Beruflich Dokumente
Kultur Dokumente
P = principal
= original amount borrowed
= original amount invested
I = interest
= a dollar amount of money
representing a fee or service charge
paid to the lender for the use of
his/her money
Thus, S−P=I
Notes
• a(t) = original investment + interest
• t = term of the investment
= time elapsed from date of investment
• time is measured in periods; but most
common period used is YEARS
• We assume (for now) that no principal is
added or withdrawn during the term, so
that any change in the value of the
investment is due strictly to the effect of
interest
1. A(0) = P
2. A(t) = P a(t)
4. A(t) is a continuous
Define
In = amount of interest earned in period n
where
In = A(n) − A(n − 1)
Example 1.1.1
You are given that the accumulation function is
a(t) = b(t − 1)2 + ct + d. You are also given that
under this accumulation function, $800 invested
at time 0 accumulates to $920 at time 1 and
$3704 at time 3.
We define,
Note
The rate of interest is expressed as a
percentage
→ i = 6% means i = 0.06
→ i = 4 ½% means i = 0.045
a (n) − a (n − 1)
in =
a (n − 1)
The above can also be written in terms of
the amount function:
A( n) − A(n − 1) In
in = =
A(n − 1) A(n − 1)
Example 1.2.1
In example 1.1.1, calculate the effective rate of
interest earned in year 1, year 6 and year 10.
Solution to 1.2.1
There are many different functional forms of
the accumulation function, a(t)
In = I = P i t
We know that I = S − P
Thus,
S = P+I = P+Pit
= P(1 + it )
In other words:
a(t) = 1 + i t
Notes
number of months
t=
12
number of days
(a) Exact Interest: t = 365
number of days
(b) Ordinary Interest: t = 360
(also referred to as the Banker’s Rule)
Example 1.3.1
Calculate the future value in 5-years of $5000
invested today, earning simple interest at i = 5%.
Solution to 1.3.1
Example 1.3.2
Using exact and ordinary interest, what will
$15,000 accumulate to over 120 days at a simple
interest rate of i = 7%?
Solution to 1.3.2
Example 1.3.3
How long will it take $1500 to earn $22.50 in
simple interest at i = 9%?
Solution to 1.3.3
Effective Rate of Interest
a (n) − a (n − 1) [1 + in] − [1 + i(n − 1)] i
in = = =
a (n − 1) [1 + i( n − 1)] [1 + i (n − 1)]
Example 1.3.4
An investment of $600 is earning 6% per year
simple interest. Calculate the effective rate of
interest earned in years 1, 5 and 10.
Solution to 1.3.4
Example 1.3.5
You borrow $1500 on March 13, 2018 and
another $2000 on June 24, 2018. If you are
being charged simple interest at i = 12%, how
much do you need to pay back on September 13,
2018?
Solution to 1.3.5
Example 1.3.6
You deposit $200 today, $300 at the end of 2-
months, $400 at the end of 5-months and $500 at
the end of 8-months. At the end of the year, you
have $1429.75. What rate of simple interest is
assumed?
a(t) = (1 + i ) t
Note
The term (1 + i ) t is called the accumulation
factor
Solution to 1.4.1
Example 1.4.2
A loan of $2500 is taken out and is due with
interest at 8%. How much is to be paid back in
8-months if
(a) It is a simple interest rate
(b) It is a compound interest rate
Solution to 1.4.2
Comparison of Compound and Simple
Interest
Example 1.4.3
You deposit $3000 today and another $X at the
end of 1.5-years in a fund earning interest at
i = 3.5%. At the end of 6 years, you have
accumulated $5600. What is the value of X?
Solution to 1.4.3
Bonus Example
A deposit of $5000 is made today in a fund
earning compound interest at i. Another deposit
of $8000 is made into the same fund at the end
of 3-years. At the end of 6-years, the fund has
accumulated to $16,000. What is the value of i?