Chapter 2

Simple interest and simple

discount

Outcome of chapter
To master the basic concepts and applications of simple interest and simple
discount.

K EY CONCEPTS
⋆ Interest ⋆ Timeline
⋆ Simple interest ⋆ Simple discount
⋆ Principal or present value ⋆ Discount rate
⋆ Term ⋆ Nominal or face value
⋆ Interest rate ⋆ Number of days
⋆ Amount or future value ⋆ Time value of money
⋆ Due date or maturity date
One of the characteristics that is said to distinguish adults from small children
is that adults often delay compensation/rewards/payment – for instance, sav-
ing half a bar of chocolate until tomorrow – whereas your average baby will
almost certainly eat the lot now, even if it doesn’t really want it. However,
in certain circumstances, the baby’s “grab it now” instinct is actually sounder
than the adult’s willingness to wait – though not for reasons that the baby
could appreciate!
Most of the principles of financial decision making are based on a simple
concept, namely that of time preference. All things being equal, we would
prefer to receive a sum of money now rather than the same amount some time
in the future. Offered a simple choice between R5 000 now and R5 000 in a
year’s time, the choice is clear: We would take the money now. Why? There
are several reasons for this. What student doesn’t need spending money now?
But more importantly, opportunity cost is involved in every financial decision
taken.
For example, if your local bank approaches you, the client, with an offer that,

3
ARSK13-B CHAPTER 2. SIMPLE INTEREST AND DISCOUNT

if you deposit your savings of R5 000 with it for a year, the bank will, at the
end of that time, return R5 000 to you, you will regard such an offer as totally
unattractive - given the “sacrifice” you would have to make over the next 12
months in going without the R5 000 for a year! You could invest that money
or you could use it to purchase goods and services from which you could
derive satisfaction now. Clearly, the bank will have to offer you some reward
to part with your cash. In effect, the bank should offer to pay you not just
R5 000 after a year, but R5 000 plus a financial reward. This financial reward
is known as interest.
Interest rate calculations are straightforward. Because they are one of the
basic building blocks of financial mathematics, we shall take some time to
explore the principles of interest rate calculations.

Study
2.1 Simple interest
unit
After working through this section, you should be able to 1
⊲ explain the terms
– interest and rate of interest
– principal and present value
– term (of a loan)
– sum accumulated and future value
⊲ relate the above-mentioned terms using the formula for simple interest and
sum accumulated
⊲ calculate any one of the above-mentioned variables, given the others
⊲ apply the simple interest formula to practical applications

Let us define interest.

Definition 2.1 Interest is the price paid for the use of borrowed money.
The party who uses or borrows the money pays interest to the party who lends
the money. Interest is calculated as a fraction of the amount borrowed or saved
(principal amount) over a certain period of time. The fraction, also known as
the interest rate, is usually expressed as a percentage per year, but must be
reduced to a decimal fraction for calculation purposes. For example, if we
have borrowed an amount from the bank at an interest rate of 12% per year,
we can express the interest as:
12% of the amount borrowed
or 12/100 of the amount borrowed
or 0,12× the amount borrowed.
When and how interest is calculated will result in different types of inter-
est. For example, simple interest is interest that is calculated on the principal
amount that was borrowed or saved at the end of the completed term.

4
CHAPTER 2. SIMPLE INTEREST AND DISCOUNT ARSK13-B

Now let’s look at an example:

How much simple interest will be paid on a loan of R10 000 borrowed for a
year at an interest rate of 10% per year?
10% of R10 000 must be paid as the interest per year for the use of the money.

10 000 × 0,10 = 1 000

The interest per year is R1 000.

Suppose we are using the money for two years

10 000 × 0,10 × 2 = 2 000

Then the interest for the full loan period is R2 000.

In this case, we have multiplied the amount used by the interest rate per year
multiplied by the number of years used.
Thus:
Definition 2.2 Simple interest is interest that is computed on the principal for
the entire term of the loan and is therefore due at the end of the term. It is
given by
I = Prt
where
I is the simple interest (in rand) paid at the end of the term for the use of the
money
P is the principal or total amount borrowed (in rand) which is subject to
interest (P is also known as the present value [PV ] of the loan)
r is the rate of interest, that is, the fraction of the principal that must be paid
each period (say, a year) for the use of the principal (also called the
period interest rate)
t is the time in years, for which the principal is borrowed.

Note
1. The units used for the rate of interest and the term must be consistent.
If, for example, the interest rate is calculated per annum, then the
term t must be in years, or a fraction thereof. If the interest rate is
expressed for a shorter period (say, per month), then the term must be
expressed accordingly (i.e. in months). Thus we need to change the
months or days or weeks to a fraction of a year by dividing the months
by the number of months in a year, namely 12, the weeks by 52, the days

5
ARSK13-B CHAPTER 2. SIMPLE INTEREST AND DISCOUNT

by 365 etc. It must be pointed out that, in this respect, a distinction is

sometimes made between the so-called ordinary interest year, which is
based on a 360-day year, and the exact interest year, which is based
on a 365-day year. In the former case, each month has 30 days, each
quarter 90 days, etc. In the latter, the exact number of days or months
of the loan is used. Unless otherwise stated, we shall always work with
exact periods.
2. In other textbooks, you may find that different symbols are used for the
different variables. For example, the formula for simple interest may be
written as
I = Cin
where C represents the capital or principal, i is the rate of interest and
n is the number of periods. This should not be a source of confusion to
you.

Definition 2.3 The amount or sum accumulated (S) (also known as the matu-
rity value, future value or accrued principal) at the end of the term t is given
by

S = Principal value + Interest

S = P+I
S = P + Prt
S = P(1 + rt). (See Note below.)

Note
When we replaced S = P + Prt with S = P(1 + rt) above, we applied the so-
called distributive law of multiplication over addition. This is a basic rule of
mathematics that states
ab + ac = a(b + c).
In the above example, we had a = P, b = 1 and c = rt.

Definition 2.4 The date at the end of the term, at which the debt is to be paid,
is known as the due date or maturity date.

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CHAPTER 2. SIMPLE INTEREST AND DISCOUNT ARSK13-B

The following exercise will help revise these concepts:

Exercise 2.1
Calculate the simple interest and the sum accumulated for R5 000 bor-
rowed for 90 days at a simple interest rate of 15% per annum.
See Appendix A at the end of the chapter, for solutions of the exer-
cises

Sometimes we not only consider the basic formula I = Prt but also turn it
inside out and upside down, as it were, in order to obtain formulæ for each
variable in terms of the others.
Of particular importance is the concept of present value P or PV, which is
obtained from the basic formula for the sum or future value S, namely

S = P(1 + rt).

Dividing by the factor (1 + rt) gives

S
P= .
1 + rt
How do we interpret this result? We do it as follows: P is the amount that
must be borrowed now to accrue to the sum S, after a term t, at interest rate
r per year. As such, it is known as the present value of the sum S. Stated
formally:
Definition 2.5 The present value of a debt (S) at a date prior to the due date
is the value (P or PV ) of the debt at the date in question and it is given by the
formula
S
P=
1 + rt
where r is the interest rate and t is the “time to run to maturity”.
Again, you should have no difficulty with the following exercise:

Exercise 2.2
Determine the present value of a loan issued today with a maturity va-
lue (future value) of R12 000 in two years’ time, if a simple interest rate
of 12% per annum, is applicable.
See Appendix A at the end of the chapter, for solutions of the exer-
cises

7
ARSK13-B CHAPTER 2. SIMPLE INTEREST AND DISCOUNT

Study
2.2 Timelines
unit
After working through this section, you should be able to
⊲ draw a timeline to assist you in solving simple interest case problems re-
2
lating the future values and the present values via the interest received, and
clearly indicating the interest rate on and term for it.

A useful way of representing interest rate calculations is with the aid of a

so-called timeline. Time flow is represented by a horizontal line. Inflows
of money are indicated by an arrow from above, pointing to the line, while
outflows are indicated by a downward-pointing arrow below the timeline.
For a simple interest rate calculation, the timeline will be as follows:

PV or P
| t = Term |
r=
Interest | |
rate
FV or
S = P(1 + rt)

At the beginning of the term, the principal P (or present value) is deposited
(or borrowed) – that is, it is entered onto the line. At the end of the term, the
amount or sum accumulated, S (or future value), is received (or paid back).
Note that the sum accumulated includes the interest received. Remember that

that is
Sum accumulated = Principal + Interest received NB
S = P + Prt
= P(1 + rt)

or equivalently

Future value = Present value + Interest received.

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 CHAPTER 2. SIMPLE INTEREST AND DISCOUNT ARSK13-B

Using a timeline, exercise 2.1 above may be represented as follows:

R5 000
90
| 365 years |
r = 15% | |

R5 184,93
Similarly, exercise 2.2 above may be represented as follows:

R9 677,42
| 2 years |
r = 12% | |

R12 000

Note that the structure of these two problems is essentially the same. The only
difference, apart from the figures, is that, in the former case, the future value
was unknown, whereas in the latter, we were asked to find the present value.

Study
2.3 Simple discount
unit
After working through this section, you should be able to
3 ⊲ explain the terms
– discount and discount rate
– discounted or present value
– face or future value
– term
⊲ relate the above in a formula and represent it, using a timeline
⊲ calculate
– the simple discount for money market instruments
– the effective interest rate for a given discount rate

Definition 2.6 Interest calculated on the face (future) value of a term and
paid at the beginning of the term is called discount.
In section 2.1, we emphasised the interest that has to be paid at the end of the
term for which the loan (or investment) has been made. At the due date, the
principal borrowed plus the interest earned is paid back.
In practice, there is no reason why the interest cannot be paid at the beginning
rather than at the end of the term. Indeed, this implies that the lender deducts
the interest from the principal in advance. At the end of the term, only the

9
ARSK13-B CHAPTER 2. SIMPLE INTEREST AND DISCOUNT

principal is then due. Loans handled in this way are said to be discounted and
the interest paid in advance is called the discount. The amount thus advanced
by the lender is termed the discounted value. The discounted value is simply
the present value of the sum to be paid back, and we could approach the
calculations using the present value technique in section 2.1. Expressed in
terms of the timeline of the previous section, it means that we are given S and
asked to calculate P (as was the case in exercise 2.2).

P
| t |

| |d

S
The discount on the sum S is then simply the difference between the future
value and the present value. Thus, the discount (D) is given by

D = S − P.

In the case of exercise 2.2, this would be

D = 12 000 − 9 677,42
= 2 322,58.

Thus we can state that the R12 000 loan is sold at a discount of R2 322,58 two
years prior to the due date.
Definition 2.7 The discount D is given by

D = Sdt

(compared to the formula for simple interest I = Prt), where d = simple dis-
count rate and the discounted (or present) value of S is

P = S−D
= S − Sdt
= S(1 − dt)

or

Present Value = Future Value − (Future Value × Discount rate × Time).

PV = FV − (FV × d × t)
PV = FV (1 − dt)or
P = S(1 − dt)

(compared to the formula for the accumulated sum or future value for simple
interest S = P(1 + rt)).

10
CHAPTER 2. SIMPLE INTEREST AND DISCOUNT ARSK13-B

This may be expressed in the form of the following timeline:

PV = discounted or = P
present value

✛
t = term of discount ✲
❄ d=
discount rate

❄
FV = face value or
future value = S
Two things are important here. Firstly, this is structurally similar to the time-
line for simple interest. Secondly, since we are working with simple discount,
and the discount rate is now expressed as a percentage of the future value (and
not as a percentage of the present value as before), a minus sign appears in
the formula. This means that the discount, FV × d × t, is subtracted from the
future value to obtain the present value.

Example 2.1
Determine the simple discount on a loan of R3 000 due in eight months
at a discount rate of 15%. What is the discounted value of the loan?
What is the equivalent simple interest rate r?
8
Now S = 3 000, d = 0,15 and t = 12 = 23 .

This is represented by a timeline

?
8
| t= 12
|

d = 15% | |

Thus R3 000

D = Sdt
2 8
= 3 000 × 0,15 × (As 12 = 23 .)
3
= 300

that is, the simple discount is R300.

P = S−D
= 3 000 − 300
= 2 700

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ARSK13-B CHAPTER 2. SIMPLE INTEREST AND DISCOUNT

The discounted value is R2 700. In order to determine the equivalent interest

rate r, we note that R2 700 is the price now and that R3 000 is paid back eight
months later.
I = S−P
= 3 000 − 2 700
= 300
The interest is thus R300. The question can therefore be rephrased as follows:
What simple interest rate, when applied to a principal of R2 700, will yield
R300 interest in eight months?
But
I = Prt
and with substitute, we get
2
300 = 2 700 × r ×
3
300 2
= r×
2 700 3
300 3
× = r
2 700 2

that is
3 300
r = ×
2 2 700
= 0,1667.

Thus, the equivalent simple interest rate is approximately 16,67% per annum.

Note
There is a considerable difference between the interest rate of 16,67% and
the discount rate of 15%. It emphasises the important fact that the interest
rate and the discount rate are not the same thing. The point is that they act
on different amounts, and at different times – the former acts on the present
value, whereas the latter acts on the future value.

Exercise 2.3
1. A loan of R4 000 must be paid in six months’ time. Determine the
amount of money that you will receive now if a simple discount rate of
18%, per annum, is applicable. Determine the equivalent simple inter-
est rate.

12
 CHAPTER 2. SIMPLE INTEREST AND DISCOUNT ARSK13-B

2. Determine the simple interest rate that is equivalent to a discount rate

of
(a) 12% for three months
(b) 12% for nine months
Hint: Let S = 100 and use the appropriate formulæ to set up an equation
for r. See Appendix A at the end of the chapter, for solutions of the
exercises

Study
2.4 Counting days
unit
After working through this section, you should be able to
4 ⊲ determine the number of days between any two dates and apply this to
problems involving simple interest and simple discount for a term specified
by initial and final dates.

With simple interest and simple discount calculations, it is often important to

know the exact number of days between the beginning and end of the relevant
term. For this purpose, the convention is as follows:

NB To calculate the exact number of days between the beginning and the end of
the relevant term, the day on which the money is lent (or deposited) is counted,
but not the day the money is repaid (or withdrawn).

In its simplest form, it means that if I deposit money in a bank today and
withdraw it tomorrow, I will receive interest for one day and not two. This is
obviously the reason for counting in this way.
Many financial calculators have a “day function” which makes the calculation
of the number of days between two dates quite easy. Alternatively, older
financial textbooks often have tables from which the number sought can be
read off with relative ease. For our purposes, we will simply go ahead and
“count on our fingers” (the original calculator!) OR use Appendix C.

Example 2.2
Determine the number of days between 19 March and 11 September of
the same year.
List the months and relevant number of days in each month, and then deter-
mine the total.

13
ARSK13-B CHAPTER 2. SIMPLE INTEREST AND DISCOUNT

Month Number of days

March 13 (including 19 March∗ )

April 30
May 31
June 30
July 31
Augustus 31
September 10 (excluding 11 September)
176
∗ Count on your fingers!

OR
Use Appendix C, page 33, of this study guide.
Day number 254 (11 September) minus day number 78 (19 March) equals
176.

Exercise 2.4
Determine the number of days from 12 October to 15 May of the fol-
lowing year.
See Appendix A at the end of the chapter, for solutions of the exer-
cises

Exercise 2.5
Suppose an investor wishes to purchase a treasury bill (with a par value,
that is, face value of R1 000 000,00), maturing on 2 July, at a discount
rate of 16,55% per annum and with a settlement date of 13 May of
the same year. What would the required price be (that is, the present
or discount value – also referred to as the consideration)? What is the
equivalent simple interest rate of the investment? See Appendix A at
the end of the chapter, for solutions of the exercises

Note
The settlement date is the date at which he, the investor, must pay.

14
 CHAPTER 2. SIMPLE INTEREST AND DISCOUNT ARSK13-B

Study
2.5 The time value of money
unit
After working through this section, you should be able to
5 ⊲ explain the concept of dated values of money and illustrate this using time-
lines
⊲ give rules for moving money forward or backward in time to a specific date
⊲ apply the rules to obtain the value of a given debt (or investment) at different
dates
⊲ apply the time value concept to reschedule debts

From what has been said before, it is evident that money has a time value.
To be specific, we introduced the concepts “present value” and “future value”
of a particular debt or investment, and showed that the two are related by the
equation
Future value = Present value + Interest
or, in symbols,

S = P + Prt
= P(1 + rt).

This means the following:

Definition 2.8 A particular investment has different values at different dates.
For example, R1 000 today will not be the same as R1 000 in six months’
time. In fact, if the prevailing simple interest rate is 16% per annum, then, in
six months, the R1 000 will have accumulated to R1 080.
1
1 000 × (1 + 0,16 × ) = 1 080
2

On the other hand, a value of R2 000 in two months, time was worth less when
the loan was issued. It was worth
2 000
2

= 1 923,08
1 + 0,16 × 12

R1 000 R1 080
Case 1
6
12 = 12 years
16% | |
2
12years
R1 923,08 Case 2 R2 000

15
ARSK13-B CHAPTER 2. SIMPLE INTEREST AND DISCOUNT

In more general terms, we may depict the symbolic case as follows:

P S

t
| |
current date later date
S
P= (1+rt) S = P(1 + rt)

We can formulate the above results as two simple rules:

1. To move money forward from the issued date (determine a future value)
where simple interest is applicable, inflate the relevant sum by multiply-
ing by the factor (1 + rt).
NB
2. To move money backward to the issue date (determine a present value),
where simple interest is applicable, deflate the relevant sum by dividing
by the factor (1 + rt).
Note: The second rule is equivalent to multiplying by a factor of (1 + rt)−1.

The point is that the mathematics of finance deals with dated values of money.
This fact is fundamental to any financial transaction involving money due at
different dates. In principle, every sum of money specified should have an
attached date. Fortunately, in practice, it is often clear from the context what
the date implied is.

Example 2.3
Jack borrows a sum of money from a bank now and, in terms of the
agreement, he must pay back R1 000 nine months from today. How
much does he receive now if the agreed rate of simple interest is 12%
per annum? Suppose he wants to repay his debt at the end of one year.
How much will he have to pay then?
To answer the first question we must bring back the R1 000 by nine months to
today, using the stated rate of simple interest.

This is represented on a timeline.

P0 =?
9
12 years
9 months
r = 12% | |
0
R1 000

16
CHAPTER 2. SIMPLE INTEREST AND DISCOUNT ARSK13-B

1 000
P0 = 9
1 + 0,12 × 12
= 917,43

Thus, the amount borrowed is R917,43.

To calculate the amount owed at the end of a year, we have to move the issued
value of R917,43 forward by 12 months.
This is represented on a timeline.

R917,43 S =?
12 months

r = 12% | |
0 12 months

12
P12 = 917,43 × (1 + 0,12 × )
12
= 1 027,52

The amount owed at the end of the year is R1 030,00. Notice how I have used
a subscript attached to the letter P to indicate the relevant month to which the
money is referring to.

Note
Please note that you can not move the value at month 9 to month 12, as simple
interest is calculated using the original principle or issued value of the loan.
If you use the R1 000 of month 9 and move it forward just 3 months, it will
include interest on interest as the R1 000 already includes interest and give
you the following value that is wrong!
 
3
P12 = 1 000 1 + 0,12 × = 1 250
12

The definition of simple interest states: Simple interest is interest that is com-
puted on the principal for the entire term of the loan and is therefore, due at
the end of the term.

Exercise 2.6
Melanie owes R500, due in eight months. For each of the following
cases, what single payment will repay her debt if money is worth 15%
simple interest per annum?
(a) now

17
ARSK13-B CHAPTER 2. SIMPLE INTEREST AND DISCOUNT

(b) six months from now

(c) in one year
See Appendix A at the end of the chapter, for solutions of the exer-
cises

2.6 Summary of chapter 2

In this chapter, the basic concept of and formulæ pertaining to simple interest
were discussed. The basic formula for simple interest is

S = P(1 + rt)

where P is the principal invested for a term t at rate r per year, and S the sum
accumulated at simple interest.
The present value, P, of S is defined as

S
P= .
1 + rt
The concept of a timeline that relates the present value and the future value
graphically was introduced and shown to be a useful tool:

PV or P
| t = term |
r=
interest | |
rate
FV or
S = P(1 + rt)
The inverse concept of simple discount was discussed. The discounted (or
present) value of S was defined as

P = S−D
= S(1 − dt)

where d is the discount rate.

Finally, the above concepts of present value and future value were used to
introduce the time value of money. It was stressed that, in principle, the value
of any debt or investment must be linked to a specific date.
The relationship between values at different dates is summarised by the fol-
lowing timeline:

18
CHAPTER 2. SIMPLE INTEREST AND DISCOUNT ARSK13-B

P = S/(1 + rt)

t
| |
issue date later date

P S = P(1 + rt)

2.7 Evaluation exercises

See Appendix B at the end of the chapter for solutions of the evaluation
exercise.
1. At what rate of simple interest will R600 amount to R654 in nine months?
2. A loan was issued on 1 April and a value of R1 500 is payable on 1
October of the same year. A simple interest rate of 16% per annum, is
applicable. What is the issued value of the loan.
3. The simple discount rate of a bank is 16% per annum. If a client signs
a note to pay R6 000 in nine months’ time, how much will the client
receive? What is the equivalent simple interest rate?
4. Anthony borrowed R3 000 on 4 February at a simple interest rate of
15% per annum. He paid R1 000 on 21 April of the same year, R600 on
12 May of the same year, and R700 on 11 June of the same year. What
was the balance due on 15 August of the same year if payments were
subject to the same simple interest as the original debt?

19
ARSK13-B CHAPTER 2. SIMPLE INTEREST AND DISCOUNT

20
 Appendix A
Answers to exercises

From error to error, one discovers the entire truth.

—S IGMUND F REUD

Chapter 2. Simple interest and simple discount

Exercise 2.1
Since the interest rate is expressed “per annum” and the interest rate and term
must be consistent, we first have to express the term t in years. Change the
days to a fraction of a year:
90
t=
365
Then
I = Prt
90
= 5 000 × 0,15 ×
365
= 184,93

The interest is R184,93.

S = P+I
= 5 000 + 184,93
= 5 184,93
The accumulated amount is R5 184,93.
OR
S = P(1 + rt)
90
= 5 000(1 + 0,15 × )
365
= 5 184,93

21
ARSK13-B APPENDIX A. ANSWERS TO EXERCISES

The accumulated amount is R5 184,93.

Note, as pointed out earlier, reference is occasionally made to a 360-day year.
This has its origin in precalculator days when sums of the above type were
tedious. In the above example, the effect of this would have been that t =
90 1
360 = 4 , which obviously makes manual calculation much easier. However,
unless the contrary is stated, you should always assume that the “exact” year
(365 days in a year) is used.

Exercise 2.2
Now S = R12 000, r = 0,12 and t = 2.
Thus
S
P =
1 + rt
12 000
=
1 + 0,12 × 2
= 9 677,42

The present value of the loan when it is paid, is R9 677,42.

Exercise 2.3:1
6
We have S = R4 000, d = 0,18 and t = 12 = 21 .

D = Sdt
1
= 4 000 × 0,18 ×
2
= 360

The discount is R360. The discounted value is

P = S−D
= 4 000 − 360
= 3 640

You will therefore receive R3 640.

Since the interest (I) paid is R360, we use

I = Prt.

Therefore
1
360 = 3 640 × r ×
2

22
APPENDIX A. ANSWERS TO EXERCISES ARSK13-B

or
360 1
= r×
3 640 2
360 2
× = r
3 640 1
360
r = ×2
3 640

= 0,1978.

Thus, the equivalent simple interest rate is 19,78% per annum.

Exercise 2.3:2

3
(a) We take S = 100. Since d = 0,12 and t = 12 = 14 , we find

D = Sdt

= 100 × 0,12 × 14

= 3

and P = S−D

= 100 − 3

= 97.

Since I = 3 and I = Prt

3 = 97 × r × 14
3
thus r = 97 ×4

= 0,1237.

OR

Let us derive a formula:

S = P(1 + rt) 1

P = S(1 − dt) 2

Substitute P of 2 into 1 thus

S = S(1 + rt)(1 − dt)

23
ARSK13-B APPENDIX A. ANSWERS TO EXERCISES

Now solve for r.

1
1−dt = 1 + rt
1
rt = 1−dt −1
Substitute the given values into the formula
1−1+dt
= 1−dt
0,12
r = 3
dt 1−0,12× 12
= 1−dt
= 0,1237.
dt
r = 1−dt × 1t
d
= 1−dt

Thus, the equivalent simple interest rate is 12,37% per annum.

9
(b) Again, S = R100 and d = 0,12 but now t = 12 = 34 . Thus

3
D = 100 × 0,12 ×
4
= 9

and

P = 100 − 9
= 91.

From

I = Prt
3
9 = 91 × r ×
4
thus
4 9
r = ×
3 91
= 0,1319.

OR

d
r =
1 − dt
0,12
=
1 − 0,12 × 34
= 0,1319.

In this case, the equivalent simple interest rate is 13,19% per an-
num.

24
APPENDIX A. ANSWERS TO EXERCISES ARSK13-B

Exercise 2.4
Count and add the days from 12 October to 15 May of the following year as
follows:
Month Number of days

October 20 (including 12 October)

November 30
December 31
January 31
February 28
March 31
April 30
May 14 (excluding 15 May)
215
OR

Day number 365 (31 December) minus day number 285 (12 October) plus
day number 135 (15 May) equals 215.
There are thus 215 days between the two dates.

Exercise 2.5
First determine the day number of the maturity date, namely 2 July (day num-
ber 183); and then subtract the day number of the settlement date, 13 May
(day number 133). Thus, 183 − 133 = 50 days. The value at the maturity date
is the so-called par value, which is given as R1 000 000. The discount rate is
given as 16,55% per annum.

P = S(1 − dt)
 
50
= 1 000 000 1 − 0,1655 ×
365
= 977 328,77

The present value at the settlement date is therefore R977 328,77. This is the
price the investor must pay on 13 May in order to receive R1 000 000 on 2 July
(i.e. 50 days later).
Now

I = 1 000 000 − 977 328,77

= 22 671,23

25
ARSK13-B APPENDIX A. ANSWERS TO EXERCISES

The interest earned is therefore R22 671,23. Since such interest is on the
purchase price, we can calculate the equivalent simple interest rate as follows:

I = Prt
I
r =
Pt
22 671,23
= 50
977 328,77 × 365
= 0,1693391

OR
d
r =
1 − dt
0,1655
= 50
1 − 0,1655 × 365
= 16,93%

Thus, the equivalent simple interest rate is 16,93% per annum.

Exercise 2.6
The three problems can be represented on a timeline (all at 15% per annum):
12
12
8
12
6
12
| | | |
0 6 8 12
P0 P6 R500 P12
(a)
500
P0 = 8
1 + 0,15 × 12

= 454,55

Melanie must pay R454,55 now.

(b)
 
2
P6 = 454,55 1 + 0,15 ×
12

= 488,64

Melanie must pay R488,64 at month 6.

26
APPENDIX A. ANSWERS TO EXERCISES ARSK13-B

(c)
 
12
P12 = 454,55 × 1 + 0,15 ×
12
= 522,73

Melanie must pay R522,73 at month 12.

27
ARSK13-B APPENDIX A. ANSWERS TO EXERCISES

28
 Appendix B
Solutions to evaluation exercises

Nothing is a waste of time if you use the experience wisely.

—Auguste Rodin

Chapter 2. Simple interest and discount

1.

S = P(1 + rt)
S
1 + rt =
P
S
rt = −1
P
S


− 1
r = P
t
9
Now S = 654, P = 600 and t = 12 = 43 .
Thus
654
600 −1
r = 3
4
= 0,12.

The rate of interest is therefore 12% per annum.

2. The future value is obtained using the formula

S = P(1 + rt).

The present value is given by

S
P=
1 + rt

29
ARSK13-B APPENDIX B. ANSWERS TO EVALUATION EXERCISES

where S = 1 500, r = 0,16 and t the time from maturity to issued date,
which is from 1 April to 1 October which is six months, that is:
? R 1 5 0 0

r = 1 6 %

1 A p r 1 Ju l 1 O c t

6 1
t= = .
12 2
Thus
1 500
P =
1 + 0,16 × 12
= 1 388,89
The present value is R1 388,89.
9
3. We have S = R6 000, d = 0,16 and t = 12 = 34 .
Thus

D = Sdt
3
= 6 000 × 0,16 ×
4
= 720
and the discounted value is

P = S−D
= 6 000 − 720
= 5 280.

The client receives R5 280.

Now the interest paid is R720.
Using I = Prt gives 720 = 5 280 × r × 43 or
720 4
r = ×
5 280 3
= 0,1818.
OR
d
r =
1 − dt
0,16
=
1 − 0,16 × 43
= 0,1818.

Thus, the equivalent simple interest rate is 18,18% per annum.

30
APPENDIX B. ANSWERS TO EVALUATION EXERCISES ARSK13-B

4. The following diagram shows the debt, the payments, the dates at which
such payments are made, and the days to settlement:
R3 000
192 days
116 days
95 days
65 days
15% | | | | |
4 February 21 April 12 May 11 June 15 August

R1 000 R600 R700 ?

P1 P2 P3

 
192
Value of R3 000 = 3 000 × 1 + 0,15 ×
365
= 3 236,71

The value of the debt at the end (15 August) is R3 236,71.

The values of the three payments on 15 August are, respectively
 
116
P1 = 1 000 × 1 + 0,15 ×
365
= 1 047,67.

 
95
P2 = 600 × 1 + 0,15 ×
365
= 623,42.

 
65
P3 = 700 × 1 + 0,15 ×
365
= 718,70.

Thus, the total value of the payment is

R2 389,79 (1 047,67 + 623,42 + 718,70).
The outstanding debt on 15 August is thus R846,92 (3 236,71−2 389,79).

31
ARSK13-B APPENDIX B. ANSWERS TO EVALUATION EXERCISES

32
 Appendix C
The number of each day of the
year

FOR LEAP YEARS ADD ONE TO THE NUMBER EVERY DAY AFTER FEBRUARY 28
Day Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Day
1 1 32 60 91 121 152 182 213 244 274 305 335 1
2 2 33 61 92 122 153 183 214 245 275 306 336 2
3 3 34 62 93 123 154 184 215 246 276 307 337 3
4 4 35 63 94 124 155 185 216 247 277 308 338 4
5 5 36 64 95 125 156 186 217 248 278 309 339 5
6 6 37 65 96 126 157 187 218 249 279 310 340 6
7 7 38 66 97 127 158 188 219 250 280 311 341 7
8 8 39 67 98 128 159 189 220 251 281 312 342 8
9 9 40 68 99 129 160 190 221 252 282 313 343 9
10 10 41 69 100 130 161 191 222 253 283 314 344 10
11 11 42 70 101 131 162 192 223 254 284 315 345 11
12 12 43 71 102 132 163 193 224 255 285 316 346 12
13 13 44 72 103 133 164 194 225 256 286 317 347 13
14 14 45 73 104 134 165 195 226 257 287 318 348 14
15 15 46 74 105 135 166 196 227 258 288 319 349 15
16 16 47 75 106 136 167 197 228 259 289 320 350 16
17 17 48 76 107 137 168 198 229 260 290 321 351 17
18 18 49 77 108 138 169 199 230 261 291 322 352 18
19 19 50 78 109 139 170 200 231 262 292 323 353 19
20 20 51 79 110 140 171 201 232 263 293 324 354 20
21 21 52 80 111 141 172 202 233 264 294 325 355 21
22 22 53 81 112 142 173 203 234 265 295 326 356 22
23 23 54 82 113 143 174 204 235 266 296 327 357 23
24 24 55 83 114 144 175 205 236 267 297 328 358 24
25 25 56 84 115 145 176 206 237 268 298 329 359 25
26 26 57 85 116 146 177 207 238 269 299 330 360 26
27 27 58 86 117 147 178 208 239 270 300 331 361 27
28 28 59 87 118 148 179 209 240 271 301 332 362 28
29 29 88 119 149 180 210 241 272 302 333 363 29
30 30 89 120 150 181 211 242 273 303 334 364 30
31 31 90 151 212 243 304 365 31

33
ARSK13-B APPENDIX C. THE NUMBER OF EACH DAY OF THE YEAR

34
 Appendix D
Formulæ

Simple interest
S = P(1 + rt)
S ≡ accumulated amount / future value
P ≡ principal / present value
r ≡ interest rate per year
t ≡ time in years

Simple discount
P = S(1 − dt)
P ≡ principal / present value
S ≡ accumulated amount / future value
d ≡ discount rate per year
t ≡ time in years

Compound interest
jm tm
S = P(1 + )
m
S ≡ accumulated amount / future value
P ≡ principal / present value
jm ≡ nominal interest rate per year
m ≡ number of compounding periods per year
t ≡ time in years
OR

S = P(1 + i)n
S ≡ accumulated amount / future value
P ≡ principal / present value
i ≡ nominal interest rate per compounding period
n ≡ number of compounding periods

Effective interest rate

jm m
  
Jeff = 100 1+ −1
m

35
ARSK13-B APPENDIX D. FORMULÆ

Jeff ≡ effective interest rate (as a percentage)

jm ≡ nominal interest rate per year
m ≡ number of compounding periods per year

Continuous compounding
 
jm
c = m ln 1 +
m

c ≡ continuous compounding rate

jm ≡ nominal interest rate per year
m ≡ number of compounding periods per year
ln ≡ ln function on the calculator

S = Pect

S ≡ accumulated amount / future value

P ≡ principal / present value
e ≡ ex exponential function (on calculator)
c ≡ continuous compounding rate
t ≡ time in years

Converting interest
 m !
jm n
i=n 1+ −1
m

i ≡ converted interest rate per period

n ≡ number of compounding periods
jm ≡ given nominal interest rate per year
m ≡ number of compounding periods per year of the given nominal rate

Converting continuous compounding to effective interest rate

J∞ = 100(ec − 1)

J∞ ≡ effective interest rate for continuous compounding (as a percentage)

e ≡ ex exponential function (on calculator)
c ≡ continuous compounding rate

Future value of an annuity

(1 + i)n − 1
 
S=R
i

S ≡ accumulated amount / future value

R ≡ equal payment (amounts) paid at equal intervals
i ≡ interest rate per year divided by the number of compounding periods per year
n ≡ number of years multiplied by the number of compounding periods per year

Present value of an annuity

(1 + i)n − 1
 
P=R
i(1 + i)n

36
APPENDIX D. FORMULÆ ARSK13-B

P ≡ principal / present value

R ≡ equal (payment) amounts paid at equal intervals
i ≡ interest rate per year divided by the number of compounding periods per year
n ≡ number of years multiplied by the number of compounding periods per year

Annuity due
P = (1 + i)Ra n i or S = (1 + i)Rs n i

Multiply the answer of the present value or future value of an annuity with (1 + i).

Increasing annuity
 
Q nQ
S = R+ sn i−
i i

S ≡ accumulated amount / future value

R ≡ equal (payment) amounts paid at equal intervals
Q ≡ amount by which the regular payments will increase every period
i ≡ interest rate per period
n ≡ number of compounding periods
(1+i)n −1
sn i ≡ i ; an ordinary annuity

Perpetuity
R
P=
i
P ≡ present value / principal
R ≡ equal payment per period
i ≡ interest rate per period
The relationship between the future value and the present value of an annuity:

s n i ≡ (1 + i)na n i

s n i is the future value of a n i and a n i is the present value of s n i .

The real cost of a loan

Tr = Ra n r − P

Tr ≡ total real cost of the loan

R ≡ equal amount (payment) paid at equal intervals
n ≡ total number of compounding periods
r ≡ inflation rate per period
P ≡ original loan

Internal rate of return

C1 C2 C3 Cm
+ + + ...+ − Iout = 0
(1 + i)1 (1 + i)2 (1 + i)3 (1 + i)m

C1 , . . .Cm ≡ cash inflows in the sequence in which they appear

i ≡ internal rate of return
Iout ≡ initial investment

37
ARSK13-B APPENDIX D. FORMULÆ

Net present value

C1 C2 C3 Cm
NPV = + + + ...+ − Iout
(1 + K)1 (1 + K)2 (1 + K)3 (1 + K)m

NPV ≡ net present value

C1 , . . .Cm ≡ cash flows in the sequence in which they appear
K ≡ cost of capital, that is, the interest rate at which money can be borrowed
Iout ≡ initial investment

Profitability index
Present value of cash inflows
PI =
Present value of cash outflows
OR
NPV + Outlays (initial investment)
PI =
Outlays (initial investment)

Modified internal rate of return

 1
C n
MIRR = −1
PVout

MIRR ≡ modified internal rate of return

C ≡ future value of all the positive cashflows
PVout ≡ present value of all the negative cash flows
n ≡ the lifetime of the project in time periods

Bonds
P = da n z + 100(1 + z)−n

P ≡ present value of the stock

d ≡ half-yearly coupon rate
z ≡ half-yearly yield to maturity
n ≡ number of coupons still outstanding after the settlement - excluding
the coupon date that follows the settlement date

Accrued interest
H−R
Cum interest = 365 ×c

−R
Ex interest = 365 ×c
H ≡ number of days between the coupon date before the settlement
date and the coupon date, following the settlement date
R ≡ number of days from the settlement date to the coupon date
following the settlement date
c ≡ yearly coupon rate

Arithmetic mean
∑ni=1 xi
x̄ =
n

38
APPENDIX D. FORMULÆ ARSK13-B

x̄ ≡ arithmetic mean
n ≡ number of observations
∑ ≡ sum
xi ≡ the i-th observation.

Weighted mean
∑ni=1 xi wi
x̄w =
∑ni=1 wi
x̄w ≡ weighted mean
n ≡ number of observations
∑ ≡ sum
xi ≡ the i-th observation
wi ≡ the i-th weight

Standard deviation s
∑ni=1 (xi − x̄)2
S=
n−1
S ≡ standard deviation
n ≡ number of observations
∑ ≡ sum
xi ≡ the i-th observation
x̄ ≡ arithmetic mean

Variance √
V = S2 or S = V

V ≡ variance
S ≡ standard deviation

Slope of a straight line

Change in y-value
b=
Change in corresponding x-value

b ≡ slope of a straight line.

Pearson’s correlation coefficient

n ∑ni=1 xi yi − ∑ni=1 xi ∑ni=1 yi
r= q q
n ∑ni=1 x2i − (∑ni=1 xi )2 n ∑ni=1 y2i − (∑ni=1 yi )2

r ≡ correlation coefficient
xi ≡ value of the independent variable for the i-th observation
yi ≡ value of the dependent variable for the i-th observation
n ≡ number of pairs of data points

39
ARSK13-B APPENDIX D. FORMULÆ

40