LESSON 7
INTEREST AND FUTURE VALUE
Finance and Financial Markets| 1st Semester
● Time (n)
WHAT IS INTEREST - Number of years or
Interest is the price you pay to borrow portion of a year that the
money or the cost you charge to lend principal is borrowed or
most often reflected as an annual invested.
percentage of the amount of a loan.
NATURE OF SIMPLE INTEREST
For example, a bank will pay you Interest computed on the principal
interest when you deposit your money only . Assume you borrow P5,000 for 2
in a high account. The bank pays you years at a simple interest rate of 12%
to hold and use your money to invest annually. Calculate the annual interest
in other traConversely, if you borrow cost.
money to pay for a large expense, the
lender will interest on top of the Simple Interest = Principal x Interest
amount you borrowed. Rate x Time
= P5,000 x 0.12 x 2
INTEREST
= P1,200
Nature of Interest
● Payment for the use of money.
NATURE OF COMPOUND INTEREST
● Difference between amount
borrowed or invested (principal) Illustration: Compound Interest
and amount repaid or collected. Assume you deposit P1,000 in Bank
Two, where it will earn simple interest
Elements involved in financing of 9% per year, and you deposit
transaction: another P1,000 in Citizens Bank, where it
● Principal (p) will earn compound interest of 9% per
- Amount borrowed or year compounded annually. Also
invested. assume that in both cases you will not
withdraw any cash until three years
● Interest Rate (i) from the date of deposit. Compute the
- An annual percentage. interest to be received and the
accumulated year-end balances for
Citizens Bank.
LESSON 7
INTEREST AND FUTURE VALUE
Finance and Financial Markets| 1st Semester
The future value of a P1,000 investment
Illustration Solution: Compound earning 9% for three years is P1,295.03.
Interest
Illustration: Using tables
NATURE OF FUTURE VALUE OF A
SINGLE AMOUNT
Future value (FV) is the value of a
current asset at a future date based
on an assumed rate of growth. The
Illustration 2:
future value is important to investors
Johan and Marlene invested P20,000 in
and financial planners, as they use it to
a savings account paying 6% interest
estimate how much an investment
at the time their son, Jomar, was born.
made today will be worth in the future.
The money is to be used by Jomar for
his college education. On his 18th
Value at a future date of a given
birthday, Jomar withdraws the money
amount invested, assuming
from his savings account. How much
compound interest.
did Jomar withdraw from his account?
Illustration: Using the formula
LESSON 7
INTEREST AND FUTURE VALUE
Finance and Financial Markets| 1st Semester
FUTURE VALUE OF ANNUITY Illustration 2:
The future value of an annuity is the Alden and Maine’s daughter, Ilana, has
value of a group of recurring payments just started high school. They decide to
at a certain date in the future, start a college fund for her and will
assuming a particular rate of return, or invest P2,500 in a savings account at
discount rate. The higher the discount the end of each year she is in high
rate, the greater the annuity's future school (4 payments total). The
value. account will earn 6% interest
compounded annually. How much will
Illustration 1: be in the college fund at the time Ilana
Assume you invest P2,000 at the end of graduates from high school?
each year for three years at 5% interest
compounded annually.
Illustration 2 Using Tables:
Solution:
LESSON 7
INTEREST AND FUTURE VALUE
Finance and Financial Markets| 1st Semester
you buy a stock today for P100 that
awards a 2% dividend each year, you
can calculate the future value.
Alternatively, if you want to have
P10,000 of future value on hand for a
down payment for a car next year, you
can solve for the present value.
UNDERSTANDING THE FUTURE VALUE Present value and future value simply
OF AN ANNUITY indicate the value of an investment
Because of the time value of money, looking forward or looking back. The
money received or paid out today is two concepts are directly related, as
worth more than the same amount of the future value of a series of cash
money will be in the future. That's flows also has a present value. For
because the money can be invested example, a present value of P1,000
and allowed to grow over time. By the today may be equal to the future value
same logic, a lump sum of $5,000 of P1,200 today. Most often, investors
today is worth more than a series of and analysts will know one value and
five $1,000 annuity payments spread try to solve for the other. For instance, if
out over five years. you buy a stock today for P100 that
awards a 2% dividend each year, you
WHAT IS THE RELATIONSHIP BETWEEN can calculate the future value.
PRESENT VALUE AND FUTURE VALUE Alternatively, if you want to have
P10,000 of future value on hand for a
Present value and future value simply
down payment for a car next year, you
indicate the value of an investment
can solve for the present value.
looking forward or looking back. The
two concepts are directly related, as
the future value of a series of cash
flows also has a present value. For
example, a present value of P1,000
today may be equal to the future value
of P1,200 today. Most often, investors
and analysts will know one value and
try to solve for the other. For instance, if
