Maths in the Workplace

lecture 9
financial maths

Simple Interest
Example Suppose 500 is invested for 3 years at 10% interest. The interest is compounded annually. At the end of each year the interest is calculated and added on. At the end of year 1: Interest is 50 so the total is now 550. Simple Interest: The interest will be the same each year i.e. 50

Compound Interest
Interest is given on the interest as well as the initial amount invested. Virtually all financial investments use compound interest rather than simple interest. At the end of year 2 the compound interest is 10% of 550 which is 55, giving a total of 605.

 At the end of year 3 the compound interest is 10% of 605 = 60.50 investment total is 605+60.50=665.50
COMPARING SIMPLE & COMPOUND year simple compound 1 550 550 2 600 605 3 650 665.50

Compound Interest
Calculating interest year by year is inefficient if you want the investment value at some time in the future. In the first example the investment value can be obtained by multiplying each year by 1 + 10% = 1+10/100 = 1.1
After 1 year: Investment is 500 x1.1 =550 After 2 years: Investment is 500 x(1.1)2= 605 After 3 years: Investment is 500 x(1.1)3 =665.50

Compound Interest: future years

After 5 years: Investment is 500 x (1.1)5 After 10 years: Investment is 500 x (1.1)10

After n years: Investment=500 x (1.1)n

Compound Interest
In general P = original sum invested or principal S = final sum or future value r = percentage interest rate compounded annually then after n years n

r S P 1 100

 Example Calculate the value in 10 years of 1000 invested at 6% interest compounded annually. ANSWER: P= 1000 r= 6 n= 10

Compound Interest

Compound Interest
P = 1000 r= 6 n=10

S=1000 x (1+6/100)10 S=1000 x (1.06) 10 S=1790.85

 Example Calculate the value in 5 years of 3000 invested at 4% interest compounded annually. ANSWER: P = 3000 r= 4 n=5 S=3000 x (1.04) 5 S= 3649.96

Compound Interest

Compounding at different intervals

The interest on an investment can be added more frequently than annually, it can be calculated quarterly, monthly, weekly, daily or even continuously. Example Consider the 500 invested for 3 years at 10% interest. Compounded annually S=665.50. Now compound the interest quarterly (every 3 months)

Compounding Quarterly
Divide the interest by 4 10%/4 = 2.5% for each quarter 1 + 2.5% = 1.025 500 x 1.025 = 512.50 (end of 1st quarter) In the 3 year term there are 12 quarters S= 500 x (1.025)12 = 672.44 Compare with annual compounding What do you notice? You get more money.

Compounding Monthly
Divide the interest by 12 10%/12 = 0.833% (to 3DP) for each month 1 + 0.833% = 1.00833 (WATCH the 0s) In the 3 year term there are 36 months S= 500 x (1.00833)36 = 674.09 Compare with quarterly compounding What do you notice? Slightly more money: 674.09 compared to 672.44

Compounding Weekly
Divide the interest by 52 (52 weeks in 1 year) 10%/52 = 0.1923% for each quarter 1 + 0.1923% = 1.001923 In the 3 year term there are 156 weeks S= 500 x (1.001923)156 = 674.73

Compounding Daily
Divide the interest by 365 (assume its not a leap year) 10%/365 = 0.027397% for each quarter 1 + 0.027397% = 1.00027397 In the 3 year term there are 1095 days (again assume none are leap years) S= 500 x (1.00027397)1095 = 674.90

Compounding at different intervals

Compare all the results: Compounded annually: Compounded quarterly: Compounded monthly: Compounded weekly: Compounded daily:
665.50. 672.44 674.09 674.73 674.90

I'll leave it to you to check that if you compound every second you get 674.93

Tutorial work
In the computer labs In the lab you will do Excel Tasksheet 2 (p. 60) that's all for today's lecture