THE ECONOMIC ENVIRONMENT

LESSON 2
MONEY – TIME RELATIONSHIP
AND EQUIVALENCE
LESSON 3
INTEREST AND MONEY - TIME RELATIONSHIP
 SIMPLE INTEREST
• Interest - is the difference between the amount of money lent and the amount of
money later repaid.
• Simple Interest - is interest that is computed only on the original sum and not on
accrued interest. In practice, simple interest is paid on short-term loans in which
the time of the loan is measured in days.
 a) Ordinary simple interest is computed on the basis of 12 months of 30
days each or 360 days a year.

b) Exact simple interest is based on the exact number of days in a year, 365
days for an ordinary year and 366 days for a leap year.

EXAMPLE 1: You have agreed to loan a friend Php 5000 for 5 years at a simple
interest rate of 8% per year. How much interest will you receive from the loan'? How
much will your friend pay you at the end of 5 years?
Given:
P = 5000 i = 8% per year
n = 5 years I=? F=?
 EXAMPLE 2: Determine the ordinary simple interest on Php 700 for 8 months
and 15 days if the rate of interest is 15%.
Given:
P = 700 i = 15% per year
n = 8(30) + 15 = 255 days
OLUTION:
255
𝐼 = 𝑃𝑛𝑖 = 700 0.15 = 𝑃ℎ𝑝 74.38
360

EXAMPLE 3: Determine the exact simple interest on Php 500 for the period
from January 10 to October 28, 1996 at 16% interest.
Given:
OLUTION:
P = 500 i = 15% per year 292
𝐼 = 𝑃𝑛𝑖 = 500 0.16 = 𝑃ℎ𝑝 63.83
n = 8(30) + 15 = 255 days 366
Jan. 10-31 = 21 May = 21 Sep = 30
Feb = 29 June = 31 Oct = 28
March = 31 July = 30 292 days
April = 30 Aug = 31
CASH - FLOW DIAGRAM
A cash – flow diagram is simply a graphical representation of cash flows
drawn on a time scale. Cash – Flow diagram for economic analysis problems is
analogous to that of free body diagram for mechanics problems.

Receipt (positive cash flow or cash inflow)

disbursement (negative cash flow or cash outflow)

A loan of Php 100 at simple interest of 10% will become Php 150 after 5
years.
150

0 1 2 3 4 5

100
Cash Flow diagram on the viewpoint of the lender
 100

0 1 2 3 4 5

150
Cash Flow diagram on the viewpoint of the borrower

COMPOUND INTEREST
In calculations of compound interest, the interest for an interest period is
calculated on the principal plus total amount of interest accumulated in prewious
periods. Thus compound interest means “interest on top of interest”.
P
n–1
1 2 3
n
0

F
Compound Interest (Borrower’s Viewpoint)
Interest Period Principal at Interest Earned Amount at End of Period
Beginning of Period During Period
1
2 i
𝟐

3 𝟐 𝟐
i 𝟐 𝟐
𝟑

.... .... .... ....

n 𝒏 𝟏 𝒏 𝟏 𝒏

𝑷(𝟏 + 𝒊)𝒏

The quantity 𝒏
is commonly called the “single payment compound
amount factor” and is designated by the functional symbol F/P, i%, n. Thus,

𝑭
( )
𝑷

The symbol F/P, i%, n is read as “F given P at i percent in n interest periods.”

 𝒏
(𝟏 + 𝒊)

The quantity 𝒏 is commonly called the “single payment present worth

factor” and is designated by the functional symbol P/F, i%, n. Thus

𝑷
( )
𝑭

The symbol P/F, i%, n is read as “P given F at i percent in n interest periods.”

RATES OF RETURN

a) Nominal Rate of Interest

The nominal rate of interest specifies the rate of interest and a
number of interest periods in one year.

If the nominal rate of interest is 10% compounded quarterly, then i = 10%/4

= 2.5%, the rate of interest per period.
 a) Effective Rate of Interest
Effective rate of interest is the actual or exact rate of interest on
the principal during one year. If Php 1.00 is invested at a nominal rate of 15%
compounded quarterly, after one year this will become,

The actual interest earned is Php 0.1586, therefore, the rate of interest
after one year is 15.85%. Hence,

t - years
EXAMPLE 4: Find the nominal rate which if converted quarterly could be used
instead of 12% compounded monthly. What is the corresponding effective rate?

Given:
= the unknown nominal rate
=4 = 12

Nominal Rate Effective rate

r% compounded quarterly −1
.
12% compounded monthly

𝑟
1+ −1= −1
4

1+ = 1.1268

= 1.0303
EXAMPLE 5: Find the amount at the end of two years and seven months if Php
1000 is invested at 8% compounded quarterly using simple interest for anytime less
than a year interest period?
Compounded quarterly
Given:

%
For compounded interest, , n = 2(4) = 8
For simple interest,

2 years
2
7 months
 EQUATION OF VALUES
An equation of value is obtained by setting the sum of the values on a
certain comparison or focal date of one set of obligations equal to the sum of the
values on the same date of another set of obligations.

EXAMPLE 6: A man bought a lot worth Php 1,000,000 if paid in cash. On the
installment basis, he paid a down payment of Php 200,000; Php 300,000 at the end of
one year; Php 400,000 at the end of three years and a final payment at the end of five
years. What was the final payment if interest was 20%.

800,000

0 1 3 5
𝐴 300,000 (P/F, 0.2, 1)

𝐴 300,000 𝐵 400,000 (P/F, 0.2, 3)

𝐵 400,000
𝐶 𝑄 (P/F, 0.2, 5)

𝐶 𝑄
Using today as the focal date, the equation of values is

CONTINUOS COMPOUNDING AND DISCRETE PAYMENT

In discrete compounding the interest is compounded at the end of each
finite – length period, such as a month, a quarter or a year.
In continuous compounding, it is assumed that cash payments occur once a
year, but the compounding is continuous throughout the year.
F

0 1 2 3 ... mn

n years
P Continuous Compounding (Lender’s Viewpoint)
 𝒓 𝒎𝒏

𝑟 1 1
𝑎+ = 1+ = 1+
𝑚 𝑘 𝑘

Thus;
EXAMPLE 7: Compare the accumulated amounts after 5 years of Php
1,000 invested at the rate of 10% per year compounded a) annually, b)
semiannually, c) quarterly, d) monthly, e) daily, and f) continuously.
Given: 𝑷(𝟏 + 𝒊)𝒏

= Php 1,000
t = 5 years

. ( )( ) 𝑁𝑂𝑇𝐸: 𝐼𝑛 𝑐𝑜𝑚𝑝𝑜𝑢𝑛𝑑𝑒𝑑 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡

𝑢𝑠𝑒 𝑒𝑖𝑡ℎ𝑒𝑟 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑦𝑒𝑎𝑟 𝑜𝑟 𝑎
. ( )( ) 𝑙𝑒𝑎𝑝 𝑦𝑒𝑎𝑟 𝑑𝑒𝑝𝑒𝑛𝑑𝑖𝑛𝑔 𝑖𝑛 𝑤ℎ𝑖𝑐ℎ
𝑠𝑡𝑎𝑡𝑒𝑑 𝑖𝑛 𝑡ℎ𝑒 𝑝𝑟𝑜𝑏𝑙𝑒𝑚. 𝐵𝑢𝑡 𝑖𝑓
𝑛𝑒𝑖𝑡ℎ𝑒𝑟 𝑜𝑓 𝑡ℎ𝑒 𝑡𝑤𝑜 𝑠𝑡𝑎𝑡𝑒𝑑 𝑖𝑛 𝑡ℎ𝑒
. ( )( ) 𝑝𝑟𝑜𝑏𝑙𝑒𝑚, 𝑎𝑙𝑤𝑎𝑦𝑠 𝑢𝑠𝑒 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦
𝑦𝑒𝑎𝑟.
. ( )( )

. ( )( )

( . )( )
THANK YOU!!!