CHAPTER 1 – INTEREST CONCEPTS, SIMPLE AND COMPOUND INTEREST
1.2 Basic concepts
Equation Description Calculator
K Capital amount PV
S Accumulated amount FV
𝑖 Effective interest rate per year
(")
I/YR
𝑖 Nominal interest rate per year
No. times per year interest is
𝑚 P/YR
earned/compounded
𝑛 No. of years
N
N No. interest periods (𝑛 x 𝑚)
• +R = receiving money
Þ Taking out a loan
Þ Withdrawing money from an account
• -R = giving money
Þ Making a loan payment
Þ Investing money into an account
1.3.1 Simple Interest
• No interest on interest
• Solve equation mathematically
S = K (1 + 𝑖𝑛)
S = K + K𝑖𝑛
S = K [1 + (number of periods) x (interest rate per unit per period)]
• Interest on interest
• Just put question into notation equation, not solving mathematically
• Solve using financial calculator Tine Value of Money functions
𝑚𝑥𝑛 𝑖 (") K S (white)
𝑛 𝑚 (orange)
Bracket notation: have a present value, need its future value
S = K (1 + 𝑖)) ® 𝑖 effective per year; 𝑛 years (not used often)
"+)
$ (")
S = K ,1 + "
- ® 𝑖 (") nominal per year; 𝑛 years; 𝑚 interest periods per year
V notation: have a future value; need its present value
,
K = (-.$)$ = 𝑆𝑣 )$ ® 𝑖 effective per year; 𝑛 years (not used often)
"+)
K = 𝑆𝑣 %(") ® 𝑖 (") nominal per year; 𝑛 years; 𝑚 interest periods per year
"
Compounding per year
• Nominal interest rates – how frequent interest is compounded in a year
• 𝑖 (") (general)
Þ 𝑖 – I/YR
Þ 𝑚 – P/YR
• 𝑖 (-) VS 𝑖 (/)
Þ the more times interest is compounded per year the more interest will be
earned
$ (&')
• -/
= effective interest rate per month (used in calculations)
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