Financial Mathematics

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Outline

Simple and Compound Interest

Ordinary Annuities

Loan Repayment or Paying Off a Debt

Other Applications of Financial Mathematics

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Learning Outcome

At the end of the lesson, the students are able to:

1.to compute the accumulated or present value of a certain amount of money
2.to compute the accumulated or present value of a series of periodic payments
(annuity)
3.to construct an amortization schedule when paying off a loan

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Simple and Compound Interest

Principal - the money a bank or other lender is willing to lend you.

The amount of credit and the interest rate that you may obtain depend on the
assurance you can give the lender that you will be able to repay the loan based on
any of the following:
► your credit reputation
► your capacity to earn money or income or
► the security or collateral you pledge to be paid to the lender in case you
default in your payment.

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Simple and Compound Interest

The most common ways of borrowing money is through

► a loan paid in periodic installments,
► a credit card,
► a depository account in banks (banks are the borrowers), and
► a stock or a bond (gov’t and private corporations sell bonds to raise funds).

Interest is the money the borrower pays for the use of the lender’s money. One
type of interest is called simple interest.

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Simple and Compound Interest

Simple Interest
Simple interest is based on the entire amount of the loan for the total period of
the loan. The formula used to find simple interest follows.

Interest = principal × rate × time

I = Prt

where P is the principal amount, r is the interest rate and the nonnegative
value of t (t ≥ 0) is the term of the investment (number of days, months or
years for which the money will be lent).

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 Simple and Compound Interest
Since simple interest is usually assumed for short-term transactions, the time
# of days between two dates
t=
# of days in a year
is considered to be a fraction of a year and is determined under the following
different conventions:
► Exact Interest. Exact number of days between dates is used and the number of
days in a year is taken to be 365 days (366 days for leap years).
► Ordinary Interest. Each month is said to have 30 days and the number of
days in a year is taken to be 360 days (i. e. 12 × 30).
► Banker’s Rule or Merchant’s Rule. Exact number of days between dates is
used and the number of days in a year is taken to be 360 days. Under this rule,
an investor or lender mathematically yields the highest amount of interest so
banks would prefer this method.

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Simple and Compound Interest
Example
Suppose that Feli borrowed PHP 25,000 from the Provident Fund on March 8
and pays the entire sum including interest on October 3 of the same year, and
that the interest rate is 5%. Find the amount of interest earned, if it is
computed using (1) exact simple interest (2) ordinary simple interest and (3)
banker’s rule. Assume non leap year.

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 Simple and Compound Interest
Example
Suppose that Feli borrowed PHP 25,000 from the Provident Fund on March 8 and
pays the entire sum including interest on October 3 of the same year, and that the
interest rate is 5%. Find the amount of interest earned, if it is computed using (1)
exact simple interest (2) ordinary simple interest and (3) banker’s rule. Assume
non leap year.

Solution: From March 8 to October 3, there are exactly

N = 23 + 30 + 31 + 30 + 31 + 31 + 30 + 3 = 209 days and under ordinary interest, there
are N = 22 + 30 + 30 + 30 + 30 + 30 + 30 + 3 = 205 days. Thus the amount of interest
is 209
1. I = 25, 000 × 0.05 × 365 = PHP 715.75
205
2. I = 25, 000 × 0.05 × 360 = PHP 711.81
209
3. I = 25, 000 × 0.05 × 360 = PHP 725.69
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Simple and Compound Interest

Remark
The amount of interest per period accrued under simple interest is fixed or
constant (i.e. it is always a percentage of the principal amount or
mathematically, P × r every period).

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Simple and Compound Interest

Accumulated and Present Value

In an investment transaction, the value of a principal plus the total interest accrued
during the term is termed as its accumulated value or future value and we shall
denote it by A. Thus,
A=P+I
where P is the principal amount, and I is the interest earned.
Suppose at some time in the future, we would like to obtain a certain amount of
money. We will discount interest from the accumulated value to determine its
present value or the amount to be invested to earn the desired interest. Moreover,
the present value of a certain amount at the beginning of the term is the principal
value (P = A − I ).

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Simple and Compound Interest

Accumulated Value under Simple Interest

If a principal amount P is invested for a term t (t ≥ 0) earns simple interest at a

rate
r , then its accumulated value at the end of the term is given by

A=P+I
= P + Prt
A = P(1 + rt).

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 Simple and Compound Interest
Investments that involve compound interest may play an important role in reaching
some of your long-term financial goals such as investments. An investment is the
use of money or capital for income or profit.

Two classes of Investments

► Fixed Investment
In a fixed investment, the amount invested as principal may be guaranteed
and the interest is computed at a fixed rate. Guaranteed means that the
exact amount invested will be paid back together with any accumulated
interest.
Example: savings accounts, money market deposit accounts, certificates of
deposit, and government savings bond
► Variable Investment
In a variable investment, neither the principal nor the interest is
guaranteed.
Example:stocks, mutual funds, and commercial bonds Simple and Compound Interest 13/61
Simple and Compound Interest

Compound Interest
Investments made at a compound interest has the property that the interest
earned at the end of one period is automatically invested in the next period to
earn additional interest.

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Simple and Compound Interest

Let us see the difference of simple and compound interest.

Consider an amount of PHP of 1,000 which is invested at a periodic interest rate of
5%. The amounts in the account after 3 periods assuming (a) simple interest and
(b) compound interest will be
(a)Simple Interest
Year 1 : 1, 000 + 0.05(1, 000) = 1, 050
Year 2 : 1, 000 + 0.05(1, 000) + 0.05(1, 000) = 1, 000(1 + 0.05(2)) = 1, 100
Year 3 : 1, 000 + 0.05(1, 000) + 0.05(1, 000) + 0.05(1, 000) = 1, 000(1 + 0.05(3))
= 1, 150
(b)Compound Interest
Year 1 : 1, 000 + 0.05(1, 000) = 1, 050
Year 2 : 1, 050 + 0.05(1, 050)) = 1, 050(1 + 0.05) = 1, 102.50
Year 3 : 1, 102.50 + 0.05(1, 102.50) = 1, 102.50(1 + 0.05)
= 1, 157.625 ≈ 1, 157.63
Simple and Compound Interest 15/61
Simple and Compound Interest 16/61
Simple and Compound Interest 17/61
Simple and Compound Interest

A
Most debts and investments earn
compound interest
compound interest, where interest is
earned on both the original principal and 1 + r
• simple interest
the interest up to that point (or we say,
1
”interest is compounded”). An investment
with compound interest will be worth
more every year and thus will earn more
interest. Hence, banks charge compound
interest for long-term transactions. t
1

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Simple and Compound Interest

Example

Regine invested PHP 80,000 in a savings account with an interest of 1.8%

convertible (compounded) monthly. If she, does not make any deposit nor
withdrawal into this account, determine the amount in the account after 2
years.

Solution:
By the previous formula,

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Simple and Compound
Interest
Example

Cyrus would like to invest enough money in a certificate of deposit (CD) now to
pay for his son’s college expenses. If he estimates that he will need PHP
1,500,000 in 6 years, how much should he invest now in a CD that has a rate
of 2.5% compounded quarterly?

Solution:

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Simple and Compound Interest

Caution: Convert percentages to decimal carefully. Round off amounts of money

to the nearest centavo. Do not round off in the middle of the computation because
the final answer may be off by a huge amount especially when dealing with large
amounts of investments. Have a good scientific calculator available to aid your
computations.

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Ordinary Annuities

Annuity
An annuity is an account into which, or out of which, a sequence of scheduled
payments is made.

Examples of annuities:
► It may be an investment account that you have with a bank, insurance
company, or financial management firm.
► It may contain investments in stocks, bonds, mutual funds, money market
accounts, and other types of investments.
► savings account for college or retirement

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 Ordinary Annuities

Consider an annuity with PhP 100 regular payments at the end of n periods such that it
earns interest at an effective rate of 5% per period. The accumulated value after n period
will be as follows.

Recall the basic compound interest formula An = An−1(1 + r ).

Starting with an empty account, we can begin with:

A0 =0
A1 = A0(1 + 0.05) + 100 = 0(1.05) + 100 = 100
A2 = A1(1.05) + 100 = 100(1.05) + 100 = 100(1.05 + 1)
A3 = A2(1.05) + 100 = 100(1.05 + 1)(1.05) + 100 = 100(1.052 + 1.05 + 1)
.
.
An = 100(1.05n−1 + 1.05n−2 + . . . + 1)
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Ordinary Annuities

To simplify, multiply both sides to 1.05.

1.05An = 100(1.05n + 1.05n−1 + . . . + 1.05)

Subtract 1.05An − An.
1.05An = 100(1.05n + 1.05n−1 + . . . + 1.05)
−An = −(100(1.05n−1 + 1.05n−2 + . . . + 1.05 + 1))
An(1.05 − 1) = 100(1.05n − 1)
Solving for An.

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Ordinary Annuities

In general, the accumulated value of an annuity with regular payments R after n

periods that earns an interest rate r is

(1 + r )n − 1
A=R× .
r
Following the same process, the present value of an annuity with
regular payments/payouts R after n periods that earns an interest
rate r is
1 − (1 + r )−n
P=R× .
r

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Ordinary Annuities

Remarks:
► The present value of an annuity is used to calculate payout annuity, amortized
loans or installment loans.
► In payout annuity, you start with money in the account, and pull money out of
the account on a regular basis. Any remaining money in the account earns
interest. After a fixed amount of time, the account will end up empty.

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Ordinary Annuities

Ordinary Annuity
An annuity into which equal payments are made at regular intervals, with the
interest compounded at the end of each interval and with a fixed interest rate for
each compounding period, is called an ordinary annuity or a fixed annuity.

AV and PV of an Ordinary Annuity

If an ordinary annuity has regular payments of R at the end of each of the n
periods and earns interest at an effective rate of r per period. Then its present
and accumulated values are given by

(1 + r )n − 1 1 − (1 + r )−n
A=R× And P=R×
r r

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Ordinary Annuities

Remarks:
► Since annuities are mostly long-term transactions, we will assume that
interest is compounded at an effective rate of r every period
► The n such regular payments noted above are said to be made at the end of
each payment period such that no additional payments nor withdrawals are
made during the term.
► All payments in the ordinary annuities considered in this material are considered
guaranteed payments. Such annuities are referred to as certain annuities. If
payments depend on the occurrence of an event, then we call it a contingent
annuity (e.g. payments in an annuity from a pension fund are paid out as long
as the annuitant is alive). The latter is not covered in this material and may be
discussed in detail in an advanced course in financial mathematics as it will
require deeper knowledge of probabilities.

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Ordinary Annuities
Example

JB and Maryvhic are depositing PHP 10,000 each quarter in an ordinary annuity
that pays 4% interest compounded quarterly. Determine the accumulated
amount in this annuity after 5 years. How much total interest was earned?

Solution: Note that there are n = 4 × 5 = 20 quarterly payments and the quarterly rate
is 1% so the value of the annuity after 5 years is
(1.01)20 − 1
A = 10, 000 × 0.01 = PHP 220,190.04
The total interest is hence equal to
I = Accumulated Amount − Total Payments
= 220, 190.04 − 10, 000(20)

= 220, 190.04 − 200, 000 PHP 20,190.04

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Ordinary Annuities

Example
Kate wants to be able to take PhP 20,000 per month for a total of 20 years
from her retirement account. The account earns 6% interest. How much will
she needs in her account when she retires?

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Ordinary Annuities

Example
Jeremiah is willing to pay a loan with PHP 3,000 monthly installments for 3
years at a rate of 8% convertible monthly. How much money can he borrow
today?

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Loan Repayment or Paying Off a Debt

A loan is an arrangement in which a lender gives money or property to a borrower,

and the borrower agrees to return the property or repay the money, usually along
with interest, at some future point(s) in time. Various methods of repaying a loan are
possible. We will consider two of them: The amortization method and the sinking
fund method.

Amortization Method
In the amortization method the borrower makes installment payments to the
lender. Usually these payments are at a regularly spaced periodic intervals;
the progressive reduction of the amount owed is described as the
amortization of the loan. Examples include car loan, home mortgage
repayment.

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Loan Repayment or Paying Off a
Debt
When using the amortization method, the payments form an annuity whose present
value is equal to the original amount of the loan. In this section, we want to
determine the unpaid balance, also referred to as the outstanding loan balance
or unpaid principal at any time after the inception of the loan.

Two approaches in finding the amount of the outstanding balance:

► Prospective Method: the outstanding loan balance at any point in time is
equal to the present value at that date of the remaining payments.
► Retrospective Method: the outstanding loan balance at any point in time is
equal to the original amount of the loan accumulated to that date less the
accumulated value at that date of all payments previously made.

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.

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 Loan Repayment or Paying Off a Debt

Example
A loan of PhP 200,000 is being repaid with quarterly payments of PhP 20,000
at the end of each year. The interest rate charged on the loan is 8%
compounded quarterly. Calculate the outstanding balance of the loan
immediately after the 5th payment.

Solution: There were already 5 quarterly payments done and we have no

information about how many more payments are remaining so we compute for
the outstanding loan balance retrospectively as follows

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Loan Repayment or Paying Off a Debt

Example
A loan is being repaid with level monthly payments of PHP 1,000. Calculate the
outstanding balance of the loan if there are 12 payments left. The next payment
will be paid one year from now and the interest rate is 6% convertible monthly.

Solution: There are 12 monthly payments and we have no information about how
much the principal loan balance is and how many payments have been made
previously so we compute for the outstanding loan balance as follows

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Loan Repayment or Paying Off a Debt

When a loan is being repaid with the amortization method, each payment is
partially a repayment of principal and partially a payment of interest.
Determining the amount of each for a payment can be important (for tax
purposes, for example). An amortization schedule is a table which shows the
division of each payment into principal and interest, together with the
outstanding loan balance after each payment is made.

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Loan Repayment or Paying Off a Debt
Let L be the principal loan balance (i.e. the outstanding loan balance at time 0) being repaid with
regular installment payments of R, then an amortization schedule would look the table below.

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Loan Repayment or Paying Off a Debt

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Loan Repayment or Paying Off a
Debt
Example
Consider a loan PHP 30,000 with level payments to be made at the end of
every 2 months for 10 months at a bimonthly rate of 5% (need not divide by 6,
this is already the effective rate every 2-month period unless we say
”compounded bimonthly”). Construct a loan amortization schedule for this.

Solution:We first compute for the amount of each level payment. This is
obtained as follows

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Loan Repayment or Paying Off a Debt

Immediately fill the payment column with this amount.

Payment Interest Principal Outstanding

Period Amount Paid Repaid Balance
0 PHP 30,000.00

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Loan Repayment or Paying Off a Debt

Immediately fill the payment column with this amount.

Payment Interest Principal
Outstanding
Period Amount Paid Repaid Balance
0 PHP 30,000.00
1 PHP 6,929.24 PHP 1,500.00 PHP 5,429.24 PHP 24,570.76

Payment Amount >

Interest Paid = Outstanding Balance x Rate

Principal Repaid = Payment Amount - Interest paid
New Outstanding Balance = Old Outstanding Balance - Principal Repaid
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Loan Repayment or Paying Off a Debt

Immediately fill the payment column with this amount.

Payment Interest Principal

Outstanding
Period Amount Paid Repaid Balance
0 PHP 30,000.00
1 PHP 6,929.24 PHP 1,500.00 PHP 5,429.24 PHP 24,570.76
2 PHP 6,929.24 PHP 1,228.54 PHP 5,700.70 PHP 18,870.06

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Loan Repayment or Paying Off a
Debt

Immediately fill the payment column with this

amount.
Payment Interest Principal Outstanding
Period Amount Paid Repaid Balance
0 PHP 30,000.00
1 PHP 6,929.24 PHP 1,500.00 PHP 5,429.24 PHP 24,570.76
2 PHP 6,929.24 PHP 1,228.54 PHP 5,700.70 PHP 18,870.06
3 PHP 6,929.24 PHP 943.50 PHP 5,985.74 PHP 12,884.32

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Loan Repayment or Paying Off a Debt

Immediately fill the payment column with this amount.

Payment Interest Principal Outstanding

Period Amount Paid Repaid Balance
0 PHP 30,000.00
1 PHP 6,929.24 PHP 1,500.00 PHP 5,429.24 PHP 24,570.76
2 PHP 6,929.24 PHP 1,228.54 PHP 5,700.70 PHP 18,870.06
3 PHP 6,929.24 PHP 943.50 PHP 5,985.74 PHP 12,884.32
4 PHP 6,929.24 PHP 644.22 PHP 6,285.02 PHP 6,599.30

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Loan Repayment or Paying Off a Debt

Immediately fill the payment column with this amount.

Payment Interest Principal Outstanding

Period Amount Paid Repaid Balance
0 PHP 30,000.00
1 PHP 6,929.24 PHP 1,500.00 PHP 5,429.24 PHP 24,570.76
2 PHP 6,929.24 PHP 1,228.54 PHP 5,700.70 PHP 18,870.06
3 PHP 6,929.24 PHP 943.50 PHP 5,985.74 PHP 12,884.32
4 PHP 6,929.24 PHP 644.22 PHP 6,285.02 PHP 6,599.30
5 PHP 6,929.24 PHP 329.97 PHP 6,599.27 PHP 0.00

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 Loan Repayment or Paying Off a Debt

Remarks: Observe the following from the previous example.

► The last principal repaid is off by PHP 0.03 as an effect of rounding off the level
payment computed to the nearest centavo. As a rule of thumb, you may manually
adjust this by adding this to the last principal repaid. In practice, tables are created
using spreadsheets or computer programs to avoid this rounding off errors.
► The final balance is 0. The level payment fully pays off the loan as intended.
► As the balance decreases over time the amount of interest due in each
period decreases.
► As the interest due goes down, the amount of principal paid in each period
increases.
► This method is typically applied to loans with level payments but the payments also
may change or vary over time as may apply to a payor who wish to make
payment adjustments in the middle of the term.
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Loan Repayment or Paying Off a Debt

Example
Consider the loan PHP 30,000 in the previous example. Suppose the debtor
can only pay PHP 5,000 for each of the first 2 periods and catch up with a
higher payment for the final three periods. Construct a loan amortization
schedule for this.

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Loan Repayment or Paying Off a Debt

Example
Consider the loan PHP 30,000 in the previous example. Suppose the debtor
can only pay PHP 5,000 for each of the first 2 periods and catch up with a
higher payment for the final three periods. Construct a loan amortization
schedule for this.

Solution: We first fill the first two payments with PHP 5,000.
Payment Interest Principal Outstanding
Period Amount Paid Repaid Balance
0 PHP 30,000.00

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Loan Repayment or Paying Off a Debt

Example
Consider the loan PHP 30,000 in the previous example. Suppose the debtor
can only pay PHP 5,000 for each of the first 2 periods and catch up with a
higher payment for the final three periods. Construct a loan amortization
schedule for this.

Solution: We first fill the first two payments with PHP 5,000.
Payment Interest Principal Outstanding
Period Amount Paid Repaid Balance
0 PHP 30,000.00
1 PHP 5,000.00 PHP 1,500.00 PHP 3,500.00 PHP 26,500.00

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Loan Repayment or Paying Off a Debt

Example
Consider the loan PHP 30,000 in the previous example. Suppose the debtor
can only pay PHP 5,000 for each of the first 2 periods and catch up with a
higher payment for the final three periods. Construct a loan amortization
schedule for this.

Solution: We first fill the first two payments with PHP 5,000.
Payment Interest Principal Outstanding
Period Amount Paid Repaid Balance
0 PHP 30,000.00
1 PHP 5,000.00 PHP 1,500.00 PHP 3,500.00 PHP 26,500.00
2 PHP 5,000.00 PHP 1,325.00 PHP 3,675.00 PHP 22,825.00

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Loan Repayment or Paying Off a Debt

Example
Consider the loan PHP 30,000 in the previous example. Suppose the debtor
can only pay PHP 5,000 for each of the first 2 periods and catch up with a
higher payment for the final three periods. Construct a loan amortization
schedule for this.

Solution: We first fill the first two payments with PHP 5,000.
Payment Interest Principal Outstanding
Period Amount Paid Repaid Balance
0 PHP 30,000.00
1 PHP 5,000.00 PHP 1,500.00 PHP 3,500.00 PHP 26,500.00
2 PHP 5,000.00 PHP 1,325.00 PHP 3,675.00 PHP 22,825.00
3

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 Loan Repayment or Paying Off a Debt

Thus, the outstanding balance after two payments is PHP 22,825.00 which will be repaid with higher revised
payments determined as follows

As expected, it is higher than the first two payments.

Payment Interest Principal Outstanding

Period Amount Paid Repaid Balance
0 PHP 30,000.00
1 PHP 5,000.00 PHP 1,500.00 PHP 3,500.00 PHP 26,500.00
2 PHP 5,000.00 PHP 1,325.00 PHP 3,675.00 PHP 22,825.00
3 PHP 8,381.54 PHP 1,141.25 PHP 7,240.29 PHP 15,584.71

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 Loan Repayment or Paying Off a Debt

Thus, the outstanding balance after two payments is PHP 22,825.00 which will be repaid with higher revised
payments determined as follows

As expected, it is higher than the first two payments.

Payment Interest Principal Outstanding

Period Amount Paid Repaid Balance
0 PHP 30,000.00
1 PHP 5,000.00 PHP 1,500.00 PHP 3,500.00 PHP 26,500.00
2 PHP 5,000.00 PHP 1,325.00 PHP 3,675.00 PHP 22,825.00
3 PHP 8,381.54 PHP 1,141.25 PHP 7,240.29 PHP 15,584.71
4 PHP 8,381.54 PHP 779.24 PHP 7,602.30 PHP 7,982.41

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Loan Repayment or Paying Off a Debt

Thus, the outstanding balance after two payments is PHP 22,825.00 which will be repaid with higher revised
payments determined as follows

As expected, it is higher than the first two payments.

Payment Interest Principal Outstanding
Period Amount Paid Repaid Balance
0 PHP 30,000.00
1 PHP 5,000.00 PHP 1,500.00 PHP 3,500.00 PHP 26,500.00
2 PHP 5,000.00 PHP 1,325.00 PHP 3,675.00 PHP 22,825.00
3 PHP 8,381.54 PHP 1,141.25 PHP 7,240.29 PHP 15,584.71
4 PHP 8,381.54 PHP 779.24 PHP 7,602.30 PHP 7,982.41
5 PHP 8,381.54 PHP 399.12 PHP 7,982.41 PHP 0.00

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Loan Repayment or Paying Off a Debt

Thus, the outstanding balance after two payments is PHP 22,825.00 which will be repaid with higher revised
payments determined as follows

As expected, it is higher than the first two payments.

Payment Interest Principal Outstanding
Period Amount Paid Repaid Balance
0 PHP 30,000.00
1 PHP 5,000.00 PHP 1,500.00 PHP 3,500.00 PHP 26,500.00
2 PHP 5,000.00 PHP 1,325.00 PHP 3,675.00 PHP 22,825.00
3 PHP 8,381.54 PHP 1,141.25 PHP 7,240.29 PHP 15,584.71
4 PHP 8,381.54 PHP 779.24 PHP 7,602.30 PHP 7,982.41
5 PHP 8,381.54 PHP 399.12 PHP 7,982.41 PHP 0.00

Note that we adjusted the last principal repaid manually by PHP 0.01 so the final balance will be 0.

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Other Applications of Financial Mathematics
► Stocks
When the owners of a company wish to raise money to expand their company,
they often decide to sell part of the company to investors. When an investor
purchases a portion of a company, the investor is said to own stock in the
company. The unit of measure of the stock is called a share. By buying
shares of stock, an investor is becoming a part owner, or shareholder, of the
company.
Large companies may have many millions or even billions of shares of stock
available for trading to the general public. For example, as of 2020, there are
about 4.334 billion shares of Apple, Incorporated, owned by thousands of
investors. On July 30, 2020, each of these shares was worth $ 380.16.
Investing in stocks over a long period of time is usually a good investment.
However, since the price of stocks may go down as well as up, investing in
stocks involves some risk of losing some or all of your investment.
Other Applications of Financial Mathematics 51/61
Other Applications of Financial Mathematics
► Bonds
A bond is a type of loan. When government agencies or corporations need money, they often
borrow money from investors by selling, or issuing, bonds. When an investor purchases a bond,
the investor is actually lending money to the bond’s issuer. The issuer agrees to pay the investor
a certain interest rate over a stated period of time, usually from 1 to 30 years. The date on which
the issuer repays the loan is called the date of maturity.

Although bonds are generally considered safer investments than stocks, they do have some
risks. On rare occasions, issuers may fail to make interest payments or may fail to return the
investment entirely. A more common risk is that the value of a bond may decrease if interest
rates increase. Such a decrease may cause investors to lose some of their investment if they
decide to sell their bond before the date of maturity. In general, though, bonds offer a very stable
investment that usually provide a higher return on investment than savings accounts or
certificates of deposit without many of the risks associated with investing in stocks.

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► Mutual Funds
A mutual fund is an investment tool that enables investors to indirectly own a wide variety of stocks, bonds, or other
investments. When investors purchase shares in a mutual fund, they are actually placing their money in a pool along
with many other investors. The investments within a mutual fund are called the mutual fund’s portfolio. The investors
of a mutual fund share the gains and losses from the investments within the portfolio. There are some distinct
advantages to investing in mutual funds rather than investing in individual stocks and bonds. First, investors in
mutual funds have their money managed by full-time professionals. Second, because large sums of money are
managed within a mutual fund, costs related to investing, known as commissions, are generally lower than they are
for purchasing individual stocks and bonds. Third, when investors purchase shares in a mutual fund, they are
indirectly purchasing shares in a multitude of stocks or bonds. This diversification can greatly help to reduce some of
the risks of investing.

One disadvantage of mutual fund investing is the potential to miss out on a large return on investment. In general,
though, investing in mutual funds is considered an excellent way to begin investing and to maintain diverse
ownership in a variety of investments.

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Other Applications of Financial Mathematics

► Home Equity Most of us are aware that one big dream is to own your own home. What
we may not realize is that in addition to having a place to call your own, several
important financial benefits occur when you own your own home.

)
First, instead of paying rent to someone else, you make a mortgage payment that
builds the equity in your home. Equity is the difference between the appraised
value of your home and your loan balance, and it usually increases with each
payment you make. As years go by, this equity may also help you qualify for other
loans such as college and car loans.
)
Second, the interest and real estate taxes you pay (in most cases) are deductible on
your income tax returns. These deductions can add up to significant savings each
year and may result in a larger tax refund.
)
Finally, over time you can typically expect your home to increase in value. Thus, your
home not only becomes your place of dwelling; in most cases, it also serves as
a wise financial investment.
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Other Applications of Financial Mathematics
► Credit Scores When consumers borrow money by obtaining car loans, home
mortgages, or other loans or through the use of credit cards, the lender takes a
risk by giving money to the borrower in exchange for the borrower’s promise to
repay the loan plus interest. To minimize their risk, lenders do research on
borrowers to determine the likelihood the borrowers will default, or fail to repay
the loans.
Banks submit our basic credit data to the Credit Information Corporation (CIC),
an Office created under Republic Act (R.A.) No. 9510, also known as the Credit
Information System Act. CIC assign a credit score to an individual after
researching the individual?s credit history, income, age, and other factors.
Lenders use the information from CIC to determine a borrower’s credit
worthiness. A high credit score suggests that the individual is more likely to
repay a loan and often enables the borrower to get lower interest rates on
loans.
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