CHAPTER 01

Basic Concepts of Interest and How to Compute Simple Interest

loan is a type of financial instrument that enables the borrowing of funds in return
for repayment of the principle in the future.

A higher credit score is equivalent to a higher approval rate from potential lenders.

five (5) C’s of Credit

1. Character - Looking into a borrower’s credit history which contains information about
previous loan transactions and on-time settlement of debts.
2. Capacity - Measures borrower’s ability to repay the loan using a debt-to-income ratio
(DTI). Debt-to-income ratio is a method of comparing one’s ability to pay their debt to
their monthly income.
3. Capital - Amount of money that the applicants have at hand. Contributing to the loan by
issuing a down payment will be seen by creditors as the borrower’s investment in the
deal.
4. Collateral - method of loan security which is often through assets borrowers are willing
to sacrifice if the debt wasn’t paid on time.
5. Conditions - Information regarding the loan itself. Creditors have to know the purpose of
the loan, the amount involved, and prevailing interest rates.

Types of Loan
1. Secured and Unsecured Loans
● Secured loan – The borrower pledges some assets, like a car or property as
collateral.
● Unsecured loan – A monetary loan that is not secured against the borrower’s
assets, so the interest rates are higher.

2. Open-ended and Closed-ended loans

● Open-ended loans – A loan that can be borrowed over and over. The conditions
are payment of credit will increase the amount of credit available hence the ability
to use it again.
● Closed-ended loan – A loan that cannot be borrowed once they’ve been repaid.
Once the loan has been repaid and borrowers require more money, they have to
file another loan.

3. Mortgage - common type of debt instrument that is used to purchase real estate,
properties, and houses. An agreement between you and a lender gives the lender the
right to take your property if you fail to repay the money you've borrowed plus interest.

4. Student loan - provided to students to help defray the costs of a college education. It is
generally paid off after graduation.
 ● Subsidized Student Loans mean that the loan is financially supported by an
organization, in this case, it's the government.
● Unsubsidized Student Loans mean that the loan is not supported by anyone
other than yourself.

5. Personal loan (signature loan) - money you borrow from a bank or other financial
institution with a set repayment period and consistent monthly payments.

6. Demand loan - informal loan that a lender can require to be repaid in full at any time.
Most common among family, friends, and close business associates but banks may also
offer this as long as they have a good reputation and credit score.

Simple Interest
is a quick and easy method to calculate interest on money.

Interest is the fee or rent that lenders charge to borrowers for the temporary use of
the borrowed money.

Principal is amount borrowed

Rate of interest is the percentage of the principal that will be charged for the specified period of
time

Anatomy of a Promissory Note

(1) The first date you will see is the loan date. It is usually the day when the note is
issued or created.
(2) The maker’s name or simply the person who created the note is the borrower.
(3) The payee’s name or simply the person who will lend you the money is the lender.
(4) The amount you will borrow from the payee or the lender which is the principal.
(5) The percentage of how much the lender will charge for the money you borrowed or
simply the interest rate.
(6) The second date you will see will be the due date or the maturity date of the
promissory note. The day you will have to pay the money borrowed plus the charge
the lender put for letting you borrow the money.

Exact interest, which is computed using 365 days as the time factor denominator.
Ordinary interest, a sort of interest when the number of days is calculated annually as 360.

variables used in the mathematical approach of Simple Interest:

P = Principal amount of the loan or investment
r = Annual rate of simple interest
t = Time period (term) of the loan or investment
I = Amount of the interest paid or received
F = Maturity value of the loan or investment

Simple interest formula:

1. I = Prt [Use this if interest is missing]

2. t = I/Pr [Use this if time period/term is missing]
3. P = I/rt [Use this if the principal amount is missing]
4. F = P+I [Use this if maturity value is missing and the only value given is principle and interest]
5. r = I/Pt [Use this if the annual rate is missing]
6. F = P(1+rt) [Use this if the maturity value is missing and the given values are principal
amount, rate, and time period/term]

CHAPTER 02
Simple discount note

Simple Discount - refers to the amount deducted from the maturity value of an obligation when
it is discounted to the date of the obligation.
- calculated by subtracting the initial cash flow from one period to the next until the last
maturity date, at which point it equals the present value of an obligation.

Bank - a financial institution licensed to receive deposits and make loans. provide related
services such as individual retirement accounts (IRAs), certificates of deposit (CDs), currency
exchange, and safe deposit boxes.

Discount - the reduction of either the monetary amount or a percentage of the normal selling
price of a product or service.

Bank discount - the reduction of either the monetary amount or a percentage of the normal
selling price of a product or service.

face value and the maturity value - The amount of interest charged is called a bank discount.

Proceeds - The amount of money the borrowers receive

Computing the proceeds - deals with the computation of the proceeds in discounting a note.

Discount rate - is used when looking at an amount of money to be received in the future and
calculating its present value. deducted from a future value of money to provide its present value.
Time means the period when money is invested, usually expressed in years.

NOTE - This is a legal responsibility for the first party (original borrower) to pay his obligations in
a certain amount of money, on a particular date, to the second party (lender).

Discount on a note - determining the value of the note

Recourse - The relationship between the seller of the note and the third party

Contingent liability - potential liability that may or may not result from discounting a promissory
note

In simpler terms, the simple interest is computed on the principal while the simple
discount is computed on the maturity value.

Remember that the maturity value of simple interest and simple discount is equal.

F = Maturity Value or Face Value

P = Proceeds
D = Bank Discount
d = Rate Discount
t = Time Period (Term)

CHAPTER 03
Compound Interest
Compound interest - Interest is periodically calculated and added to the principal.
- Amount at the end of one year is the new principal for the next year.
- Employed for short-term and long-term loans and investments, as long as the duration
exceeds one year.
- calculated by multiplying the initial loan amount, or principal, by the one plus the annual
interest rate raised to the number of compound periods minus one.

Conversion Period (compounding period or interval period)

- The time interval between succeeding interest calculations.

Compound Frequency (or conversion frequency)

- Number of compoundings that take place in a year.

Nominal Interest
- The stated annual interest rate on which compound interest calculation is based.

Periodic Interest Rate

- Rate of interest earned in one conversion period.

Maturity Value
- the amount due and payable one individual has to pay the financial obligation as of the
maturity date of the obligation

Principal Amount
- the amount of money you borrow when you originally take out a loan

Term of loan
- the number of days between the loan date and maturity date

Nominal interest rate

- stated annual interest rate on which the compound interest calculation is based
- It does not take into account the compounding periods.

Effective interest rate

- the equivalent annually compounded interest rate
- It is used to compare nominal interest rates.

Continuously compounded interest

- interest that is compounded an infinite number of times per year on a particular
investment for a specific number of years.
- An investment with an infinite number of compoundings will produce an infinitely large
balance at the end of the investment period.
Computing Equation Values

Equation
- a mathematical equality between 2 mathematical expressions
- values of obligation = values of payment

Values
- the monetary worth of something
- values of obligation
- values of payment

Focal date
- the selected date for the computation of equivalent values.

Cash Flow diagram

- Visually represent the income and expenses over some time interval

Equation of values (payment stream)

- Series of two or more payments required by a single payment or contract.
- the equality between the values of obligations and the values of payments
- Obligation = Payments

3 methods of Computing the Equation of Values

1. Discount Factor
- The focal date is usually on the left size or at the starting point

2. Accumulation factor
- The focal date is usually on the right side or at the end of the payment stream.

3. Discount-Accumulation factor
- Combination of discount factor and accumulation factor wherein the focal date
is within the coverage period of payment streams