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GROUP 2A
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TEAM MEMBERS
1. NURFARHANA NABILA BINTI NAZRI 1411328
2. MULIANI BINTI MOHAMAD TAHA 1411300
3. SITI SYURIEYATI BINTI MOHD SOFIAN 1412770
4. NUZUL FARZANA BINTI MOHD KAMIZI 1413686
5. SITI NOR AZMAH BINTI MOHD YUSOF 1410566
2.1.1 Time
Value of Money
$ 100 to be received
after one year is worth
less than the same
amount today
Why?
Inflation
SI = P0(r)(t)
SI Simple Interest
P0 Initial Deposit (t=0) / Principal
r Interest rate per annum
t Time in years
0
s t
t-s
We shall transform any period
expressed in other units (days, week,
months) into a fraction of a year
For example,
a. Daily basis (given n in days)
V ( 365 ) P (1 365 r )
n n
b. Weekly basis
V ( 52n ) P (1 52n (given
r) n in weeks)
c. ( n
12 ) P (1
Monthly basis r(given
V n
12 ) n in
months)
Example 2.1
Consider a deposit of $150 held for 20
days and attracting simple interest at a
rate of 8%. What is the value of the
deposit after 20 days?
Solution:
From the question above, we know
that P = 150
t = and r = 0.08. Thus,
V(t)=P(1+rt)
The Return on Investment
Return on investment commencing at time s
and terminating at time t can t ) Vdenoted
V (be (s) by
K(s, t)
V (s)
In the case of simple interest, V(t)=V(s)[1+r(t-s)]
K(s, t) r (t s )
V (t ) V ( s )
K(s, t)
V ( s)
V ( s )[1 r (t s )] V ( s )
V (s)
V ( s )[1 r (t s )]
1
V (s)
1 r (t s ) 1
r (t s )
Exercises
Exercise 2.1
A sum of $9, 000 paid into a bank
account for two months (61 days) to
attract simple interest will produce $9,
020 at the end of the term. Find the
interest rate r and the return on this
investment.
Solution:
61 61 9020 9000
(1 r ) 9000 9020 K (0, )
365 365 9000
r 0.0133 1.33% 0.0022 0.22%
Exercises
Exercise 2.3
How long will it take for a sum of $800
attracting simple interest to become $830 if
the rate is 9%? Compute the return on this
investment.
Solution:
(1 t 0.09) 800 830 K(0, t)
830 - 800
t 0.4167 years 800
0.0375
0.4167y 365 152.08 days
3.75%
Perpetuity
44941
Exercise 2.15
Suppose that you deposit $1, 200 at the
end of each year for 40 years, subject to
annual compounding at a constant rate
of 5%. Find the balance after 40 years.
20591
2.1.4
CONTINUOU
S
COMPOUND
ING
The continuous compounding formula is used
to determine the interest earned on an account
that is constantly compounded, essentially
leading to an infinite amount of compounding
periods.
The continuous compounding formula takes
this effect of compounding to the furthest limit.
Instead of compounding interest on an
monthly, quarterly, or annual basis, continuous
compounding will effectively reinvest gains
perpetually.
How the Continuous
Compounding Formula is derived
From the periodic compounding formula,
mt
r
V (t ) lim 1 P.
m
m
As m goes to infinity, we get
V (t ) e tr P,
where
m
r
lim 1 e, is the base of natural logarithms.
m m
Proposition 2.2
Continuous compounding produces higher
future value than the periodic compounding
with any frequency m, given the same initial
principle P and interest rate r.
Proving:
+ ln
= ln
= ln
= k(s,u)
2.1.5 HOW TO
COMPARE
COMPOUNDIN
G METHODS
More frequent compounding will produce
a higher future value than less frequent
compounding if the interest rates and the
initial principal are the same.
Growth Factor
DEFINITION 2.1
Two compounding methods are
equivalent if the corresponding
growths factor over a period of one
year are the same.
Example 2.6
Semi-annual compounding at 10% is
equivalent to annual compounding at 10.25%.
2 1
0.1 0.1025
1 1.1025 1
2 1
mt
r
e 1
rt
m
12
0.12
e 1
r
12
r 0.1194
Exercise 2.25
Find the frequency of periodic compounding at
20% to be equivalent to annual compounding
at 21%.
m 1
0.2 0.21
1 1
m 1
m 2.0
Effective Rate
For a given compounding method with
interest rate r, the effective rate is one
that gives the same growth factor over a
one year period under annual
compounding.
Thanks!
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