Mathematics in the Modern World An individual who lends his capital expects the
Chapter 5: The Mathematics of Finance debtor to pay back not only the money
Introduction
Everybody uses money. Sometimes you work
for your money and other times your money works
for you. For example, unless you are attending
college on a full scholarship, it is very likely that
you and your family have either saved money or
borrowed money, or both, to pay for your
education. When we borrow money, we normally
have to pay interest for that privilege. When we
save money, for a future purchase or retirement,
we are lending money to a financial institution and
we expect to earn interest on our investment. We
will develop the mathematics in this chapter to
understand better the principles of borrowing and
saving. These ideas will then be used to compare
different financial opportunities and make
informed decisions
Learning Objectives
At the end of this chapter, the student is expected
to:
• Differentiate simple and compound
interest;
• Define credit cards, stocks, bonds, and
mutual funds;
• Solve problems involving simple and
compound interest; and
• Display perseverance and patience in
dealing with problems associated with
• mathematics of finance.
Duration
Topic 1: Simple and Compound Interest = 2 hours
Topic 2: Credit Cards and Consumer Loans = 1.5
hours
Topic 3: Stocks, Bonds, and Mutual Funds = 1.5
hours
Lesson Proper
1.1Simple Interest and Compound Interest
In the business world, an investor who places
capital in a productive enterprise expects not only
the eventual return of his capital but also
additional payment.
originally borrowed but also an additional
amount. This additional payment or amount is
called interest. The interest is the compensation
that a borrower of capital pays to a lender for
its use. It can be viewed as a form of rent that
the borrower pays to the lender to compensate
for the loss of opportunity to use the capital to
other productive financial transaction.
Therefore, interest is the fee paid for
borrowed money. We receive interest when we
let others use our money (for example, by
depositing money in a savings account or
making a loan). We pay interest when we use
other people’s money (such as when borrow
from a bank or a friend).
5.1.1 Simple Interest
It is an interest that is calculated on the
balance owned but not on previous interest or
in other words if interest is computed on the
original principal during the whole life of the
investment, the interest due at the end of the
time is called simple interest. It is computed
entirely on the original principal (P), multiplied
by the rate of interest (r), and the time (t). This
leads to simple interest formula.
Where:
I = amount of interest
P = principal
r = rate per period of time
t = time between the date of loan is made and
the date it matures
Definitions of Basic Terms
 Principal (P) – It is the original amount
borrowed.
 Rate of Interest (r) – It is the percent that the
borrower pays for the use of the money
commonly expressed as annual interest rate.
 Time (t) – It is the length of time usually 3. Compute the simple interest of a loan
expressed in years. amounting to P50,000.00 payable in 6
 Maturity Date or Due Date – It is the date on months if the interest rate is 3.5%.
which the loan is to be repaid.
 Maturity Value (M) – It is the total amount the
borrower would need to pay back.

Examples:
1. Natasha invests P250,000 in a building society
account. At the end of the year her account is
credited with 2% interest. How much interest
had her P250,000 earned in the year?
4. Mr. Flores plans to buy a Sala set from
Department Store which cost
P12,000.00. The loan charges P1,
800.00 interest in 6 months. Find the
simple interest rate.

2. A business borrowed 10 million pesos from

the bank. If he agrees to pay an 8% annual
rate of interest, calculate the amount of
interest in (a) 5 years, (b) 10 years, and (c) 15
years.
5. Ryan borrowed P750,000 from a bank
to buy a car at 10% interest rate and
earned P30,000 interest while clearing
the loan, find the time for which the
loan was given.

According to Richard Aufmann, the day

of the year table can be used to determine the
number of days from one date to another date.
For instance, because June 30 is day 181 on the
table and November 11 is day 315, meaning
there are 315 – 181 = 134 days from June 30 to
November 11.
The table can also be used to determine
the due date of a loan. For instance, an 85 – day
loan made on march 15, which is day 74 is due
on day 74 + 85 = day 159 which is June 8.
Example:
1. Calculate the simple interest due on a
P20,600.00 loan made on February 8 and
repaid on December 8 of the same year. The
interest rate is 7%.
5.1.2 Maturity Value
It is the total amount the borrower would need
to pay back and is usually denoted by M.
Examples:
1. Calculate the maturity value of a P10,000.00
loan with 8% interest rate (a) in 5 years and (b)
in 8 months.
We can also make use of other formula in
computing for the maturity value. This can be
done by substituting Prt for I (interest).
2. Calculate the maturity value of a simple
interest, 9 months loan of P15,300. The
interest rate is 8%.
3. The maturity value of a 4-month loan of
P5,000.00 is P5075.00. What is the simple
interest rate?
i. Compound Interest
Compounding is the concept that any
amount earned on an investment can be
reinvested to create additional earnings that
would not be realized based on the original
principal, or original balance, alone The interest
on the original balance alone would be called
simple interest. The additional earnings plus
simple interest would be equal to the total
amount earned from compound interest.
In other words, an investment earns
compound interest when the interest from each
time period is added to the principal.
And the earns interest in the following time
periods. As the principal grows, the rate at which
you earn interest grows as well, because you are Interest earned after six months:
earing “interest on interest”. Compounding makes
a significant difference in the final value of an
investment. Compounding increases the amount
you earn when investing, but increase the costs Interest earned after second six months:
when you borrow money.
The compound interest formula calculates the
amount of interest earned on an account or
investment where the amount earned is The total amount in the account at the end
reinvested. By reinvesting the amount earned, an of the first year is P5,100.50 which is called
investment will earn money based on the effect of compound amount.
compounding. Maturity value formula of 𝑀 = 𝑃(1 + 𝑟𝑡) can
Examples: also be used to calculate M at the end of six
1. Jonathan deposits P5,000.00 in a savings months.
account earning 2% interest compounded
annually. 4. Mr. Agoncillo deposited P16,400.00 in
Solution: an account earning 3% interest,
Compounded annually means that the interest will compounded quarterly. How much is in
be calculated once a year. the account at the end of 1 year.
𝐼 = 𝑃𝑟𝑡 = (5,000)(0.02)(1) = 𝑃100.00
At the end of one year, his money on bank will be
𝑀 = 𝑃 + 𝐼 = 5,000 + 100 = 𝑃5100.00
During its second year,
𝐼 = 𝑃𝑟𝑡 = (5,100)(0.02)(1) = 𝑃102.00
At the end of the second year, the total amount in
the account is
𝑀 = 𝑃 + 𝐼 = 5,100 + 102 = 𝑃5,202.00
The interest earned during the third year is
calculated using the amount in the account at the
end of the second year (P5,202.00)
𝐼 = 𝑃𝑟𝑡 = (5,202)(0.02)(1) = 𝑃104.04

Notice that the interest earned every year

increases. This is what compound interest is all
about. However, compound interest is not only
limited to annually, we also have semiannually or
twice a year, quarterly or four times a year,
monthly or even daily. We call this frequency as
compounding period.
For instance, in our example number 1, if the
interest is compounded semiannually, meaning the
first interest payment occurs after 6 months and
the earned interest is added to the account.
Compound Amount Formula
Examples:
1. Mr. Misa deposited P15,000.00 in an
account earning 5% interest, compounded
quarterly, for a period of 2 years.
2. Calculate the future value of P7,500
earning 9% interest, compounded daily,
for 3 years.
3. How much interest is earned in 4 years on
P8,000.00 deposited in an account paying
6% interest, compounded semiannually.
The total amount in the account at the end
of 1 year is P16,897.56 known as the compound
amount.
b. Credit Cards and Consumer
Loans
Credit Card
A credit card is a payment card issued to
users (cardholders) to enable the cardholder to
pay a merchant for good and services based on
the cardholder’s promise to the card issuer to
pay them for the amounts so paid plus the
other agreed charges. The card issuer (usually a
bank) creates a revolving account and grants a
line of credit to the cardholder, from which the
cardholder can borrow money for payment to a
merchant or as a cash advance. In other words,
credit cards combine payment services with
extensions of credit. Complex fee structures in
the credit card industry may limit costumers’
ability to comparison shop, helping to ensure
that the industry is not price competitive and
helping to maximize industry profits. Due to
concerns about this, many legislatures have
regulated credit card fees.
Credit cards are best suited for financing
extending over a shorter time period.
Remember that it does not give you more
money, rather it enables you to have higher
purchasing power in your everyday life. And so
it is important to be aware of the price of
having a credit card. Similar to all the services
and products you use, you should be 𝑀 = 𝑃 (1 +
𝑟 𝑛 ) 𝑛𝑡 = 7,500 (1 + 0.09 360) (360)(3) = 𝑃
9,824.40 (the future value after 3 years) 𝑀 = 𝑃
(1 + 𝑟 𝑛 ) 𝑛𝑡 = 8,000 (1 + 0.06 2 ) (2)(4) =
𝑃10,134.16 (compound amount) 𝐼 = 𝑀 − 𝑃 =
10,134.16 − 8,000 = 𝑃2,134.16 (earned interest
in 4 years) aware of the terms and prices.
Remember that it is expensive to postpone
payments. Also keep in mind that the sooner
you pay, the least interest you pay. As long as
you make your payments on time, there are no
accruing interests.
Many credit cards charge annual fees
but also come with interest-free grace periods,
balance transfers and rewards.
 Usually credit card companies issue monthly
bills. If the bill is paid in full before its due date no
charges is added otherwise interest charges will
start to accrue. The most common method of
determining finance charges is the average daily
balance method.

Examples:
1. An unpaid bill for P2,500.00 had a due date
of January 15. A purchase of P1,650.00 was
made on January 18 and P560.00 was
charge on January 27. A payment of
P2,000.00 was made on January 20. The
next billing date is February 15. The
interest on the average daily balance is
1.25% per month. Find the finance charge
on the February 15 bill.

Annual Percentage Rate (APR)

A credit card’s interest rate is the price
you pay for borrowing money. For credit cards,
the interest rates are typically stated as a yearly
rate. This is called the annual percentage rate
(APR). On most cards, you can avoid paying
interest on purchases if you pay your balance in
full each month by the due date.
Annual percentage rate is the
annualized interest rate on a loan or
investment which doesn’t account for the
Finding the finance charge on the February 15 bill
effect of compounding. It is the annualized
𝐼 = 𝑃𝑟𝑡 = (2,656.13)(0.0125)(1) = 𝑃33.20
form of the periodic rate which when applied
to a loan or investment balance gives the
2. An unpaid bill P4,585.00 had a due date of
interest expense or income for the period. In
March 2. A purchase of P15,000.00 was
most cases, it is the interest rate quoted by
made on March 8 and another was on
banks and other financial intermediaries on
March amounting to P3,200.00. An
various products like loans, mortgages, credit
P875.00 was charge on March 21. A
cards, deposits, etc. It is also called the nominal
payment of P10,000.00 was made on
annual interest rate or simple interest rate.
March 15. The interest on the average
This APR was covered by the Republic
daily balance is 2.3% per month. Find the
Act No. 3765 otherwise known as the “Truth in
finance charge on the April 2 bill.
Lending Act”. It is an act requiring the
disclosure of finance charges in connection with
the extension of credit.
The policy behind the law is to protect the
people from lack of awareness of the true cost of
credit by assuring full disclosure of such cost with a
view of preventing the uninformed use of credit to
the detriment of the national economy.
The law covers any creditor, which is defined
as any person engaged in the business of extending
credit (including any person who as a regular
business practice make loans or sells or rents
property or services on a time, credit, or
instalment basis, either as principal or as agent)
who requires as an incident to the extension of
credit, the payment of a finance charge.
A finance charge includes interest, fees, service
charges, discounts, and such other charges
incident to the extension of credit as may be
prescribed by the Monetary Board of the Bangko
Sentral ng Pilipinas through regulations.
This formula can be used to estimate the
annual percentage rate (APR) on a simple interest
rate instalment loan.
Examples:
1. An investors borrowed P35,000.00 from a
bank that advertises a 12% simple interest
rate. He agrees to a 5 monthly instalment.
a. Calculate its monthly payment
First Payment: P7,000.00; Second Payment:
P7,070.00; Third Payment: P7,140.70; Fourth
Payment: P7,212.11; and Fifth Payment:
P6,577.19
These shows that each month the amount
you owe is decreasing and not by a constant
amount.
Republic Act No. 3765 tells us that the
interest rate for a loan be calculated only on
the amount owed at a particular time, not on
the original amount borrowed.
The annual percentage rate on the loan is
approximately 20%. Recall that the simple
interest rate was 12% much less than the actual
rate. The Truth in Lending act provides the
consumer with a standard interest rate, APR, so
that it is possible to compare loans. The 12%
simple interest loan described in problem no.1
is equivalent to an APR loan of about 20%.
2. A manager bought a brand new car
amounting to P750,000.00 He gave a down
payment of 25% and the balance was agreed to
be paid in 18 equal monthly instalments. The
finance charge on the balance was given at 12%
simple interest.
a. Calculate for the finance charge.
b. Calculate the annual percentage rate in
tow decimal places.
 Example:
1. A certain computer company is offering an
8% annual interest rate for 2 years on all
their computer gadget products. Joshua
Emmanuel, a computer technician,
decided to buy one set of computer unit
for P45,000.00. Find his monthly payment.

Consumer Loans
A consumer loan is when a person borrows Calculate APR on Payday Loans
money from a lender, either unsecured or secured. To calculate the APR on a short-term payday
There are several types of consumer loans and loan:
some of the most popular ones include mortgages, 1. Divide the finance charge by the loan
refinances, home equity lines of credit, credit amount
cards, auto loans, student loans, and personal 2. Multiply the result by 365.
loans. A consumer loan is a good alternative to a 3. Divide the result by the term of the
credit card if you want predictability with your loan.
monthly expenses. 4. Multiply the result by 100.
A consume loan provides a set plan for your
monthly down payments which gives many a sense
of security. You can arrive back from a vacation
paid with a consumer loans and not expect any
surprises. You will simply start paying back a pre
decided amount each month. It is also called as
consumer credit or consumer lending.
The payment amount for these loans is given
by the following formula

APR Loan Payoff Formula

Example:
 1. A lady wants to pay off the loan in 32
months. Her monthly obligation is P850.00
on a 3-year loan with an annual percentage
rate of 7.5%. Find the payoff amount.
5.3 Stocks, Bonds, and Mutual Bonds
Stocks
A stock is ownership in a company. When you
buy a stock, (you are called stockholders) you buy a
piece of the company. So if the company does well,
you do well. Congruently, if the company tanks,
your stock tanks. Just like bonds, there are many
types of stocks because there are many different
types of companies out there. Large company
stocks (large cap), mid cap stocks, small cap stocks,
international stocks, emerging stocks, tech stocks,
etc. Historically, stocks have an annual average
return. However, remember that with more return
comes more risk. So when investing in stocks, keep
in mind that you have to be able to handle the
extra risk or volatility to reap the potential reward
in the long run.
A company may distribute profits to the
owners (stockholders) in the form of dividends.
Most dividends are paid in the form of cash—for
example, a company might declare a quarterly
dividend of P0.50 per share. However, though it’s
less common, companies also have the option of
declaring stock dividends. When paying a stock
dividend, a company issues additional shares of
stock proportional to existing investors’ holdings.
Calculate Dividends Paid to a Stockholder
Example:
1. A stock pays an annual dividend of
P0.75 per share. Calculate the dividend
paid to a shareholder who has 350
shares of the company’s stock.
Solution:
(0.75 per share) (350 shares) = P262.50 (the
shareholder receives P262.50 in dividends)
Before the stock dividends are handed out,
they’re known as “stock dividends
distributable” and are listed in the stockholders’
equity section of the company’s balance sheet.
The first step in calculating stock dividends
distributable is to divide that percentage by 100
to convert it inti a decimal. In our example, 10%
would become 0.10. Next, multiply the
company’s total outstanding shares by this
decimal. You can find the number of
outstanding shares in most stock quotes.
Finally, multiply this amount by the par
value of the stock, which can usually be found in
the stockholders’ equity section of the balance
sheet. This is typically a small amount, such as
P0.01, and it has no relation to the actual share
price of the stock. Once you multiply these
figures by one another, the result is the amount
the company would list as stock dividends
distributable.
Examples:
1. A company declares a stock dividend of 0.05
shares per outstanding share, and there are 100
million total shares outstanding before the
stock dividend is paid. A quick look at the
balance sheet tells us that the stock’s par value
is P0.01 per share, so the stock dividend
distributable that the company will list on its
balance sheet can be calculated as follows:
Solution:

Bonds
The best way to describe a bond is to think of
it like a loan. You loan your money to the
government or a company, and in return they pay
you interest for the term of that loan. Typically,
bonds are considered conservative types of
investments because you can choose the length
and term of the bond and know exactly how much
money will you get back at the end of the term or
“maturity”. There are many types of bonds:
government bonds, corporate bonds, short-term
bonds, long-term bonds, municipal and inflation
protection bonds, etc. Generally, bonds are less
risky than stocks and the main way you lose money
on a bond is if the company or government issuing
the bond defaults on their obligations. Historically,
bonds have an annual average total return of 6.3%.
Bonds are subject to market risk and interest rate
risk if sold prior to maturity.
Bond values will decline as interest rates rise
and bonds are subject to availability and change in
price.
Examples:
1. Harold invested P30,000.00 in various
stocks and bonds. He earned 6% on his
bonds and 12% on his stocks. If Harold’s
total profit on both types of
investments was P2,460.00, how much
of the P30,000.00 did he invest in
bonds?
Solution:
Let x = is the amount invested at 6% on his
bonds
30,000 – x = is the amount invested at 12% on
his stocks
Equation:
(interest earned at 6%) + (interest earned at
12%) = 2,460
[(x)(0.06)] + [(30,000 – x)(0.12)] = 2,460
0.06x + 3,600 – 0.12x = 2460
6x + 360,000 – 12x = 246,000
-6x = 246,000 – 360,000
-6x = -114,000
x = 19,000 (amount invested in bonds)
30,000 – x = 30,000 – 19,000
= 11,000 (amount invested in stocks)
Checking:
[(19,000)(0.06)] + [(30,000 – 19,000)(0.12)] =
2,460
1,140 + (11,000)(0.12) = 2,460
1,140 + 1,320 = 2,460
2,460 = 2,460
Mutual Funds
Mutual funds represent another way to
invest in stocks, bonds, or cash alternatives. You
can think of a mutual fund like a basket of
stocks or bonds. A mutual fund investor is
buying part ownership of the mutual fund
company and its assets. Basically, your money is
pooled, along with the money of other
investors, into a find, which then invests in
certain securities according to a stated
investment strategy. The fund is managed by a
fund manager who reports to board directors.
By investing in the fund, you own a piece of the pie
(total portfolio), which could include anywhere
from a few dozens to hundreds of securities. This
provides you with both a convenient way to obtain
professional money management and instant
diversification that would be more difficult and
expensive to achieve on your own. Every mutual
fund publishes a prospectus. Before investing in a
mutual fund, get a copy and carefully review the
information it contains, such as the fund’s
investment objective, risks, fees, and expenses.
Carefully consider those factors as well as others
before investing.
Mutual fund units, or shares, can typically be
purchased or redeemed as needed at the fund’s
current net asset value (NAV) per share, which is
sometimes expressed as NAVPS. A fund’s NAV is
derived by dividing the total value of the securities
in the portfolio by the total amount of shares
outstanding.
Example:
1. A mutual fund has P600,000,000.00 worth of
stock, P5,000,000.00 worth of bonds, and
P1,000,000.00 in cash. The fund’s total liabilities
amount to P2,000,000.00. There are 25,000,000
shares outstanding. You invest P15,000.00 in this
fund.
a. Solve for the Net Asset Value.
b. How many shares will you buy?
Treasury Bills
Treasury bills or popularly known as T-Bills,
are peso-denominated short-term fixed income
securities issued by the Republic of the
Philippines through Bureau of Treasury. With a
minimum of P200,000.00, you can already enjoy
high yields.
T-Bills are issued at a discount to the
maturity value. Rather than paying a coupon
rate of interest, the appreciation between
issuance price and maturity price provides the
investment return. For instance, a 26-week T-
bill is prices at P9,800.00 on issuance to pay
P10,000 in six months. No interest payments
are made.
Investors buying treasury bills on auction
day, in the days when paper bills were still
issued. You can purchase treasury bills at a
bank, though a dealer or broker, or online from
a website like Treasury Direct. The bills are
issued through an auction bidding process,
which occurs weekly.
Treasury bills among the safest
investments in the market. They are backed by
the full faith and credit of the Philippine
government, and they come in maturities
ranging from four weeks to one year. When
buying Treasury bills, you will find that quotes
are typically given in terms of their discount, so
you will need to calculate the actual price.
Keep in mind that the Treasury does not
make separate interest payments on Treasury
bills. Instead, the discounted price accounts for
the interest that you will earn.
Example:
1. A certain Electric Company invest in a
P60,000.00 Philippine Treasury bill at 4.46%
interest for 30 days. The bank through
which the bill is purchased charges a
service fee of P20.00. What is the cost of
the treasury bill?
Year Table

Day – of – the – Year – Table