Presentation on theme: "Chapter 5 Mathematics of Finance"— Presentation transcript:
1Chapter 5 Mathematics of Finance Section 5.1 Simple InterestSection 5.2 Compound InterestSection 5.3 Annuities and Sinking FundsSection 5.4 Present Value of an Annuity and Amortization
2Section 5.1Simple InterestSimple interest is most often used for __________of _____________ duration.The money borrowed in a loan is called the ___________.The number of dollars received by the borrower is the ________________________.In a simple interest loan, the ___________ and present value are the same.The ______________ is the fee for a simple interest loan and usually is expressed as a percent of the principal.Simple interest is paid on the principal _____________ and not paid on interest already earned.
3Simple InterestThe simple interest of a loan can be calculated using the following formula.
4ExampleAn individual borrows $300 for 6 months at 1% simple interest per month. How much interest is paid?
5Another ExampleJane borrowed $950 for 15 months. The interest was $ Find the interest rate.
6Future ValueA loan made at simple interest requires that the borrower pay back the sum borrowed (principal) plus the interest. This total is called the future value, or amount and is equal to P + I.
7ExampleFind the amount (future value) of a $2400 loan for 9 months at 11% interest.
8Simple DiscountThe simple discount loan differs from the simple interest loan in that the interest is deducted from the principal and the borrower receives less than the principal.This type of loan is referred to as a simple ____________ note.The interest deducted is the _________________.The amount received by the borrower is the ______________.The discount _______________is the percentage used.The amount repaid is the ___________________________.
15Compound Interest Section 5.2 Suppose you deposit money into a savings account, the bank will typically pay you interest for the use of your money at a specific period of time, say every three months. The interest is usually credited to your savings account at each time period. At the next time period, the bank will pay interest on the new total, this is called _________________________.Amount of Annual Compound InterestWhen P dollars are invested at an annual interest rate r and the interest is compounded annually, the amount A at the end of t years is__________________
16ExampleSuppose $800 is invested at 6%, and it is compounded annually. What is the amount in the account at the end of 4 years?
17Amount (Future Value)The general formula for finding the amount after a specified number of compound periods is
29Effective RateThe effective rate of an annual interest rate r compounded m times per year is the simple interest rate that produces the same total value of investment per year as the compound interest.
30ExampleThe Mattson Brothers Investment Firm advertises Certificates of Deposit paying a 7.2% effective rate. Find the annual interest rate, compounded quarterly, that gives the effective rate.SOLUTIONIf we let i = quarterly rate, thenThe annual rate = 4( ) = = 7.013% (rounded). The annual rate just found is also called the nominal rate.
32Ordinary Annuity Section 5.3 An annuity refers to equal __________ paid at equal ________ intervals.The time between successive payments is called the ________________________________.The amount of each payment is the _________________________________.The interest on an annuity is _________________ interest.An _______________________ is an annuity with periodic payments made at the end of each payment period.
33Future Value (Amount) Payments are made at the end of each period. where i =n =R =A =
34ExampleHow much money will you have when you retire if you save $20 each month from graduation until retirement? Let’s assume you start saving at age 22 until age 65, 43 years, and the interest rate averages 6.6% annual rate compounded monthly.
35How much money will you have when you retire if you save $20 each month from graduation until retirement? Let’s assume you start saving at age 22 until age 65, 43 years, and the interest rate averages 6.6% annual rate compounded monthly.
40Sinking FundsA sinking fund refers to a fund that is created when an amount of money will be __________ at some future date. For example, a family may need a new car in 3 years, or a company may expect to replace a piece of equipment in the future.
41ExampleDarden Publishing Company plans to replace a piece of equipment at an expected cost of $65,000 in 10 years. The company establishes a sinking fund with annual payments. The fund draws 7% interest, compounded annually What are the periodic payments?
42Darden Publishing Company plans to replace a piece of equipment at an expected cost of $65,000 in 10 years. The company establishes a sinking fund with annual payments. The fund draws 7% interest, compounded annually. What are the periodic payments?
44You figure you will need $30,000 to use as a down payment on a house you want to buy in 5 years. How much should you put in your bank account every month to accumulate $30,000 in 5 years if your bank account pays 5% annual interest compounded monthly?
45A couple wants to start a college fund for their new born child A couple wants to start a college fund for their new born child. They figure they will need $120,000 in 18 years to pay for the child’s education in college. If they set up an annuity that pays 6.5% compounded quarterly, what is the amount of the quarterly payment they will need to achieve this goal?
47Section 5.4Present ValueThe present value of an annuity is the ______________ payment that yields the same total amount as that obtained through equal _____________ payments made over the same period of time.
48ExampleFind the present value of an annuity with periodic payments of $2000, semiannually, for a period of 10 years at an interest rate of 6% compounded semiannually.
49Equal Periodic Payments The amount needed to provide equal periodic payments can be found using the formulaor equivalently,where P = amount needed in the fundR = amount of periodic paymentsi = periodic interest raten = number of payments
50ExampleFind the present value of an annuity (lump sum investment) that will pay $1000 per quarter for 4 years. The annual interest rate is 10%, compounded quarterly.
51Two Ways to Save Money Future Value of an Annuity Present Value of an Annuity
52Two Ways to Save MoneyYou decide to save for retirement by making regular payments of $50 to an annuity that pays 5% compounded monthly. How much money will you have in 20 years?Find the lump sum payment that will yield the same amount after 20 years.
53Present Value of an Annuity The __________ required to pay out regular payments over time.Determine the amount required to collect 60 monthly payments of $2000 at 5% compounded monthly.
54Determine the amount required to collect 60 monthly payments of $2000 at 5% compounded monthly.
55AmortizationThe amortization of a debt (___________________) requires no new formula because the amount borrowed is just the present value of an annuity.
56George want to buy a car for $32,595 George want to buy a car for $32,595. He decides to put nothing down on it a want to finance it for 5 years. The car company offers him an interest rate of 5.95%. What are George’s monthly payments and how much does the car actually cost him.
57ExampleA student obtained a 24-month loan on a car. The monthly payments are $ and are based on a 12% interest rate. What was the amount borrowed?
58Balance of an Amortization The balance after n periods is the amount of compound interest minus the amount of an annuity. Mathematically we can find the balance using the formulawhere P = the amount borrowedi = periodic interest raten = number of time periods elapsedR = monthly paymentsBal(# of Payments) Be careful the solver menu must be filled in correctly
59ExampleA family borrowed $60,000 to buy a house. The loan was for 30 years at 12% interest rate. The monthly payments were $ What is the balance of their loan after 2 years?