GE301 Unit 2

Lecture 2: Cash-flow Diagrams

Compound Interest
Rates of Interest

George Y. Chao Jr.

Assistant Professor
Department of Chemical Engineering
University of Santo Tomas
Cash-Flow Diagrams ₱150
A ₱100 loan
at 10%
interest rate 1 2 4 5
0 3
for 5 years…

₱100 Viewpoint of the lender

₱100

0 1 2 3 4 5

Viewpoint of the borrower ₱150

Compound Interest Solving for F:
F = P (F/P, i%, n)
F = P (1 + i)n
P single payment compound amount factor
(1 + i)n
0 1 2 3 n-1 n

F
Solving for P:
P = F (P/F, i%, n)
P = F (1 + i)-n (1 + i)-n
single payment present worth factor
Nominal Rate of Interest (r)
Where:

i = interest rate per interest period

r = nominal rate of interest
m = number of compounding periods in a year

Nominal Rate i (interest rate per interest period)

14% compounded 14% 𝑐. 𝑠𝑒𝑚𝑖−𝑎𝑛𝑛𝑢𝑎𝑙𝑙𝑦

𝑖= = 7%
semi-annually 2

12% compounded 12% 𝑐. 𝑞𝑢𝑎𝑟𝑡𝑒𝑟𝑙𝑦

𝑖= = 3%
quarterly 4
Effective Rate of Interest (Eff. Rate)
Where:

i = interest rate per interest period

m r = nominal rate of interest
Eff. rate = (1 + i ) - 1 m = number of compounding periods in
a year

Nominal Rate Effective Rate

0.14 2
14% compounded 𝑒𝑓𝑓. 𝑟𝑎𝑡𝑒. = (1 + 2
) −1 = 0.1449
semi-annually or 14.49%

0.12 4
12% compounded 𝑒𝑓𝑓. 𝑟𝑎𝑡𝑒. = (1 + ) −1 = 0.1255
4
quarterly or 12.55%
Calculations on Effective Rate of Interest
1. Comparing nominal rates: which of the given nominal rates gives higher
interest?

8.25% compounded semi-annually

8.00% compounded monthly

2. What is the equivalent nominal rate of 9% compounded quarterly if

compounded monthly? What is r% compounded monthly?
Effective rate of 9% c. quarterly = Effective rate of r% c. monthly
0.09 4 𝑟 12
(1 + ) −1 = 1 + −1
4 12