= p [1 + (1/u)]u(rt) = p [[1 + (1/u)]u](rt)

Notice that u →0 as m→∞
and so as you are supposed to know:

[[1 + (1/u)]u → e
And thus,

p [[1 + (1/u)]u](rt) → p ert

Thus the amount accumulated if the interest is compounded continuously is:

A = p ert
Where p is the principal, r the interest rate and t the term ( number of years)
 Example (4)
What is the total accumulated amount after 3 years on a deposit of1000
Riyals at interest rate of 10% compounded continuously?

Solution:
The amount accumulated:
A = p ert , where p=1000, r = 0.1 and t = 3.
Thus,
A = 1000 e(0.1)(3)

Assignment:
1. Find the answer approximated to 2 decimal digits
(Accuracy of one Dirham)
2. Use the appropriate formula to calculate the amount accumulated if
the interest is compounded daily ( with the same accuracy) and
compare the that with the answer to question (1).
Textbook: Example 4 page 191
 Homework
Find, using the continuous compounding formula:
the total accumulated amount A after 4 years on a deposit
of 5000 Riyals at interest rate of 8% per year.

Answer: A = QR 6885.64
 I-1-05: Effective Rate of Interest
( the annual percentage yield)
reff = [1 + (r/m)]m - 1

Example (5):
What’s the effective rate if the rate if the
nominal rate of interest is 10% per year
Compounded:
1. quarterly
2. monthly
3. annually
Solution
We use the formula
reff = [1 + (r/m)]m – 1,
Where r = 10/100 = 1/10 = 0.1

1. quarterly → m = 4
reff = [1 + (0.1)/4)]4 – 1

2. monthly→ m = 12
reff = [1 + (0.1)/12)]12 – 1

3. annually → m = 1
reff = [1 + (0.1)/1)]1– 1 = 0.1 = the nominal interest

Textbook: Example 5 page 192

 Deducing the Formula of the Effective rate
of Interest
We let:
p(1+ reff ) = p[1+ (r/m)]m

Where,
r = the nominal yearly interest rate
m= the number of conversion periods per year

→1+ reff = [1+ (r/m)]m

→reff = [1+ (r/m)]m - 1

 Homework
What is the effective rate of interest reff corresponding to the following nominal
interest rate:

1. 10% per year compounded semiannually

Answer: reff = 10.25 % per year

2. 8% per year compounded monthly

Answer: reff = 8.3 % per year
 I-1-06: Present Value

What’s the principal (present value) that

should be deposited in a bank paying an
Interest at a rate of r compounded m times a
Year such that at the end of t years the
accumulated amount will be A.
We had A = p [ 1 +(r/m) ]mt
→ p = A / [ 1 +(r/m) ] mt
→ p = A [ 1 +(r/m) ] - mt
 Example (6)
What’s the principal (present value) that
should be deposited in a bank paying an
Interest at a rate of 10% compounded 3 times a
year such that at the end of 4 years the
accumulated amount will be 5000.

Solution:
p = A [ 1 +(r/m) ] - mt
We have A=5000, r =10/100=1/10= 0.1, m=3 and
t=4
→ p = 5000 [ 1 +(0.1)/3 ] –3(4)

Textbook: Examples 6 & 7 page 194

 Homework
1. What’s the present value( money already in an account) in a
bank paying an Interest at a rate of 6% compounded 2 times a year
such that at the end of 4 years the accumulated amount will be QR 40000.
Answer: P = 31576.37 Riyals

2. What’s the present value( money already in an account) in a

bank paying an Interest at a rate of 7% compounded monthly such that at the
end of 4 years the accumulated amount will be QR 40000.
Answer: P = 30255.95 Riyals
 I-1-07: using Logarithms to Solve
Problems in Finance
a. Finding the term number of years) t needed for a principal p to grow
to an accumulated amount A if invested at rate r(per year)
compounded m times a year.

We have:
A = p [ 1 + (r/m) ]mt
Hence,
A / p = [ 1 + (r/m) ]mt , dividing both sides of the equation by p

Taking the natural logarithm for both sides, we get:

ln(A/p) = ln [ 1 + (r/m) ]mt = mt ln [ 1 + (r/m) ]
Thus,
t = ln(A/p) / m ln [ 1 + (r/m) ]
 Example (7)-a
How long it will take a principal of 1000 Riyals to
grow to 1270.24 if deposited in a bank paying an
Interest at a rate of 8% compounded monthly ?

Solution:
t = ln(A/p) / m ln [ 1 + (r/m) ]

We have: p=1000, A=1270.24, r=0.08 and m=12

We can either use the deduced formula or do the
calculation from scratch:
1. Using the deduced formula:
t = ln(A/p) / m ln [ 1 + (r/m) ]
→ t = ln(1270.24/1000) / 12 ln [ 1 + (0.08/12) ]

Assignment find t !

Textbook: Example 8 page 194

2. Solving from scratch:
We have t = ln(1270.24/1000) / 12 ln [ 1 + (0.08/12) ]

A = p [ 1 + (r/m) ]mt

Thus,

1270.24 = 1000[ 1 + (0.08/12) ]12t

→ 1270.24/1000 = [ 1 + (0.08/12) ]12t ( dividing both sides by 1000)

→ ln(1270.24/1000) = ln [ 1 + (0.08/12) ]12t ( applying the logarithm to both

sides)

→ ln(1270.24/1000) =12t ln [ 1 + (0.08/12) ] ( using a logarithmic property)

→12t = ln(1270.24/1000) / ln [ 1 + (0.08/12) ]

→t = ln(1270.24/1000) / 12 ln [ 1 + (0.08/12) ]

Textbook: Example 8 page 194

 Homework
1. How long it will take an investment of P Riyals to grow to A Riyals in a
bank paying an Interest at a rate of r, compounded monthly:

a. If P = QR 5000, r= 0.12 per year and A = QR6500

Answer: 2.2 years

b. If P = QR 2000, r= 0.09 per year and A = QR4000

Answer: 7.7 years

2. How long it will take an investment of 6000 Riyals to grow to 7000 Riyals in
A bank paying an Interest at a rate of 7.5%, compounded continuously.
Answer: 2.06 years
b. Finding the interest rate needed for a principal p to grow
to an accumulated amount A if invested for t years and the
Interest is compounded m times a year.

We have:
A = p [ 1 + (r/m) ]mt
Hence,
A / p = [ 1 + (r/m) ]mt , dividing both sides of the equation by p

Taking the natural logarithm for both sides, we get:

ln(A/p) = ln [ 1 + (r/m) ]mt = mt ln [ 1 + (r/m) ]
Thus,
ln [ 1 + (r/m) ] = ln(A/p) / mt
→ 1 + (r/m) = e ln(A/p) / mt
→ r/m = e ln(A/p) / mt – 1
→ r = m [ e ln(A/p) / mt – 1]
 Example (7)-b
Find the interest rate needed a principal of 1000 Riyals to
grow to 1270.24 if deposited in a bank for 3 years and the interest is
compounded monthly ?

Solution:
We have: p=1000, A=1270.24, t=3 and m=12
We can either use the deduced formula or do the
calculation from scratch:
1. Using the deduced formula:
r = m [ e ln(A/p) / mt – 1]
→ r = 12 [ e ln(1270.24/1000) / 12(3) – 1]

Assignment find r !
2. Solving from scratch:
We have:
A = p [ 1 + (r/m) ]mt
→1270.24= 1000 [ 1 + (r/12) ]12(3)

Hence,
1270.24 / 1000 = [ 1 + (r/12) ]36 , dividing both sides of the equation by p

Taking the natural logarithm for both sides, we get:

ln(1270.24 /1000) = ln [ 1 + (r/12) ]36 = 36ln [ 1 + (r/12) ]
Thus,
ln [ 1 + (r/12) ] = ln(1270.24 /1000) / 36
→ 1 + (r/12) = e ln(1270.24/1000) / 36
→ r/12= e ln(A/p) / 36 – 1
→ r = 12 [ e ln(A/p) / 36 – 1]

Textbook: Example 9 page 195

 Homework
1. Find the interest rate needed for an investment of 5000 Riyals to
grow to 6500 Riyals in 2.2 years If interest is compounded monthly
Answer: 0.12 = 12%

1. Find the interest rate needed for an investment of 5000 Riyals to

grow to 6000 Riyals in 3 years If interest is compounded continuously
Answer: 0.0608 = 6.08%
I.2. Progressions
 I-2-01: Arithmetic Progression
An arithmetic progression is a sequence of numbers of the form:
a, a+d, a+2d, a+3d,……
Where the difference between any term and the one preceding it is a constant d
(called the difference).

Examples (8)
Consider the following sequence:
5, 7, 9, 11, 13, 15,
Here the first term a = 5 and the difference d = 2
a2 =a1 + d = 5 + 2 = 7

a3 = a2 + d = 7 + 2 = 9 = 5 + 2(2) = a + 2d

a4 = a3 + d = 9 + 2 = 11= 5 + 3(2) = a + 3d

a5 = a4 + d = 11 + 2 = 13= 5 + 4(2) = a + 4d

In general:

an = an-1 + d = a + (n-1)d
For this progression: an = 5 + 2 (n-1)
For example:
a21 = 5 + (21-1)(2) = 5 + 40 = 45
Examples (9)
Consider the following sequence:
3, 13, 23, 33, 43, 53,
Here the first term a = 3 and the difference d =10
a2 =a1 + d = 3 + 10 = 13

a3 = a2 + d = 13 + 10 = 23 = 3 + 2(10) = a + 2d

a4 = a3 + d = 23 + 10 = 33= 3 + 3(10) = a + 3d

a5 = a4 + d = 33 + 10 = 43= 3 + 4(10) = a + 4d

In general: The n-th term Formula

an = a + (n-1)d

For this progression: an = 3 + 10 (n-1)

For example:
a21 = 3 + (21-1)(10) = 3 + 200 = 203

Textbook: Example 1 page 229

Example (10)
Find the arithmetic progression with the 21st
term is being 45 and the 23rd term 49.

Solution:
We have:
45 = a + 20d and 49 = a + 22d
Subtracting the first equation from the
second, we get: 4 = 2d → d =2
Substituting d = 2 n the first equation, we get:
45 = a + 20(2) → a = 45 – 40 = 5
Thus the progression is the one given in example (8),
namely:
5, 7, 9, 11, 13, 15,……., 5+2(n-1), ………..

Textbook: Example 2 page 229

 Sum of the first n terms of an arithmetic
progression
Consider the arithmetic progression
a, a+d, a+2d, a+3d, a+4d, ….a+(n-2)d, a+(n-1)d, …….
Let s be the sum of the first n terms of the progression.
Then:
s = a + (a+d) + (a+2d) + (a+3d)+…….+[a + (n-2]d + a n
s = an + (an -d) + (an -2d) + (an -3d)+…….+[an - (n-2)d] + a
→ 2s = ( a + an ) + ( a + an ) + ( a + an ) +……+ ( a + an )
= n ( a + an )
= n [a + a + (n-1)d]
= n [ 2a + (n-1)d]
→ s = n [ 2a + (n-1)d] / 2

The sum formula for the first n terms of the

arithmetic progression:
sn = n [ 2a + (n-1)d] / 2
Example (11)
Consider the arithmetic progression of example (8)
Find:
1. The the sum of its first five terms and the first ten terms
2. the sum of the term from the sixth to the tenths

Solution:
1. We use the formula Sn = n [ 2a + (n-1)d] / 2
From example (8), we have: a=5 and d=2
Thus: S10 = 10 [ 2(5) + (10 -1)2] / 2 = 140
And S5 = 5[ 2(5) + (5 -1)2] / 2 = 45
2. The sum of the terms from a6 to a10 = S10– S5
= 140 – 45 = 95

Textbook: Example 3 page 229, Applied Example (4)

 Homework
1. For each of the following arithmetic progressions, find the 31st term and the
sum of the first 31 terms:
a. 2, 5, 8, 11, 13….
Answers: a31 = 94 and s31 = 1457

b. 1, 2, 3, 4, 5, …
Answers: a31 = 32 and s31 = 496

c. -5, -4 ½ , -4, -3 ½ , -3
Answers: a31 = 5 and s31 = 77.5

d. -5, -7, -9, -11,…

Answers: a31 = - 70 and s31 = - 1085

e. -5, 5 ½ , -6, -6½ , -7,…

Answers: a31 = - 25 and s31 = - 387.5
f. -5, -3, -1, 1,3,….
Answers: a31 = 50 and s31 = 775

g. 22, 32, 42, 52, …

Answers: a31 = 344 and s31 = 5332

h.* x, x + 2y, x + 4y, x + 6y, x + 8y….

Answers: a31 = x + 60y and s31 =31 x + 930y

i* . x + 2y, x + y, x, x – y, x - 2y,..
Answers: a31 = x - 28y and s31 = 31x – 403y
2. Repeat Ex(1) for n =33

3. Find the arithmetic progressions, satisfying the two given conditions

(an = the n-th term and sn= the sum of the first n terms)

a. a31 = 94 and a34 = 98

b. a31 = 94 and a1 = 2

b. a31 = 94 and d= 3

d. a4 = 11 and s4 = 26

Answers: 2, 5, 8, 11,…..
 I-2-02: Geometric Progression
A sequence of numbers in the form:
a, ar, ar2, ar3, …….
Where the ratio between of any term to the one preceding it is a constant r (called the ratio).

Examples (12)
Consider the following sequence:
5, 10, 20, 40, 80, 160,
Here the first term a = 5 and the ratio r= 2

a2 =a r = 5 ( 2 ) = 10

a3 = a2 r = 10(2) = 20 = 5 (2)2 = a r2

a4 = a3 r = 20(2) = 40 = 5 (2)3 = a r3

a5 = a4r = 40(2) = 80 = 5 (2)4 = a r4

In general:
an = an-1 r = a rn-1

The formula for the n-th term of the geometric progression:

an = a rn-1

a7 = a r7-1= 5(2)6 = 5(64) = 320

Textbook: Example 5 page 230

Examples (13)
Find the geometric progression with the with the third term equal 20 and the sixth term
equal 160.

Solution;
We have:
20 = ar3-1= ar2 and 160 = ar6-1 = ar5
→ 160/20 = ar5 / ar2

→ 8 = r3 → r=2

Thus,
20 = a (2)2 = 4a → a= 20/4 = 5

Textbook: Example 6page 231

 Sum of the first n terms of an geometric
progression
Consider the geometric progression
a, ar, ar2, ar3, ar4, ….ar5, ar6, …….
Where r is not equal to 1.
Let s be the sum of the first n terms of the progression.
Then:
s = a + ar +ar2 +ar3 + ar4 +…….. …….+ arn-2 + arn-1 (1)

Multiplying both sides of equation (1) by r, we get:

sr = ar +ar2 +ar3 + ar4 +…….. + arn-1 + arn (2)

Subtracting equation (2) from (1), we get:

s - sr = a – arn
→ s ( 1 – r ) = a ( 1 - rn )

→ s = a ( 1 - rn ) / ( 1 – r )

The sum formula for the first n terms of a geometric progression

with ratio distinct from 1
sn = a ( 1 - rn ) / ( 1 – r )

If r = 1, then, obviously all the terms are equal to a, and the sum of n such term will
be na.
Example (14)
Consider the geometric progression of example (12)
Find:
1. The the sum of its first three terms and the first six terms
2. the sum of the term from the fourth to the sixth term

Solution:
1. We use the formula sn = a ( 1 - rn ) / ( 1 – r )
From example (12), we have: a=5 and d=2
Thus: S3 = 5( 1 - 23 ) / ( 1 – 2 ) = 5(-7)/(-1) = 35
And S6 = 5( 1 - 26 ) / ( 1 – 2 ) = 5(-63)/(-1) = 315
2. The sum of the terms from a4 to a6 = s6 – s3
= 315 – 35 = 280

Textbook: Example 7 page 229, Applied Examples (8)

 Homework
1. For each of the following geometric progressions, find the 7th term
and the sum of the first 7 terms:
a. 2, 6, 18, 54, ….
Answers: a7 = 1458 and s7= 2186

b. 3, 6, 12, 24, 48, …

Answers: a7 = 192 and s7 = 381

2. For the following geometric progressions, find the 5th term and the
sum of the first 5 terms:
1, 10, 100, 1000, 10000,….
Answers: a5 = 10000 and s5 = 11111
2. Find the geometric progressions, satisfying the two given conditions
(an = the n-th term and sn= the sum of the first n terms)

a. a2 = 6 and a4 = 54
Answer:: 2, 6, 18, 54,…..
b. a2 = 6 and a4 = 24
Answer: 3, 6, 12, 24, 48,…:
c. a2 = 100 and a3 = 1000
Answer: 1, 10, 100, 1000,…
d. a2 = 6 and r= 3
Answer:: 2, 6, 18, 54
e. a2 = 6 and a1 = 2
Answer:: 2, 6, 18, 54
 I-3-01: Annuity
Definition
1. An annuity is a sequence of payment made at regular time interval.
2. The term of an annuity is the time period in which these payment are
made.
 Types of Annuity
A. Classification by Payment Date
1. Ordinary Annuity: If the payments are made at the end of each
payment period
2. An Annuity due: If the payments are made at the beginning of each
payment period.
3. Simple Annuity: If the payment period coincides with the interest
conversion period.
4. Complex Annuity: If the payment period differs from the interest
conversion period.
B. Classification by the start and the end of the
Term (time period in which the payments are paid)
1. An Annuity Certain: If the term is given by a fixed time interval.

2. Perpetuity: If the term is given by a fixed time interval but extends

indefinitely.

3. Contingent Annuity: If the term is not fixed in advance

Suppose that R Riyals are to be paid into an account at the end of each
period for n periods and that the account earns interest at the rate of i
per conversion period ( i = r / m , where r is the nominal interest and m is the number of conversion
periods in a
year)

Discussion:

1. The first payment is paid at the end of the first period and earns
interest at the rate i over the remaining (n-1) periods
And hence it has an accumulated amount of An = R ( 1 + i)n-1

2. The second payment is paid at the end of the second period and
earns interest at the rate i over the remaining (n-2) periods and hence it
has an accumulated amount of An-1 = R ( 1 + i )n-2

3. The third payment is paid at the end of the third period and
earns interest at the rate i over the remaining (n-3) periods and hence it
has an accumulated amount of An-2 = R ( 1 + i)n-3
.
.
.
.
Lastly, the last payment ( the n-th) payment is paid at the end of the last period and it
earns no
interest. an earns interest at the rate i over the remaining (n-3) periods and hence it
has an accumulated amount of A1 = R
Thus, the accumulated amount S of the annuity is:
= A1 + A2 + A3 + ……………. + An-3 + An-2 + An-1 + An

= R + R(1+i) + R(1+i)2 + R(1+i)3 +…………… R(1+i)n-1

= R [ [(1+i)n - 1 ] / [(1+i) - 1] , the sum of n terms of a

geometric progression
With: ratio r = 1 + I and first term a = R

The formula for (Future) Value of an Annuity:

S = R [ [(1+i)n - 1 ] / i]

Definition:
The expression [ [(1+i)n - 1 ] / i ] is called the compound-amount
factor, and denoted by Sn┐I ( pronounced S angle m @ i)
 Example (15)
Suppose that 100 Riyals be paid into an account at the end of each
quarter for 3 years and that the account earns interest at the rate of
8% per year compounded quarterly. Find the accumulated S of this
annuity (called future value of the annuity)?
Solution:
We have : S = R [(1+i)n - 1 ] / i
Where;
R = 100, n = the number of periods = 4(3) = 12
i = The interest per period = (0.08) / 4 = 0.02
Thus,
S = 100 [(1+ 0.02)12 - 1 ] / 0.02
 Example (16)
Suppose that 100 Riyals be paid into an account at the end of each
month for two years and that the account earns interest at the rate of
12% per year compounded monthly. Find the accumulated S of this
annuity?
Solution:
We have : S = R [(1+i)n - 1 ] / i
Where;
R = 100, n = the number of periods = 12(2) = 24
i = The interest per period = (0.12) / 12 = 0.01
Thus,
S = 100 [(1+ 0.01)24 - 1 ] / 0.02

Textbook: Example 1 page 206. Please notice that the payment here is made for
one year (the question says “12 monthly payment” ) and the conversion periods are also 12
( the question says “ 12% compounded monthly” ). Thus here both n and m are equal to 12.
 Homework
1. If a payment of 1800 Riyals is paid into an account at the end of
each quarter for 6 years and that the account earns interest at the
rate of 8% per year compounded quarterly. Find the amount S of
this annuity (future value of the annuity)?
Answer: 54759.35

1. If a payment of 200 Riyals is paid into an account at the end of each

month for 20.25 years and that the account earns interest at the rate
of 9% per year compounded monthly. Find the amount S of this
annuity (future value of the annuity)?
Answer: 137209.97
1. If a payment of 1000 Riyals is paid into an account at the end of
each year for 10 years and that the account earns interest at the
rate of 10% per year compounded anually. Find the amount S of this
annuity (future value of the annuity)?
Answer: 15937.42
 Present Value of An Annuity
To find the amount P that if deposited will grow to be equal
to the future value of an annuity, let:

P(1+i)n = R [ [(1+i)n - 1 ] / i ]
Where n is the number of equal periodic payments R made
at the end of each period.

→ P = R [ [(1+i)n - 1 ] / i ] / (1+i)n

= R [ [(1+i)n - 1 ] / i ] (1+i)-n

= R [ 1 - (1+i)-n ] / i
 Example (17)
Find the present value of an ordinary annuity consisting of
24 monthly payments of 100 Riyals each and earning
interest at 9% per year compounded monthly?
Solution:
We have : P = R [ 1 - (1+i)-n ] / i ]
Where;
R = 100, n = 24, i = r/m = 0.09 / 12 = 3/400 =0.0075
Thus,
P = 100 [ 1 - (1+0.0075)-24 ] / 0.0075

Textbook: Example 2 page 207 and Applied Examples (3) to (6) pages: 208
to 209
 Assignment
Go through the following applied examples in the textbook:
1. Example 3, Saving for college education
2. Example 4, Financing a car
3. Example 5, IRAs
4. Example 6, Investment Analysis.

Note:
1. In all of these examples, we use the formula for “ Present value for an
annuity”
2. In Examples(5) i = r/ 1 = r

3. In Examples(6)
For Clarck’s: i = 0.8/1 -

= R [ [(1+i)n - 1 ] / i ] (1+i)-n

= R [ 1 - (1+i)-n ] / i
 Homework
1. Find the present value of an ordinary simple annuity of 5000 Riyals
for 8 years @ 6% per year compounded annually.
Answer: QR 31048.97

2. Find the present value of an ordinary annuity of 4000 Riyals for 5

years @ 9% per year compounded annually.
Answer: QR 15558.61

3. Find the present value of an ordinary annuity of 800 Riyals for 7

years @ 12% per year compounded quarterly.
Answer: QR 15011.29
 I-3-01: Amortization & Sinking Funds
Definition
Amortization means essentially, finishing repaying back the
Loan, consisting of the principal (the amount borrowed) and
the interest, at the end of a fixed term in periodic
installment (usually of the of same size).

We will look at the case when the number of interest

conversion periods in year. is equal to the number of
payments per year.
.
Discussion:
We can think of the periodic loan repayment R as the payment on a simple
annuity and the original amount borrowed as the present value of the
annuity. Thus we can use the formula :
P = R [ 1 - (1+i)-n ] / i
→ R = Pi / [ 1 - (1+i)-n ]
This is the formula of the periodic payment R on a loan
P to be repaid (amortized) over n periods with interest
rate of i per (interest) conversion period.
Notice that
1. i =r/m,, where r is the nominal interest and m is the
number of periodic conversions per year and not the number of
Installments.
2. n is the number of all installments paid. If there are monthly
installments over 3 years, then n = 12(3) = 36.
Please, do not confuse m with n.
 Example (18)
Determine the size of each of equal installments paid at the end of the
year in order to repay (amortize) at the end of 10 years a loan of
borrowed 20000 plus the interest, if the interest rate is 10%, calculated
at the end of each year

Solution:
We use the formula:
R = Pi / [ 1 - (1+i)-n ]
Where; m = 1 ( only one conversion period per year).
n = 10 ( one installment per year for 10 years = 10 installments)
P = 20000, i = r/m = 0.1 / 1 = 0.1
Thus,
R = 20000(0.1) / [ 1 - (1 + 0.1)-10 ]

Textbook: Example 2 page 207 and Applied Examples (1) to (5) pages: 216 to 219
 Homework
1. Determine the size of each of equal installments paid at the end of
the year in order to repay (amortize) at the end of 10 years a loan of
borrowed 100000 plus the interest, if the interest rate is 8%,
calculated at the end of each year
Answer: 14902.95

2. Determine the size of each of equal installments paid at the end of

each quarter in order to repay (amortize) at the end of 3 years a
loan of borrowed 5000 plus the interest, if the interest rate is 4%,
calculated at the end of each quarter.
Answer: 444.24
3. Determine the size of each of equal installments paid at the end of
each quarter in order to repay (amortize) at the end of 12 years a
loan of borrowed 25000plus the interest, if the interest rate is 3%,
calculated at the end of each quarter.
Answer: 622.13

4. Determine the size of each of equal installments paid at the end of

each month in order to repay (amortize) at the end of 20 years a
loan of borrowed 80000 plus the interest, if the interest rate is 10%,
calculated at the end of each month.
Answer: 798.70
5. Determine the size of each of equal installments paid at the end of
the year in order to repay (amortize) at the end of 10 years a loan of
borrowed 100000 plus the interest, if the interest rate is 10%,
calculated at the end of each year
Answer: 16274.54

6. Determine the size of each of equal installments paid at the end of

each month in order to repay (amortize) at the end of 3 years a loan
plus the interest borrowed to buy a car costing QR 16000, if the
down payment is quarter of the price of the car and the interest rate
is 4%, calculated at the end of each month. What will be the interest
paid?
Answer: a. 387.21 , b. The interest paid = 12000 – 36(387.21) =
1939.42
Note that the down payment = 16000 – (16000)(1/4) = 12000

7. Change the number of years in Ex (6) t0 4 and aswer the same

questions
Answer: a. 304.35 , b. The interest paid = 2608.85
8. Determine the size of each of equal installments paid at the end of
each month in order to repay (amortize) at the end of 30 years a
loan plus the interest borrowed to buy a house costing QR 270000,
if the down payment is QR 30000 and the interest rate is 8%,
calculated at the end of each month. What will be the equity after 5
years, 10 years and 20 years ? ( ignore appreciation)
Answer: a. 1761.03
b.
b1. 41833.34
b2. 59460.71
b3. 124852.9
 Sinking Funds

Definition
Sinking funds means essentially, an account set up for a
particular goal at some date in the future.

Examples:

1. An account set up by a company to purchase new equipments

at some future date.

2. An account set up by a person to pay a debt at some future date.

3. . An account set up by a corporation to hire some expertise at some future

date.
Discussion:
We can think of the amount to be accumulated by a certain date in the
future as the future value S of an annuity. Thus, we will be able to
calculate the size R of an equal number n of installments that should
be
paid into the fund, taking into consideration the nominal interest rate
and the number of interest conversion periods in a year. This allows us
to use the formulas:

S = R [ (1+i)n - 1] / i
→ R = Si / [ (1+i)n - 1] (Sinking Fund Payment Formula)
This is the formula of the periodic payment R necessary to reach
an accumulated amount S over n periods with interest rate of i
per( interest conversion) period.
 Example (19)
Determine the size of each of equal quarterly installments that should be paid
into a (sinking) fund of 50000 to be collected in 3 years if the fund is earning
20% interest per year compounded quarterly.

Solution:
We use the formula:

R = Si / [ (1+i)n - 1]
Where; m = 4 ( 4 conversion period per year).
n = 4(3) = 12 ( 4 installments per year for 3 years)
S = 50000, i = r/m = 0.2 / 4 = 0.05
Thus,

R = 50000(0.05) / [ (1+ 0.05)12 - 1]

Textbook: Applied Examples 6 page: 220

 Homework
1.
Determine the size of each of equal semiannual installments that
should be paid into a (sinking) fund of QR 20000 to be collected in
6 years if the fund is earning 4% interest per year compounded
semiannually.
Answer: 1491.19

2. Determine the size of each of equal installments paid at the end of

every two month that should be paid into a (sinking) fund of QR
100000 to be collected in 20 years if the fund is earning 4.5%
interest per year compounded at the end of each two month.
Answer: 516.76

3. Determine the size of each of equal monthly installments that should

be paid into a (sinking) fund of QR 250000 to be collected in 25
years if the fund is earning 10.5% interest per year compounded
monthly
Answer: 172.95
4.
Determine the size of each of equal annual installments that should be
paid into a (sinking) fund of QR 2500000 to be collected in 20 years if
the fund is earning 7% interest per year compounded annually.
Answer: 60982.31

5.
Determine the size of each of equal quarterly installments that should be
paid into a (sinking) fund of QR 200000 to be collected in 10 years if
the fund is earning 9% interest per year compounded quarterly.
Answer: 3135.48

6. Determine the size of each of equal monthly installments that should be

paid into a (sinking) fund of QR 250000 to be collected in 25 years if
the fund is earning 8.5% interest per year compounded monthly.
Answer: 242.23

7. Determine the size of each of equal monthly installments that should be

paid into a (sinking) fund of QR 450000 to be collected in 30 years if
the fund is earning 10% interest per year compounded monthly.
Answer: 199.07
 Summary Hint
Starting from the formulas for :
1* . Compound interest (The accumulated amount  Future value) : A  P(1  i ) n &
a (r n  1)
2 * . Sum of geometric progressio n : S n  , where r here is the ratio and a the first term.
r 1
We can deduce all the ther formulas for :
1. Compound interest (The present value  Principal )  A(1  i )  n

2. Future value of annuity :

S  R  R(1  i )  R (1  i ) 2  R(1  i )3     R(1  i ) n 1
R[(1  i ) n  1]
(
(1  i )  1
R[(1  i ) n  1]

i
by substituti ng r  1  i and a  R in 2 *
3. The present value of annuity :
R[1  (1  i )  n ]
P
i
R[(1  i ) n  1]
is deduced from the future value of annuity S 
i
R[(1  i ) n  1]
by letting P (1  i ) 
n

4. The amount amortized

R[1  (1  i )  n ]
P
i
same as for the present value of annuity
4. The periodic payment needed to amortized a loan with an original amount P
iP
R
1  (1  i )  n
deduced from (4)

4. Periodic payment towards a Sinking Fund of amount S

iS
deduced from formula (2) for the future value of annuity R 
(1  i ) n  1
Using Excel
 Arithmetic Progression
The n-th Term & The Sum of the First n Terms

a d n a sn
n Ex 1-
2 3 31 94 1457
1 1 31 32 496 b
-5 0.5 31 5 77.5 c
-5 -2 31 -70 -1085 d
-5 -0.5 31 -25 -387.5 e
-5 2 31 50 775 f
22 10 31 344 5332 g

Ex 2-
2 3 33 100 1650 a
1 1 33 34 561 b
-5 0.5 33 6 99 c
-5 -2 33 -74 -1221 d
-5 -0.5 33 -26 -429 e
-5 2 33 54 891 f
22 10 33 364 6006 g

a First Term
d Difference
an The n-th term
Sum of the first n
sn terms

For the n-th

Formula
term
an = a+(n-1)*d

For the sum of

Formula
the first n terms
sn = n*(2*a+(n-1)*d)/2
 Geometric Progression
The n-th Term & The Sum of the First n Terms

a r n an sn
2 3 7 1458 2186 Ex 1 - a
3 2 7 192 381 Ex 1 - b
1 10 5 10000 11111 Ex 2

a First Term
d Ratio

The n-th term

an
Sum of the
sn first n terms

For the n-th

Formula
term
an = a*r^n

For the sum of

Formula
the first n terms
sn = a*(r^n-1)/(r-1)

Also sn = a*(1-(r^n))/(1-r)
 Amortization
Applying the formula of the periodic payment R on a loan
P to be repaid (amortized) over n periods with interest
rate of i per interest conversion period.

R = Pi / [ 1 - (1+i)-n ]
P r m t i n R
20000 0.1 1 10 0.1 10 3254.908 Example (18)
100000 0.08 1 10 0.08 10 14902.95 Ex 1
5000 0.04 4 3 0.01 12 444.2439 Ex 2
25000 0.03 4 12 0.0075 48 622.1261 Ex 3
80000 0.105 12 20 0.00875 240 798.7039 Ex 4
100000 0.1 1 10 0.1 10 16274.54 Ex 5
12000 0.1 12 3 0.008333 36 387.2062 Ex 6
12000 0.1 12 4 0.008333 48 304.351 Ex 7
240000 0.08 12 30 0.006667 360 1761.035 Ex 8
240000 0.08 12 30 0.006667 360 1761.035 Ex 8-2
240000 0.08 12 30 0.006667 360 1761.035 Ex 8-3
160000 0.09 12 30 0.0075 360 1287.396 Example (18)-02

P Original Loan
r yearly interest rate
m num ber of periods/yr
t num ber of years
n = mt num ber of payments in t yrs
same as num ber of periods in t yrs
I = r / m interest rate per period
→ R Periodic paym ent

Formula
R = i*P / (1-(1+i)^(-n))
 Sinking Fund
Periodic Payment Formula
Sinking Fund
Periodic Payment Formula

S r m t i n R
30000 0.1 4 2 0.025 8 3434 Example (19)
20000 0.04 2 6 0.02 12 1491.2 Ex 1
100000 0.045 6 20 0.008 120 516.76 Ex 2
250000 0.105 12 25 0.009 300 172.95 Ex 3
2500000 0.07 1 20 0.07 20 60982 Ex 4
200000 0.09 4 10 0.023 40 3135.5 Ex 5
250000 0.085 12 25 0.007 300 242.23 Ex 6
450000 0.1 12 30 0.008 360 199.07 Ex 7

S The Sum to be accumulated

r interest/yr
m number of conversion periods/yr
equal number of payment/yr
t number of years
I = r / m interest per period
n = mt number of periods in t years

→ R The periodic Payment

The Formula
R = i*S/((1+i)^n-1)