Applications

7-1

SI

Applications of
S imple I nterest
Chapter77
Chapter

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Ryerson ©
©
 Applications
7-2

SI
Learning Objectives
Learning Objectives
After completing this chapter, you will be able to:
Calculate

LO-1 …Interest paid on Savings

Accounts, Term Deposits, and
Guaranteed
Investment Certificates
LO-2 …the MARKET PRICE and rate of
return for Treasury Bills and
Commercial Paper
also…
also…
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 Applications
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Learning Objectives
Learning Objectives
State
LO-3 …the Valuation Principle and apply it to
the calculation of the Fair Market Value of an
investment providing
specified future cash flows
Describe the…
LO-4 …typical terms, conditions, and repayment
arrangements for revolving (demand)
loans, fixed-payment (demand) loans,
and Canada
Student Loans
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Notes about…
7-4

SI

LO-1

avings Accounts

Short-Term GICs
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 Applications
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About
avings Accounts
Interest
often calculated
on daily balance
and posted monthly
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Short-Term GICs
About

Guaranteed Investment Certificates

“Guaranteed” refers to the unconditional
guarantee of principal and interest by the
parent financial institution.

30 – 364 day terms

and…
and…
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Short-Term GICs
About

- Redeemable (or cashable GIC

or term deposit)
- Non-Redeemable
Redeemable (or cashable GIC
or term deposit)
Can be “cashed in” before maturity date
Non-Redeemable
Cannot be “cashed in” before maturity date
Most GICs are not redeemable before maturity

also…
also…
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Short-Term GICs
About

Can be purchased from banks, credit

unions, trust companies, and caisses
populaires (in Quebec).
(you are in effect lending money
to the financial institution)

The financial institution uses the

funds raised from selling GICs
to make loans …
most commonly, mortgage
loans
also…
also…
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Short-Term GICs
About

…Mortgage rates are typically

1.5% to 2% higher than the
interest rate
paid to GIC
…Higher investors.
rates are paid on
non-redeemable
GIC’s
…Higher rates are paid for longer
terms (within the 30 to 364-day range)
…Higher rates are paid on larger
principal amounts

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 Applications
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Short-Term GICs
About

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 Applications
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Short-Term GICs
About

e 1
a s
C For amounts of $5000 to $99,999 and
terms of 90 to 179 days,
the Royal Bank pays an interest
rate of 2.80% pa on redeemable GICs
and 3.15% on non-redeemable GICs.

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Short-Term GICs
About

In order to retain the redemption

privilege,
how much Interest (in dollars)
must be sacrificed on an
investment of $15,000 for 120
days?

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Short-Term GICs
Non-redeemable GIC
Non-redeemable GIC RedeemableGIC
Redeemable GIC

I = 15000 * .0315 * 120 / 365 I = 15000 * .028 * 120 / 365

Subtract
$155.34
== $155.34 ==$138.08
$138.08

Interest Sacrifice
Interest $17.26
Sacrifice $17.26
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Short-Term GICs
e 2
a s
C
For amounts between $10,000 and $24,999,
a bank pays a rate of 4.5% on GICs with
maturities in the 91 to 120-day range.
However, early redemption will result in a
rate of 3% being applied.

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Short-Term GICs
How much more Interest will a
120-day $22,000 GIC earn
if it is held until maturity
than if it is redeemed after 100 days?

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Short-Term GICs
120 Days
120 Days 100Days
100 Days
4.5%
4.5% 3.0% for
3.0% for early
early
I = 22000 * .045 * 120 / 365 I = 22000 * .03 * 100 / 365
Subtract
$325.48
== $325.48 ==$180.85
$180.85

MoreInterest
More $144.63
Interest $144.63
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LO-2

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Treasury Bills

Paper contracts issued to lenders by the

federal government and several
provincial governments when they
borrow money
for terms of less than one year.

…the FACE VALUE (Maturity Value) of a T-Bill

includes the Interest
that the T-bill
will earn during its life!
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Treasury Bills

Find the price of a 91-day $75,000

T-bill on its date of issue if the
going rate of interest is 5.1%.

PV = $75,000/[1+(0.051*91/365)]
= $74,058.34

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Treasury Bills

Suppose that the institutional purchaser of

the T-bill in the previous example sells it to
a client on the same day at a higher price
that represents a
lower yield to the
client of 4.6%.

profitdid
Whatprofit
What didthe
theinstitution
institutionmake
make
onthe
on thetransaction?
transaction?

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Treasury Bills

profitdid
Whatprofit
What didthe
theinstitution
institutionmake
make
onthe
on thetransaction?
transaction?

Selling Price Profit

Profit
Selling
$75000/[1 + .046(91/365)] Price $74,149.62
= $74,149.62 Acquisition
Price 74,058.34
$ 91.28
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Treasury Bills
Suppose the client who purchased the 91-day,
$75,000 T-bill in the previous example for
$74,149.62, sold the T-bill after 30 days in
order to invest the proceeds elsewhere!

(a)
(a) Whatprice
What pricewould
wouldshe
shereceive
receiveififthe
the
short-terminterest
short-term interestrate
ratefor
forthis
thismaturity
maturity
hadfallen
had fallento
to4.2%
4.2%bybythe
thedate
dateofofthe
thesale?
sale?
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Treasury Bills
(a)
(a) Whatprice
What pricewould
wouldshe
shereceive
receiveififthe
the
short-terminterest
short-term interestrate
ratefor
forthis
thismaturity
maturity
hadfallen
had fallento
to4.2%
4.2%bybythe
thedate
dateofofthe
thesale?
sale?

Determine the number of days

remaining to maturity
Calculate the Selling Price
based on the
Discounted Rate of 4.2%
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Treasury Bills
Determine the number of days

remaining
…purchased (T-Bill)to maturity
……. 91-day
…sold (T-Bill) after ………. 30 days = 61 days

Calculate the Selling Price based on the

Discounted Rate of 4.2%
PV of $75,000 discounted at 4.2% for 61 days
= $75000/[1 + .042(61/365)] SP SP== $74,477.23
$74,477.23
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 Applications
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Treasury Bills

Suppose the client who purchased the 91-day,

$75,000 T-bill in the previous example for
$74,149.62, sold the T-bill after 30 days in
order to invest the proceeds elsewhere!

(b)What
(b) Rate of
WhatRate of Return
Return(per
(perannum)
annum)did
didthe
the
clientrealize
client realizewhile
whileholding
holdingthe
theT-bill?
T-bill?

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Treasury Bills
(b)What
(b) Rate of
WhatRate of Return
Return(per
(perannum)
annum)did
didthe
the
clientrealize
client realizewhile
whileholding
holdingthe
theT-bill?
T-bill?
…Sold (T-Bill) after 30 days $74,477.23
…Purchased (T-Bill) ……. 74,149.62
Grew in 30 Days by… $ 327.61
rr==II//Pt
Pt
I
r = 327.61 / 74,149.62 (30/365)
Prt
= .053755 = 5.38%
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 Applications
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LO-3

The
The Valuation
Valuation Principle
Principle

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 Applications
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The Valuation
The Valuation Principle
Principle

…the Fair Market Value of an

investment and is the
Sum of the Present Value(PV)
of the expected cash flows
The Discount Rate used in the
Present Value(PV) calculations
should be the
Market-determined Rate of
Return
required
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for this type of investment
 Applications
7 - 29

SI
The Valuation
The Valuation Principle
Principle

Consider an investment that will deliver

a single payment of $110 one year from
now.

What is the most you should pay to buy

the investment if you
require a minimum return of
10%?

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 Applications
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The Valuation
The Valuation Principle
Principle
$110 one year from now = Future Value(FV)

$110 represents 110% or 100% + 10% Return

We are looking for the Present Value

PV = FV /(1+rt)
PV
$100isis
$100
= 110/[1+0.10*(1)] the most
most you
you
the
shouldpay
pay
== $100
$100 should

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The Valuation
The Valuation Principle
Principle

The process of calculating a

payment’s Present Value
is often called
“Discounting the
payment”
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The Valuation
The Valuation Principle
Principle

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7 - 33

The Valuation
The Valuation Principle
Principle
SI

An investment promises two payments of $2000, on

dates 1 and 4 months from now.
What pricewill
Whatprice willan
aninvestor paytoday
investorpay today
ififthe
therequired rateof
requiredrate ofreturn
return
8%??
isis8%
1 month = 1/12
4 months = 4/12
Formula
Formula PV = FV /(1+rt)
PV

(1) UsingaaTime
(1)Using TimeLine
Linedisplay,
display,and
and
(2) Bothalgebraically
(2)Both algebraicallyand
andbybycalculator
calculator
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 Applications
7 - 34

The Valuation
The Valuation Principle
Principle
SI

Months
1 2 3 4
(1)
$2000 $2000
Present
Present
Value
Value
(2) PV 2000/[1+0.08*(1/12)]
PV 2000/[1+0.08*(4/12)]

== 1986.76
1986.76 + == 1948.05
1948.05

PV= $3934.81
PV= $3934.81
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 Applications
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The Valuation
The Valuation Principle
Principle
SI
Today’s Value:
2000/[1+0.08*(1/12)]
2000/[1+0.08*(1/12)]++2000/[1+0.08*(4/12)]
2000/[1+0.08*(4/12)]
.08 .08

1 4
== 1986.76
1986.76
1948.05
1948.05
12 12
1 1

2000 2000

McGraw-Hill Ryerson © ==1986.76

1986.76 + ==1948.05
1948.05 PV= $3934.81
 Applications
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LO-4

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About 7 - 37

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… Loans where the lender has the right to

demand full repayment of the loan
at
any time!

…revolving loans
… fixed payment loans

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About 7 - 38

SI

... Borrower may repay any portion of the loan at

any time without penalty
… Interest rate charged is usually “floating”

… Interest is calculated on the same

‘statement date’ each month
… Interest is calculated up to but
not including the statement
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date
 Applications
7 - 39

SI

You negotiated a $5000 demand loan on March 1

at prime plus 2%.
The prime rate was 5% on March 1 and
decreased to 4% on May 18.
On May 20 you paid $1225 towards principal
plus the accrued interest.
The debt was completely repaid on June 30
together with the accrued interest.
What
What was
was (a)
(a) the
the total
total interest
interest charge,
charge, and
and
(b)
(b) the
the
total payment on June 30?
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SI

Record the information provided and known

in a Table format
Determine the number of days in each period
Calculate the interest accrued to date of
payment
Calculate the balance after the payment
Calculate the interest accrued and the
final balance on June 30
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 Applications
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Record the information that is known!
Interest Rate Balance
Interest
Date Prime Plus Total Days Paid $
Accrued
Mar 1 5 2 7.0 5,000.00

May18 4 2 6.0

May 20 4 2 6.0

June 30 4 2 6.0

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 Applications
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Determine the number of days in each period
Interest Rate Balance
Interest
Date Prime Plus Total Days Paid $
Accrued
Mar 1 5 2 7.0 60 5,000.00

May18 4 2 6.0 138 78

May 20 4 2 6.0 140 2

June 30 4 2 6.0 181 41

Lookup
Look up
Days
Days
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 Applications
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Calculate the interest accrued
Interest Rate Balance
Interest
Date Prime Plus Total Days Paid $
Accrued
Mar 1 5 2 7.0 60 5,000.00

May18 4 2 6.0 138 78

May 20 4 2 6.0 140 2

June 30 4 2 6.0 181 41

…Calculation
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 Applications
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SI
Calculate the interest accrued
IR
Interest
Date Total Days
Accrued Balance $5000
Mar 1 7.0 60

May18 6.0 138 78 $76.48 $5000 * 0.07 * 78/365 ==$76.48

$76.48

May 20 6.0 140 2 $ 1.64 $5000 * 0.06 * 2/365 ==$$1.64

1.64

June 30 6.0 181 41 Total==$78.12

Total $78.12
…complete the Table
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Calculate the balance after the payment
Interest Rate Balance
Interest
Date Prime Plus Total Days Paid $
Accrued
Mar 1 5 2 7.0 60 5,000.00

May18 4 2 6.0 138 78 76.48 5,076.48

May 20 4 2 6.0 140 2 1.64 5,078.12

1,303.12 3,775.00
June 30 4 2 6.0 181 41

Payment $1,225.00++Interest
Payment$1,225.00 Interest78.12
78.12
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Calculate the interest accrued and final balance on June 30

Interest Rate Balance
Interest
Date Prime Plus Total Days Paid $
Accrued
Mar 1 5 2 7.0 60 5,000.00

May18 4 2 6.0 138 78 76.48 5,076.48

May 20 4 2 6.0 140 2 1.64 5,078.12

1,303.12 3,775.00
June 30 4 2 6.0 181 41 25.44 3,800.44

Interest Accrued = $3,775.00 * .06 * 41/365 = $25.44

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You completed your college programme in December.

On June 30, you paid all of the interest that had accrued
(at prime +2.5%) on your $5800 Canada Student
Loan during the six-month grace period.
You selected the fixed rate option (prime+5%) and
agreed to make end-of-month payments of $95
beginning July31.
The prime rate began the grace period at 6% and rose
by 0.5% effective March 29.
On August 13, the prime rate
rose another 0.5%. to use…
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SI

Record the information provided and known in a

Table format
Determine the number of days in the grace period
Calculate the interest accrued during the grace
period
(a) Calculate the total interest paid in the first two
regular payments
(b) Calculate the balance after the second payment
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Record the information that is known!
Interest Rate Balance
Interest
Date Prime Plus Total Days Paid $
Accrued
Dec 31 6 2.5 8.5 5,800.00
Mar 29 6.5 2.5 9.0
June 30 6.5 5.0 11.5
End of Grace Period
July 31 6.5 5.0 11.5
Aug 13 7.0 5.0 12.0
Aug 31 7.0 5.0 12.0

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Determine the number of days in each period
Interest Rate Balance
Interest
Date Prime Plus Total Days Paid $
Accrued
Dec 31 6 2.5 8.5 5,800.00
Mar 29 6.5 2.5 9.0 88 88 Interest includes
June 30 due to
June 30 6.5 5.0 11.5 181 93 grace period
July 1 End of Grace Period
July 31 6.5 5.0 11.5 212 30
Aug 13 7.0 5.0 12.0 225 13
Aug 31 7.0 5.0 12.0 243 18
Lookup
Look up
Days
Days
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Calculate the interest accrued during the grace period

Interest Rate Balance
Interest
Date Prime Plus Total Days Paid $
Accrued
Dec 31 6 2.5 8.5 5,800.00
Mar 29 6.5 2.5 9.0 88 88
June 30 6.5 5.0 11.5 181 93
End of Grace Period
July 31 6.5 5.0 11.5 212 30
Aug 13 7.0 5.0 12.0 225 13
Aug 31 7.0 5.0 12.0 243 18
…Calculation
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Calculate the interest accrued during the grace period

IR
Interest
Date Total Days Balance $5800
Accrued
Dec 31 8.5
Mar 29 9.0 88 88 118.86 $5800 * 0.085 * 88/365= $118.86
$118.86
June 30 11.5 181 93 131.56 $5800 * 0.09 * 93/365= $133.00
$133.00
End of Grace Period

July 31 11.5 212 30 Includes June

Includes June 30
30

Aug 13 12.0 225 13

Total== $251.86
Total $251.86
Aug 31 12.0 243 18
…complete the Table
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Calculate the interest accrued during the grace period

Interest Rate Balance
Interest
Date Prime Plus Total Days Paid $
Accrued
Dec 31 6 2.5 8.5 5,800.00
Mar 29 6.5 2.5 9.0 88 88 118.86 5,918.86
June 30 6.5 5.0 11.5 181 93 133.00 6,051.86
End of Grace Period
251.86 5,800.00
July 31 6.5 5.0 11.5 212 30
Aug 13 7.0 5.0 12.0 225 13
Aug 31 7.0 5.0 12.0 243 18
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(a)
SI
Calculate the total interest paid in the
first two regular payments
Interest Rate Balance
Interest
Date Prime Plus Total Days Paid $
Accrued
Dec 31 6 2.5 8.5 5,800.00
Mar 29 6.5 2.5 9.0 88 88 118.86 5,918.86
June 30 6.5 5.0 11.5 181 93 133.00 6,051.86
End of Grace Period
251.86 5,800.00
July 31 6.5 5.0 11.5 212 30 95.00
Aug 13 7.0 5.0 12.0 225 13
Aug 31 7.0 5.0 12.0 243 18 95.00
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…Calculation
 Applications
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(a)
SI
Calculate the total interest paid in the
first two regular payments
Balance $5800.00
First Payment $95.00 Add: Interest 54.82
July 1 - July 31 interest 5854.82
$5800 * .115 * 30/365 = $54.82 Less: Payment 95.00
Second Payment $95.00
Balance 5759.82
Add: Interest 23.59
July 31 - August 13 interest Interest 34.09
$5759.82 * .115 * 13/365 = $23.59 5817.50
August 13 - August 31 interest Less: Payment 95.00
Balance 5722.50
$5759.82 * .12 * 18/365 = $34.09
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…complete the Table
 Applications
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(a) & (b)
SI
…the total interest paid and the balance
after the second payment
Interest Rate Balance
Interest
Date Prime Plus Total Days Paid $
Accrued
Dec 31 6 2.5 8.5 5,800.00
Mar 29 6.5 2.5 9.0 88 88 118.86 5,918.86
June 30 6.5 5.0 11.5 181 93 133.00 6,051.86
End of Grace Period
251.86 5,800.00
July 31 6.5 5.0 11.5 212 30 54.82 95.00 5,759.82

Aug 13 7.0 5.0 12.0 225 13 23.59 5,783.41

Aug 31 7.0 5.0 12.0 243 18 34.09 95.00 5,722.50
McGraw-Hill Ryerson © Total Interest $112.50
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SI

This completes
This completes Chapter
Chapter 77

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