INSTITUT SUPERIEUR DE GESTION

Course: Financial Mathematics

Lecturer: Mr. Akum Oben

Specialty: All

Level: HND 1

Course Outline

 Simple Interest
 Compound Interest
 Determination of Future Value and Present Value
 Précompté interest and effective interest
 Investments analysis (comparing series of simultaneous investments)
 Short-term financial transactions : - Current Account and interest
 Commercial Discount - real rate of discount
 Rate of Interest apparent
 Rate of real interest

Course Objective

The course Financial mathematics is intended to equip the students with analytical skill
necessary for making rational financial decisions when confronted with a series of investment
alternatives. Also, the students will be informed on why one particular investment will be
superior over several other alternatives.
UNIT1 Introduction of Investment Decision

1.0 What is an investment

An investment can be viewed differently by different set of individuals as follows :

 To an Accountant an investment can be regarded as an asset or item acquired with the

aim of generating income.
 To an economist, it is the purchase of goods that are not meant for immediate
consumption but for future use.
 In finance, it is monetary asset purchased with the idea that the asset will provide
income in the future or will be sold at a price higher than the price at which it was
acquired in order to make PROFIT

Investment decisions should be done Rationally and not out of emotions with the aim of
maximising benefits. It should be noted that investors are usually confronted with several
investment alternatives the best choice is that with the greatest benefit.

1.1 Sources of Funds for Business

There are two categories of sources from which a business can acquire the needed funds: –
Internal and External.

Most businesses use a mixture of both sources. That part of finance raised by the business
internally or through the sale of shares is regarded as Equity financing. By issuing shares,
companies forfeit a tiny part of the ownership of the company to the shareholder (s)
meanwhile, that part of the financing need raised externally is regarded as Debt financing.

The act of borrowing is another crucial issue as the cost of borrowing must be compared to the
benefits that will arise from the investment. For the investment to be worth undertaking, the
benefits from the investment should be morethan the interet paid to borrow the money that
financed the investment.

The proportion of Debt to Equity in the Capital Structure of a company is known as Gearing
ratio.

Debt
Gearing =
Equity

Example : The capital structure of a company is such that; debt financing is 5000,000frs and
equity is 20,000,000frs what is the gearing ratio and what is the significance of the gearing
ratio ?
Ans : 0.25. It signifies that for every one francs that the company spends, debt constitute 0.25francs.

1.2 Interest

 Interest is defined as the cost of borrowing or lending money

 Rate of money paid on deposit. This rate can be calculated in two ways : Simple interest
and Compound interet.

1.3 Simple Interest

The compensation paid to lenders for forfeiting present consumption and risking their money
calculated on the basis of a simple interest implies the same amount of interest will be paid
during the periodic interval of interest payment and interest earned in previous periods are
not included in the determination of interest earned in subsequent periods.

P∗R∗T
Simple interest determined as : S.I = P X R X T (R expressed in decimals) or S.I = (R
100
expressed as a percentage)

Where:

S.I = Simple interest,

P = Principal,

R = Interest rate,

T = Time period.

It implies :
I X 100 I X 100 I X 100
T= PX R R = P XT P = R XT

Examples

1) A student deposited 200,000frs in a savings account, which attracts interest

at the rate of 15% per annum.
Determine:
i) The amount of interest earned after 3 years
ii) The total amount of money in the account at the end of the 3years
period
 iii) How much will the student be having in his account if he deposited
200,000frs each year
Solution

i) S.I = P*R*T

P= 200,000frs

R= 0.15

T= 3

⸫ S.I 200,000frs * 0.15 * 3 = 90,000frs

ii) Total amount of money in account = Principal + interest earned

= 200,000frs + 90,000frs = 290,000frs

iii) S.I Year1 = 200,000frs * 0.15* 1 = 30,000frs

S.I Year2 = 400,000frs * 0.15 * 1 = 60,000frs
S.I Year3 = 600,000frs * 0.15 * 1 = 90,000frs
Total interest earned = 180,000frs

Amount in account at the end of year 3 :

Amount = principal + simple interest earned

= 600,000frs + 180,000frs

= 780,000frs

Exercise

1) Determine the rate of interest if P= 400,000frs, T= 1year and SI = 60,000frs

2) You took a 3years loan of 100,000frs that is charged at 5% simple interest
i) How much interest will you pay for the loan ?
ii) Howmuch interest will you pay annually ?

1.4 compound interest

Compound interest is calculated on the principal amount and also on the accumulated interest
of previous periods (interest earned on interest).

Compound interest therefore implies the principal and the interest will appreciate in the future.
This brings in the concept of Future value and Present Value.

Future Value is what a present amount is worth in the future while present value is what a
future amount is worth today.

Amount of interest = P {(1 + i) n - 1}

Where : P = Principal

i= annual interest rate expressed in percentage terms

n= number of compounding periods for a year

Compounding periods are the time intervals between when interest is due payment.

Interest can be compounded annually, semi-annually, quarterly, monthly, daily, continuously,

or on any other basis. However, Interest on an account may accrue daily but only credited
monthly.

Continuing with the previous example, what would be the amount of interest if it is charged on
a compounding basis ?

Solution

Amount of interest = P {(1 + i) n – 1}

= 100,000 {(1 + 0.05)3 – 1}

= 15,762.5frs.

The compound interest earned (15,762.5frs) is greater than that earned on simple interest
basis (15,000frs) because of the interest earned on interest of previous periods.

Accumulated interest of previous periods

 Year Principal(P) Interest (i=5%) Total Amount

(fcfa) (fcfa) (fcfa)

1 100,000 5,000 105,000

2 105,000 5,250 110,250

3 110,250 5,512.5 115,762.5

Total Interest 15,762.5

As has been illustrated in the calculation of simple interest and compound interest above,
it can be seen that for simple interest,the same interest amount is paid over the 3 years
period

(Year1 = 5,000fcfa, year 2 = 5,000fcfa, year 3 = 5,000fcfa)

While for compound interest it differs yearly due to the interest paid on previously
generated interest (year 1= 5,000fcfa, year 2 = 5,250fcfa, year 3 = 5,512.5fcfa)

Compounding Periods

Compounding period is the time interval between when interest is due payment to an
account. Interest can be compounded annually, semi-annually, quarterly, monthly, daily,
continuously, or on any other basis. Interest on an account may accrue daily but only
credited monthly.

The higher the number of compounding periods, the greater the amount of
compound interest yielded.

Illustration :

Consider a one year loan of 10,000fcfa valued at 10%, determine the compound interest
when interest is paid : annually, semi-annually, and quarterly.

Solution :
P= 10,000,

i = 0.1

n= 1

m= 1, 2,3) where m is the number of compounding period

i) When interest is paid annually

C.I = P{(1+i) nm – 1}

= 10,000{(1+0.1)1x1 – 1}

= 1,000fcfa

ii) When interest is paid semi- annually

= 10,000{(1+0.1)1x2 – 1}

= 2,100fcfa

iii) When interest is paid quarterly

= 10,000{(1+0.1)1x3 – 1}

= 3,310fcfa