Lesson 1: Simple Interest
Have you ever invested money? If you have, odds are that you’ve received some ‘extra’
money after you cashed your investment in with the bank (or financial institution).
What is that extra money? Essentially, you earn interest on money that you place in an
investment. You also pay interest when you borrow money. Examples of interest include
bank accounts, loans, mortgages, annuities, and so on.
As an introduction to the financial unit, we will first discuss the idea of simple interest.
Simple interest is the type of interest you might earn when you open your first savings
account. Banks use this type of interest when the investor wants to make a very low-risk
type of investment.
Simple interest is calculated by taking the principal amount (the starting amount), and
multiplying it by the annual interest rate (the percentage of your original amount that you
will earn). The annual interest rate is converted to a decimal, to account for being only a
percentage. Finally, the time period is always specified so that the investor knows how much
should be earned. The amount is the total amount of money you earn, including all of the
collected interest.
Some additional terms to know:
▪ P : principal, the money invested or borrowed
▪ r : the interest rate, as a decimal
▪ A : the sum of the principal and the interest
▪ I : the total interest earned
▪ t : the length of time for the investment
We can use the formula, I = Prt, to determine how much money we will earn in interest. To
determine the final amount, we use the formula, A = P + I.
Example 1: Consider a simple interest investment of P= $1000, interest rate 5%/annum and
where n = number of years. Complete the chart to determine the amount of money after 4
years.
Year (n) 1 2 3 4
Interest
Amount
What type of function (sequence) is this? ______________________
Example 2: Robert deposits $500 into a guaranteed investment certificate (GIC) that
earns 6% per year, simple interest. How long will it take for his investment to double?
Example 3: Robert deposits $500 into a second GIC. What annual rate of interest must be
earned so that the investment doubles in exactly 8 years?
Lesson 2: Compound Interest – Future Value
Compound Interest is interest that is added to the principal before new interest earned is
calculated. Interest is calculated on the principal and the interest already earned.
Future Value is the total amount A, of an investment after a certain length of time.
The formula that can be used to calculate the future value of an investment or loan is:
A = P(1 + i)n A = future value
P = Principal
i = rate of interest per compounding period
n = number of compounding periods
Total Interest I = P [(1 + i)n – 1]
Example 1: Sam borrows $8500 at 5.2% per year, compounded annually. How much will he
have to pay back after 12 years?
Example 2: Joanne invests $5000 at 4.5% /a, compounded quarterly, on her 16th birthday.
How much will the investment be worth on her 21st birthday?
Example 3: If you invest $1000 today, how long will it take for your investment to
double…
a) With 5% /a simple interest?
b) With 5% /a compounded semi-annually?
Lesson 3: Compound Interest – Present Value
Present Value is the principal that would have to be invested now to get a specific future
value in a certain amount of time. PV is used for present value instead of P, since P is used
for principal.
The formula that can be used to calculate the present value of an investment or loan is:
PV = present value
A
PV = A = amount at the end of the investment
(1 + i ) n i = rate of interest per compounding period
n = number of compounding periods
I = A – PV
Example 1: How much money should Anton’s parents invest now so that it will grow to $15
000 in 10 years at 6% per annum compounded annually?
Example 2: Tamara received $250 for her 14th birthday, which she invested at 6% per
year. Tamara’s investment is now worth $317.62. At what age did she cash in her
investment?
Example 3: Tom invested $5000 that he would like to grow to at least $50 000 by the
time he retires in 40 years. What annual interest rate, compounded annually, will provide
this outcome?
Lesson 4: Future Value of Ordinary Annuities
An annuity is a sum of money paid as a series of regular payments. An ordinary annuity is
an annuity for which each payment is made at the end of each compounding period.
The amount of an annuity is a financial application of the sum of a geometric series.
The formula for the amount, A, of an ordinary annuity is:
R[(1 + i ) n − 1] A = amount at the time of the last payment
A= R = payment made at the end of each compounding
i period
n = number of compounding periods
i = interest rate per compounding period
Example 1: Carol puts away $500 every 3 months at 5.2% per year compounded quarterly.
How much will her annuity be worth in 25 years?
Example 2: Sadia plans to invest $2000 quarterly for 5 years. Her financial advisor
informs her that her investment will grow to $45 682.40 after 5 years. What annual rate
of interest, compounded quarterly, did this annuity earn?
Example 3: Felicia plans to invest $2600 at 6% per year, compounded annually, for the 15
next years. Compare the effects on the final amount if the deposits are made and the
compounding periods are:
▪ Annual
▪ Quarterly
▪ Monthly
▪ Weekly
Lesson 5: Present Value of Ordinary Annuities
Recall: An annuity is a sum of money paid as a series of regular payments.
Since we already know how to calculate the future value of an annuity, we will now examine
how to calculate the present value of an annuity. Essentially, calculating the present value
involves finding the amount of money to be invested or loaned at the present time.
The amount of an annuity is a financial application of the sum of a geometric series. The
formula for the present value, PV, of an ordinary annuity is:
PV = present value amount
1 − (1 + i) −n R = payment made at end of each compounding
PV = R period
i n = number of compounding periods
i = interest rate per compounding period
Example 1: Sarah wants to make an investment so that she will receive $400 every 6
months for the next 4 years. Her first payment will be in 6 months from now. How much
money should she invest now at 6% per annum, compounded semi-annually?
Example 2: Chris wants to buy a new VW Beatle. After visiting the dealer, Chris manages to
negotiate a final purchase price of $26,375. Only the GST and PST have to be added to the
final cost. Chris has a down payment of $3000, which is applied before taxes. He must now
invest the remaining amount for the car so that he will have enough money to cover the
monthly payments. He decides he wants to pay the car off over a 4-year period. What are
the monthly payments if the money is invested today at 6%/a, compounded monthly?
Example 3: Vicki receives an inheritance of $20 000. She decides that she wants to invest
this money in a savings account so that she can withdraw money every 3 months over the
next 4 years of university. She finds an account that gives her 6.5% per annum, compounded
quarterly. How much will she be able to withdraw each time?