PSE CERTIFIED SECURITIES

SPECIALIST COURSE
(PSE CSSC)
Course No. 4 : Mathematics of Investment

Lecturer: Reynaldo R. Nograles

Southville International School and Colleges (SISC)
Capital Market Institute of the Philippines (CMIP)

1
WHAT IS INTEREST?
Interest is the amount paid
for using someone else’s
money or for borrowing the
money of someone else.

2
WHAT IS INTEREST RATE?
It is the RATE at which the
amount of interest is being
paid (or will be paid) by the
BORROWER or USER of
the money to the LENDER
or OWNER of the money.

3
IN WHAT UNITS
Interest AREareINTEREST
rates RATES
expressed EXPRESSED?
in PESO(s)
PER UNIT OF PESO BORROWED PER
UNIT OF TIME
Examples:
1. An interest rate of 3% per month means that the
borrower pays the lender P3 per month for every P100
that the borrower borrows from the lender.

2. An interest rate of 4% per annum on your bank

deposit means that the bank pays you a GROSS*
INTEREST of P4 per year for every P100 of your
money that the bank holds or uses.

*N.B.: Interests on bank deposits are subject to 20% tax

4
WHAT METHODS ARE USED TO CALCULATE THE
AMOUNT OF INTEREST?

1. Simple Interest Method

2. Simple Discount Method
3. Compound Interest
Method

5
HOW IS THE AMOUNT OF INTEREST CALCULATED UNDER
THE SIMPLE INTEREST METHOD?
Amount of Interest = I= P • i • n

Where ; P = the amount borrowed (or the amount of investment);

commonly called the Principal
i = the simple interest rate per interest period
= ___% per interest period
n = the number of interest periods corresponding to the term
of the loan (or to the maturity period of the investment )

N.B.: a. The units of i and of n have to be COMPATIBLE before the

formula
I= P • i • n can be correctly applied!
b. The principal P is oftentimes referred to as the PRESENT
VALUE of the investment
c. The amount of interest I shall be paid only at the END of n
interest periods, not before!
6
IF P = THE PRESENT VALUE OF THE INVESTMENT,
WHAT IS THE FUTURE VALUE OF THE INVESTMENT?

Future Value = F = P + I

Under Simple Interest : F = P + P • i • n

or F = P (1+in) A P = F
1+in

N.B.: Because I is payable only at the end of n

interest periods, F can be realized or enjoyed
only at the end of n interest periods, not
before! 7
ILLUSTRATIVE PROBLEMS ON SIMPLE INTEREST:
1. A invests P100, 000 in an investment instrument that
pays interest at the rate of 12% p.a. simple . What is
the value of A’s investment after 9 months? How much
interest does his investment earn?
(Answer: P109, 000; P9, 000)

2. Obtain the present value of P 245, 000 over a period of

18 months at an interest rate of 15% p.a. simple.
(Answer: P200, 000)

3. At what simple interest rate per quarter will money

double itself when invested for 5 years?
(Answer: 5% per quarter)

8
WHAT IS THE BANKER’S RULE?
It is a procedure that banks
follow to determine, using simple
interest method, the amount of
interest I earned by the money or
deposit of a depositor.

N.B.: Show the procedure on the whiteboard

9
 ILLUSTRATIVE PROBLEM ON THE
BANKER’S RULE:
On 14 February 2011, A put P100, 000 into a time deposit
that will mature on 17 July 2011. The bank offers a
GROSS interest rate of 3.5% p.a. simple on this deposit.
How much NET interest will this deposit earn upon
maturity?

(Answer: P 1, 190)

10
 WHAT IS THE SIMPLE DISCOUNT METHOD OF
CALCULATING SIMPLE INTEREST?
It is a method of calculating the amount of simple interest on a loan
by: multiplying the simple interest rate by the amount of loan and by
the term of the loan (or the repayment period of the loan) and then
DEDUCTING THIS AMOUNT OF INTEREST IN ADVANCE. Thus, the
borrower receives an amount (called the loan proceeds) which is less
than the recorded amount of loan.
i.e., Amount of simple interest deductible in advance
=D=F•d•n
Where F = amount of loan
d = simple interest rate deductible in advance
= simple discount rate
n = repayment period or term of the loan
= number of interest periods at the end of which the
loan has to be paid in full
=>Loan Proceeds = P = the amount obtained by the borrower
=F–D
=F-F•d•n
= F (1-dn)
N.B.: The simple discount method finds wide application among11
 ILLUSTRATIVE PROBLEM ON THE
SIMPLE DISCOUNT:
1. A borrowed P100, 000 from a lender that charged a
simple interest rate of 3.5% per month DEDUCTIBLE IN
ADVANCE and he agreed to repay the loan at the end
of 10 months. How much loan proceeds did A receive?
(Answer : P65, 000)

2. A borrowed P80, 000 from a lender that charged a

simple interest rate of 5% per month deductible in
advance and he got a loan proceeds of P50, 000. What
is the term or maturity period of the loan?
(Answer : 7.5 months)

12
WHAT IS MEANT BY “TIME VALUE OF MONEY?”
It means that as one moves FORWARD THROUGH TIME,
the VALUE OF HIS / HER MONEY INCREASES OR
GROWS.

A The future value F of one’s money is always bigger

than the present value P of the money;
i.e., F > P or P < F.

N.B. :
1. The process of obtaining the future value F (using
either the simple interest method or the simple
discount method or the compound interest method) is
called ACCUMULATING.

2. The process of getting the present value P(using

13
ILLUSTRATIVE EXERCISES ON ACCUMULATING AND
DISCOUNTING:
1. Accumulate P100, 000 for 30 months at a simple
interest rate of 18% p.a.
(Answer : P145, 000)
2. Accumulate P100, 000 for 30 months at a simple
discount rate of 18% p.a.
(Answer : P181, 818.18)
3. Discount P100, 000 over a period of 30 months at a
simple interest rate of 18% p.a.
(Answer : P68, 965.52)
4. Discount P100, 000 over a period of 30 months using a
simple discount rate of 18% p.a.
(Answer : P55, 000)
14
GIVEN A SIMPLE INTEREST RATE i, HOW DO
WE OBTAIN THE EQUIVALENT SIMPLE
DISCOUNT RATE d ?

Answer : Derive an equation for d in

terms of i.
N.B.: Recitation or Participation credits await volunteers
who can derive the equation correctly on the board!

15
GIVEN A SIMPLE DISCOUNT RATE d, HOW DO
WE OBTAIN THE EQUIVALENT SIMPLE
INTEREST RATE i ?

Answer : Derive an equation for i in

terms of d
N.B.: Recitation or Participation credits await volunteers
who can derive the equation correctly on the board!

16
ILLUSTRATIVE PROBLEMS ON EQUIVALENT
SIMPLE INTEREST RATE AND SIMPLE
DISCOUNT RATE:
1. A lender charges a simple discount rate of 4% per
month over a period of one and one-half years. What is
the equivalent monthly simple interest rate?

2. Find the simple discount rate per year equivalent to a

simple interest rate of 12% per year over a period of 18
months.

17
COMPOUND INTEREST METHOD
1. Derive the future value equation under the compound
interest method
2. Show how to obtain the total amount of interest I
under compound interest method
3. Show the present value equation under the compound
interest method (in terms of v)

N.B.: Emphasize the following:

a. The compatibility between the unit of i and the unit
of n; the possible units of n
b. The interest earned during each interest period is
ADDED TO THE PRINCIPAL AT THE BEGINNING OF
THE PERIOD AND THIS SUM BECOMES THE
PRINCIPAL AT THE BEGINNING OF THE NEXT 18
INTEREST PERIOD!
ILLUSTRATIVE PROBLEMS ON THE COMPOUND
INTEREST METHOD:
1. A invested P100, 000 in an instrument that offers an
interest rate of 16% p.a.c.q. What is the accumulated
value of this investment at the end of 30 months? How
much total interest will be earned at the end of 30
months?
(Answers: F = P148, 024.43; I = P48, 024.43)

2. Discount (i.e., find the present value of) P88, 000 over a
period of 5 years at an interest rate of 12% p.a.c.m.
(Answer: P48, 439.57)

19
 EQUIVALENT COMPOUND INTEREST RATES:
ILLUSTRATIVE PROBLEMS:
1. Find the effective annual compound interest rate
equivalent to
a. 14% p.a.c.s.
b. 18% p.a.c.m.
c. 4% p.q.c.q.
2. What annual interest rate compounded monthly is
equivalent to
a. 16% p.a.c.q.?
b. 5% p.s.c.s.?
3. Which is the better rate: 15.8% p.a.c.q. or 16% p.a.c.s.?

N.B.: Derive first the GOVERNING EQUATION relating iA,20iS,

i i
 DETERMINING THE FUTURE VALUE OR THE PRESENT
VALUE OF AN INVESTMENT WHEN THE INTEREST RATE
DURING THE TERM OF THE INVESTMENT VARIES:
1. Derive the future value equation:
i.e., F = P (1+i1)n1 (1+i2)n2 (1+i3)n3…………(1+ik)nk
2. Show the present value equation:
P=F.v1n1.v2n2.v3n3……..vR nk

N.B.
1. The time intervals n1, n2, n3, ……….. nk need not be equal in
lengths.
2. i1, i2, i3,………. ik, need not have the same compounding
periods.
3. The units of n1 and i1 should be COMPATIBLE,; the same
should be true for the units of n2 and i2, of n3 and i3, and so
on.
21
ILLUSTRATIVE PROBLEMS ON VARYING COMPOUND
INTEREST RATES:
1. Accumulate P100, 000 over a period of 5 years under the
following interest rate scenarios:
a. 18% p.a.c.m. during the first year
b. 16% p.a.c.s. during the next two years
c. 14% p.a.c.s. during the last two years
(Answer: P214, 195.46)
2. Discount P200, 000 over a period of 3 years under the
following interest rate scenarios
a. 18% p.a.c.q. during the first year from today
b. 15% p.a.c.m. during the second year from today
c. 12% p.a.c.s. during the third year from today
(Answer: P128, 591.14)
22
SOLVING FINANCIAL / INVESTMENT TRANSACTION
PROBLEMS USING AN EQUATION OF VALUE
STEPS:
1. Make a time diagram or line showing the positions and
the values of all obligations and all payments on this
line.
2. Choose a valuation date (or comparison date). For
convenience, this valuation date is usually the date on
which a payment is made.
3. Find the value on the valuation date of EACH of the
obligations and payments by either accumulating or
discounting.
4. Set up the equation of value;
i.e., Total of the valuation date values of all payments
=Total of the valuation date values of all obligations 23
ILLUSTRATIVE PROBLEM ON EQUATION OF VALUE:
If money is worth 15% p.a.c.m., what two equal payments,
the first to be made at the end of 3 years and the second to
be made at the end of 6 years, will settle the following
obligations?

a. P100, 000 due NOW;

b. P 50, 000 plus interest thereon at the rate of 18%
p.a.c.m., due at the end of four years;
c. P100, 000 plus interest thereon at the rate of 20%
p.a.c.q., due at the end of five years;
d. P150, 000 plus interest thereon at the rate of 22%
p.a.c.s., due at the end of seven years.

(Answer: P486, 461.978)

24
INDIVIDUAL HOMEWORK ON EQUATION OF
VALUE

(To be submitted next meeting) :

Please get the questionnaire from

RRN.

25
ANNUITY: A sequence of EQUAL periodic
payments made at EQUAL time intervals
or time periods (Illustrate on the
whiteboard!)
PAYMENT INTERVAL OR PAYMENT PERIOD:
The period of time between 2 consecutive payments

TERM OF AN ANNUITY:
The time from the beginning of the first payment
interval or first interest period to the end of the last
payment interval or interest period; this is expressed in
number of interest periods or number of payment
intervals.
26
 CLASSIFICATION OF ANNUITIES:
1. ANNUITY CERTAIN: An annuity wherein the payments
are CERTAIN or SURE to be paid without any conditions
EXAMPLES: The installment payments on a car, a house or
an appliance.

2. CONTINGENT ANNUITY: An annuity wherein the

payments are subject to certain conditions
EXAMPLES: Monthly pensions being paid to a retired or a
disabled worker or employee; the retirement pension shall
be paid to the retiree if he/she is still alive; the disability
pension shall be paid to the worker if he/she is still
disabled. 27
 SIMPLE ANNUITY: An annuity certain
whose payment interval is equal to the
interest compounding period
TYPES OF SIMPLE ANNUITY:
1.ORDINARY ANNUITY: A simple annuity wherein the periodic
payments are made at the END OF EACH PAYMENT INTERVAL OR
INTEREST PERIOD and the first payment is made at the end of the first
interest period.
(Pls. see illustration on the whiteboard)

2.ANNUITY DUE: A simple annuity wherein the periodic payments are

made at the BEGINNING OF EACH PAYMENT INTERVAL OR INTEREST
PERIOD and the first payment is made at the beginning of the first
interest period.
(Pls. see illustration on the whiteboard)

3.DEFERRED ANNUITY: Either an ordinary annuity or an annuity28due

PRESENT VALUE OF AN ORDINARY ANNUITY
HAVING n PERIODIC PAYMENTS OF R PESOS:
PV OF ORDINARY ANNUITY =A =R 1-vn
i
(Derive this equation or formula on the
whiteboard)

EMPHASIS: A is the value of the ordinary

annuity at the BEGINNING of the FIRST
interest period!

29
FUTURE VALUE OR ACCUMULATED VALUE OF
AN ORDINARY ANNUITY OF n PERIODIC
PAYMENTS OF R PESOS:

FV OF ORDINARY ANNUITY = S = R (1+i)n-1

i
(Derive this equation or formula on the
whiteboard)

EMPHASIS: S is the value of the ordinary

annuity at the END of the LAST interest
period!
30
 ILLUSTRATIVE PROBLEMS ON ORDINARY
ANNUITY:
1. A bought a flat-screen LCD TV on a monthly installment basis at
an interest rate of 24% p.a.c.m. for a term of 3 years. If the TV costs
P50, 000 and if the installments are to be paid at the end of each
month how much is the monthly installment?
(Answer: P1, 961.64)

2. B paid P500, 000 as down payment for a brand new SUV. The
balance shall be paid via monthly installments of P24, 349.00 per
month (at the end of each month) for 5 years. If the interest rate on
the installment plan is 21% p.a.c.m., what was the cash price of the
SUV?
(Answer: P1, 400, 036.08)

3. A 25-year old employee intends to deposit P5, 000 every end of

the month into a trust fund that will earn interest at the rate of 12%
p.a.c.m. Assuming no withdrawals are made from the fund, how
much money will be in the fund when the employee retires at age 60 31
years?
 PRESENT VALUE OF AN ANNUITY DUE HAVING n PERIODIC
PAYMENTS OF R PESOS:
PV OF ANNUITY DUE = Ä = R 1-vn (Derive this equation or
formula on the whiteboard)
iv
EMPHASIS: Ä is the value of the annuity due at the BEGINNING of the
FIRST interest period!
N.B.: Please compare this formula/equation with that for the PV of an
ordinary annuity (pls. see slide 29)
FUTURE VALUE OF AN ANNUITY DUE HAVING n PERIODIC
PAYMENTS OF R PESOS:
FV OF ANNUITY DUE = Š = R (1+i)n-1 (Derive this equation or
iv formula on the whiteboard)

EMPHASIS: Š is the value of the annuity due at the END of the LAST
interest period!
N.B.: Please compare this formula equation with that for the FV of an
ordinary annuity (pls. see slide 30)
32
ILLUSTRATIVE PROBLEMS ON ANNUITY DUE:

1. Redo illustrative problem 1 on slide no. 31; this time

assume that the installments are to be paid at the beginning
of each month.
(Answer: P1, 923.18)

2. Rework on illustrative problem 2 on slide no. 31,

assuming that the monthly payments are to be made at the
beginning of every month.
(Answer: P1, 415, 786.73)

33
FORMULAS OR EQUATIONS FOR DEFERRED ORDINARY ANNUITY:
(Illustrate the time diagram on the whiteboard)
PV OF DEFERRED ORDINARY ANNUITY Adef = A • vd
==R 1-vn .vd
i
Where: d= no. of INTEREST PERIODS in the deferment time
interval EMPHASIS: A is the value of the ordinary annuity at the
BEGINNING of the TERM of the annuity while A def is the value of the
ordinary annuity TODAY.
FV OF DEFERRED ORDINARY ANNUITY = Sdef = FV OF ORDINARY
ANNUITY= S = R (1+i)n-1
i
QUERY: Why is Sdef = S?
(Answer: Because the FV of an ordinary annuity is THE
VALUE of the annuity at the END of the LAST interest period
or payment interval and, therefore, is not affected by the
34
deferment time interval!)
 ILLUSTRATIVE PROBLEMS ON DEFERRED
ORDINARY ANNUITY:
1. A housewife pays a down payment of P20, 000 for an appliance. The
balance shall be paid via monthly installments of P2, 000 every end of the
month for 36 consecutive months and the first payment shall be due at
the end of the 7th month. If the interest rate on the installment plan in 18%
p.a.c.m., what is the cash price of the appliance?
(Answer: P70, 593.73)

2. On his child’s 7th birthday a man puts into a trust fund a certain amount
that earns interest at the rate of 12% p.a.c.m. The purpose of the fund is to
provide ten semestral payments of P80, 000 each for the child’s 5-year
college education. If the first payment is to be made on the child’s 16th
birthday, determine the amount that the man has to put into the trust fund.
(Answer: P211, 870.67)

35
 VALUING AN ANNUITY ON ANY GIVEN DATE:

STEPS:
1. Determine A or Ä or S or Š on the APPROPRIATE DATE

2. Accumulate or discount A or Ä or S or Š to the given date

depending on the position of A or Ä or S or Š relative to the
given date.
3. Remember that:
3.1. A or Ä are the values of the annuity at the BEGINNING
OF THE FIRST INTEREST PERIOD

3.2. S or Š are the values of the annuity at the END of the

LAST or nth INTEREST PERIOD
36
 . ILLUSTRATIVE PROBLEM ON VALUING AN
ANNUITY ON ANY DATE:
An ordinary annuity is made up of 60 monthly payments of
P50, 000 each the first of which is due at the end of one
year. If money is worth 24% p.a.c.q., calculate the value of
the annuity

a) At the end of one year

b) At the end of 6 years
c) At the end of 8 years
d) Now

(Answer: a. P1, 754, 452.45; b. P5, 626, 766.55; c.P8,

968.210.94; d.P1, 389, 690.67)
37
 AMORTIZATION OF LOAN OR DEBT:
(Illustrate using a time diagram):
Let R = the periodic amount of amortization payable every
END of the interest period
L = the amount of loan or debt to be amortized
n = the repayment period of the loan
= no. of interest periods
i = the interest rate on the loan
= __% per interest period compounded every end of
he interest period

GOVERNING EQUATION:
L = the PV of an ordinary annuity of R payments for n
interest periods
= R 1-vn
i 38
ILLUSTRATIVE PROBLEMS ON AMORTIZATION:

1. A loan of P2M shall be repaid via monthly amortizations

over a period of 10 years at an interest rate of 12%
p.a.c.a. Find the monthly amortization.

(Answer: P27, 989.44)

39
SUGGESTED WORKSHEET FOR CONSTRUCTING
AN AMORTIZATION SCHEDULE:
PERIOD (n) PERIODIC INTEREST PRINCIPAL PRINCIPAL
AMORTIZATI PAYMENT REPAYMENT BALANCE AT
ON DURING THE DURING THE THE END OF
PERIOD PERIOD THE PERIOD
0 L
1 P P P P
2 P P P P
3 P P P P
4 P P P P
. P P P P
. P P P P
. P P P P
. P P P P
n P P P P
40
 ILLUSTRATIVE EXERCISE ON CONSTRUCTING
AN AMORTIZATION SCHEDULE:

A loan of P100, 000 will be amortized for 18 months via

QUARTERLY AMORTIZATIONS at an interest rate of 16%
p.a.c.q.
a) Construct an amortization schedule.
b) What is the balance on the loan after 4 amortizations
have been paid?
c) How much of the 3rd amortization amount will go to
interest payment?

N.B.: After constructing the amortization schedule, highlight

some important observations on the schedule.
41
 DETERMINING THE PRINCIPAL BALANCE (or OUTSTANDING
PRINCIPAL) ON THE LOAN AT ANY TIME DURING THE
AMORTIZATION PERIOD AFTER k AMORTIZATIONS HAVE BEEN
PAID (WITHOUT CONSTRUCTING AN AMORTIZATION SCHEDULE):
N.B. : Show diagram on the whiteboard.

METHOD 1: PROSPECTIVE METHOD

PB = PRINCIPAL BALANCE or OUTSTANDING PRINCIPAL
= Present value of all UNPAID AMORTIZATIONS

==R 1-vn-k
i
Where: R = the periodic amortization amount
i = the interest rate per interest period compounded every
end of the period
n = the term of the loan
= the no. of periodic amortizations or the no. of interest
periods
k = the no. of PAID amortization amounts 42
 DETERMINING THE PRINCIPAL BALANCE (or OUTSTANDING
PRINCIPAL) ON THE LOAN AFTER k AMORTIZATIONS HAVE BEEN
PAID (WITHOUT CONSTRUCTING AN AMORTIZATION
SCHEDULE):CONTINUATION

METHOD 2: RETROSPECTIVE METHOD

PB = the accumulated value of the original amount of loan

minus the accumulated value of the k payments

L (1+i) k - R (1+i)k -1)

=
i

Where : L = the original amount of loan

43
 ILLUSTRATIVE PROBLEM ON DETERMINING
THE PRINCIPAL BALANCE AT ANY TIME
DURING THE AMORTIZATION PERIOD:
A loan of P500, 000 will be amortized monthly (at the end of
each month) over a period of 15 years at an interest rate of
18% p.a.c.m.

a. Calculate the monthly amortization amount.

b. Determine the principal balance after 12 amortizations
have been paid
c. How much of the 20th amortization amount will go to
interest payment?
d. How much of the 20th amortization amount will go to
principal repayment?
44
(Answers: a.P8, 052.105; b.P492, 799.866; c. P7, 319.489; d.
INDIVIDUAL HOMEWORK ON AMORTIZATION

Please get the questionnaire from

RRN

45
 SINKING FUND METHOD OF PAYING A LOAN OR DEBT:

FEATURES OF THE METHOD:

1. The borrower and the lender agree on the term of the loan, i.e., on the
number of interest periods at the end of which the loan shall be fully
paid.

2. At the end of every interest period, the borrower pays the lender ONLY
THE PERIODIC INTERESTI = r x LON THE LOAN;
PERIODIC INTEREST =
Where : r = the interest rate per interest period agreed between the
borrower and the lender
L = amount of loan

3. At the end of each interest period the borrower makes EQUAL

PERIODIC DEPOSITS (R) into a fund (i.e., SINKING FUND) IN A
TRUSTEE BANK such that at the end of the agreed number of interest
periods, the ACCUMULATED VALUE OF THE DEPOSITS shall be equal
to the AMOUNT OF LOAN. THIS ACCUMULATED VALUE THEN GOES 46
TO THE LENDER AS FULL PAYMENT OF THE LOAN.
SINKING FUND METHOD OF PAYING A
LOAN OR DEBT:
Features of the method (continuation):
4. Amount of Loan = L = accumulated value of all the
periodic deposits
= 1 i 1
n
R
i

where: n = the agreed no. of interest periods

or = the no. of periodic deposits
i = the interest rate on the fund per interest
period compounded every end of the interest
period
= the growth rate of the sinking fund
R = the amount of periodic deposit
N.B.: In the sinking fund method, two interest rates are involved: r which
is NOT COMPOUNDED and i which is compounded.

47
 ILLUSTRATIVE PROBLEM ON THE SINKING
FUND METHOD OF PAYING A LOAN:

A borrows P100, 000 from B. A agrees to pay B annual

interest for 5 years at the rate of 16% p.a. To pay back the
loan, A shall make annual end-of-year deposits for 5 years
into a sinking fund in a bank that offers an interest rate of
12% p.a.c.a. on the fund. How much money must A raise at
the end of each year in order to settle his obligation.

(Answer: P31, 740.97)

48
SUGGESTED WORKSHEET FOR CONSTRUCTING
A SINKING FUND SCHEDULE:
PERIOD (n) AMOUNT IN INTEREST DEPOSIT AMOUNT IN
THE FUND AT EARNED BY INTO THE THE FUND AT
THE THE FUND FUND AT THE THE END OF
BEGINNING DURING THE END OF THE THE PERIOD
OF THE PERIOD PERIOD
PERIOD
1 0 0 P P
2 P P P P
3 P P P P
4 P P P P
. P P P P
. P P P P
. P P P P
. P P P P
n P P P P
49
ILLUSTRATIVE PROBLEM ON CONSTRUCTING A
SINKING FUND SCHEDULE:
A borrows P500, 000 from a friend. They agree that the loan
shall be repaid in full at the end of 18 months via A’s
QUARTERLY deposits (every end of the quarter) into
a sinking fund in a mutually agreed bank. If the bank offers
an interest rate of 12% p.a.c.m. on the fund,
a) How much should A’s quarterly deposit be?
b) Construct a sinking fund schedule.

(Answer: a. P77, 240.352)

50
 INDIVIDUAL HOMEWORK ON THE SINKING
FUND METHOD OF PAYING AN OBLIGATION:

Please get the questionnaire from

RRN

51
 DETERMINING THE FAIR PRICE OF A BOND:
1. Define first the following terms:
a. Face Amount or Face Value (F) of the bond
b. the coupon period of the bond
c. the coupon rate r of the bond
d. the maturity period or tenor of the bond in terms of
the no. of coupon periods
e. the maturity value (MV) of the bond
f. the YTM of the investor on the bond
2. Draw the time diagram showing the coupons and the MV
3. Derive the Pricing equation: P = Fr 1-vn + MV • vn
i

EMPHASIS: a. the coupon period and the compounding

period of i
MUST BE THE SAME before the pricing equation
52
is
. ILLUSTRATIVE PROBLEM ON BOND PRICING:

A bond with a face amount of P500M will mature at par in

ten years and will pay QUARTERLY coupons at the rate of
12% p.a.

a. How much should an investor pay for this bond if he/she

wants a YTM of 18% p.a. effective (i.e., 18% p.a.c.a.)?

b. Another investor wants a YTM of 15% p.a. effective on

this bond. At what price should he/she be willing to buy
this bond?

(Answers: a. P382, 751, 156.00; b. P441, 163, 791.20)

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INDIVIDUAL HOMEWORK ON BOND PRICING:

A bond having a face amount of P100M will mature at par

in five years and will pay semi-annual coupons at the rate
of 10% p.a. How much should an investor pay for this
bond if he/she wants a YTM of 16% p.a. effective?

(Answers: P81, 615, 381.00)

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