JAIIB/Diploma in Banking & Fina

nce Accountin
g & Finance for Bankers

S.C.Bansal
MODULE-A

BUSINESS MATHEMATICS – Present

ation & MCQs
 Why Mathematics in Banking
• To calculate interest on deposits and advances
• To calculated yield on bonds in which banks hav
e to invest substantial amount.
• To calculate depreciation
• To decide on buying/selling rates of foreign curr
encies
• To calculate minimum capital required by the ba
nk
• To appraise loan proposals
 What level of maths is required
• In banking, very high level of maths is not
needed
• We should know the following basic mathe
matical operations
• Addition,e.g. 24+33+9+56=122
• Subtraction,e.g.138-41-72=25
• Multiplication,e.g. 1.1*1.1=(1.1)2 =1.21
• Division,e.g.1/12=0.0833
Weightage of maths in JAIIB/DBF E
xam
• Constitutes one of the four modules of the
paper of Accounting & Finance( total 3 pap
ers)
• Therefore, the weightage in the total exam
is about 10%
• It is possible to get good score in question
s related to this module, as only simple ma
thematics is involved and use of calculator
is allowed
Can we cover entire syllabus in this
class
• We can have conceptual clarity of the enti
re syllabus on business maths.
• You need to read the book thoroughly and
solve problems
• You may get in touch with me whenever y
ou need any clarification
• My mail id is bansalsc2006@yahoo.com
 Simple interest
• Important symbols ; P=amount deposited initially
, called Principal
• r=rate of interest. 12% per annum means that if
you deposit Rs 100 for one year,you will get inter
est of Rs 12 at the end of the year.In our calculat
ions,we will take r=12/100=0.12 p.a.
• T=number of years for which P is deposited
• I=total interest receivable. I=P*r*T
• A=amount receivable.A=P+I=P+(P*r*T)=P(1+rT)
 Compound interest
• If you deposit Rs 100 @12%p.a.,it becomes Rs 112 at t
he end of one year.For next year,you should get interest
on Rs112,which is 112*12/100=13.44.This is called com
pounding.In case of simple interest, you would have rec
eived interest of Rs 12 only for the 2nd year also.
• Compounding can be yearly,as shown above, or can be
monthly,quarterly,half yearly etc.More frequent compoun
ding means more interest for you.
• In yearly compounding, A=P(1+r) after 1year, P(1+r)2 aft
er 2years,and so on.After T years, A=P(1+r)T
• If compounding is n times in a year, A=P(1+r/n)nT
• Rule of 72 is used to find the period in which our money
doubles.
 Discount factor
• We have seen that P becomes P(1+r)T in T years.Theref
ore,if somebody promises to give you Rs P(1+r)T after T
years,you should know that it is worth only Rs P today.
• Amount receivable in future is to be multiplied by a numb
er(always less than one) to arrive at the present worth of
that amount.
• In above example,P(1+r)T is to be multiplied by 1/(1+r)T t
o arrive at present worth P. So ,The discount factor is 1/(
1+r)T.
• E.g.,if rate of intt is 10%p.a., r=0.10. Therefore, discount
factor is 1/1.10 for 1 year, 1/1.21for 2 years and so on.
 Present value of money
• PV= Future amount* Discount Factor(DF)
• DF = 1/(1+r)T
• E.g.,if rate of intt is 10%p.a., r=0.10. Therefore,
discount factor is 1/1.10 for 1 year, 1/(1.10)2 =1/
1.21 for 2 years and so on.
• In above example,PV of Rs 100 ,to be received
after 2 years will be, 100*1/(1.10)2 =100/1.21=Rs
82.64.Similarly,PV of Rs 100,to be received after
5 years, will be100*1/(1.10)5
 Future value of money
• Depending on the rate of interest, the amount you receiv
e in future(A), will be more than the amount(P) available
now.
• A=P(1+r)T ,when the compounding is yearly.
• Therefore,FV=Present Amount*(1+r)T . We call (1+r)T co
mpounding factor.
• E.g.,if rate of intt is 10%p.a., r=0.10. Therefore, compoun
ding factor is 1.10 for 1 year, (1.10)2 =1.21 for 2 years an
d so on.
• In above example,FV of Rs 100 , after 2 years will be, 10
0*(1.10)2 =100*1.21=Rs 121.Similarly,FV of Rs 100, afte
r 5 years, will be100*(1.10)5
 Annuities
• A series of fixed payments/receipts at a sp
ecified frequency, over a fixed period.
• E.g. Payment of Rs 1000 every year by LI
C for next 20 years . Also, a Recurring dep
osit with bank for Rs 100 for 5 years.
• 2 types of Annuities. Ordinary Annuity; pay
ment is at the end of the period. Annuity D
ue;payment is at the beginning of each per
iod.
Present and Future value of Annuit
y
• For calculating PV of Annuity, PV of each payme
nt is calculated and added.E.g. if Rs 100 is paid
at the end of each year for 10 years, we calculat
e pv of each of these 10 payments of Rs 100 se
parately and add these 10 values.
• Similarly, for calculating FV of Annuity, FV of eac
h payment is calculated and added.E.g. if Rs 10
0 is paid at the end of each year for 10 years, we
calculate fv of each of these 10 payments of Rs
100 separately and add these 10 values.
Precaution while calculating PV an
d FV
• In the formulae, given in the books,we hav
e to correctly arrive at r, i.e.the interest rat
e.E.g.the given intt rate is 12%p.a.If the pa
yment is received yearly, r will be equal to
12/100=0.12.But if payment is received mo
nthly, it will be 12/100*12=0.01.For quarter
ly payment, it will be 0.03 and for half yearl
y payment, it will be 0.06
 Sinking fund
• Concept same as that of Annuity
• Suppose, you need a fixed amount(A) afte
r,say, 5 years.You deposit an amount(C)e
very year with a bank.This becomes A afte
r 5 years and can be used for repaying a d
ebt or any other purpose.As the rate of intt
and the FV is known, we can calculate C.
 Bonds
• A Bond is a form of debt raised by the issuer of t
he bond.
• Issuer of the bonds pays interest to the purchase
r for using his money.
• Terms associated with bonds: Face value, Coup
on rate, Maturity, Redemption value, Market valu
e.
• Face value and redemption value may be differe
nt but these are fixed and known.
• Market value of the bond may be different form t
he face value and keeps changing.
 Valuation of bonds
• The purchaser of the bonds gets regular interest paymen
ts as also the redemption amount on maturity.
• The interest on bond( also called coupon rate) is fixed at
the time of its issue. But interest rate in the market keeps
changing, and,therefore,market price of bond also chang
es.
• The market price or intrinsic value of a bond is different fr
om the face value if the coupon rate is different from the
market interest rate at that particular time.
• Market value is equal to PV of all the coupon receipts an
d redemption value discounted at the prevailing market r
ate.
 Yield on bonds
• Current yield =coupon interest/current mar
ket price.
• E.g. if face value of a bond is Rs 50, coup
on rate is 8% pa, and market price is Rs 4
0, then the current yield=4/40=0.1 or 10%
• Yield to Maturity(YTM) is that discount rate
at which all future cash flows equal the pre
sent market value.
 Theorems for bond valuation
• Effect of change in market interest rate
• Effect of maturity period
• Bond price is inversely proportional to YT
M
• Interest rate elasticity= %age change in pri
ce/%age change in YTM
 Capital budgeting
• Used to choose between various projects.
• A capital project involves capital outflow( investment) an
d capital inflows(net profit) over the life of the project.
• PV of all cash inflows will be +ve and PV of all cash outfl
ows will be negative.PV will depend on the discount rate(
cost of capital)
• Summation of all the PVs of cash inflows and outflows is
called Net Present Value(NPV)
• IRR is that discount rate at which NPV of a project is zer
o.
• Other method used for capital budgeting is pay back peri
od method.
 Depreciation
• Concept of depreciation
• Straight line method;(cost-residual value)/
estiamted usful life
• Written Down Value method or declining b
alance mehtod : %age is fixed
 Forex Arithmatics
• Earlier RBI used to fix buying and selling rates of
Forex.Now LERMS( liberalised exchange rate m
anagement system) is used.
• Direct and indirect quotations.From 2-8-93 only
direct quotations are being used.
• Cross rate/chain rule; e.g. if 1US$=Rs 48 and 1
Euro=US$1.25, then 1Euro=Rs1.25*48
• Value date: Cash/ready,TOM, Spot, Forward
• Premium and discount.
• Factors affecting premium/discount
 Capital adequacy
• Need for capital in banks.
• How much capital?
• Basel II norms
• RBI norms
 Sample questions
• 1.What is the Present Value of Rs. 115,000 to be received after 1
year at 10%?
– 121,000
– 100,500
– 110,000
– 104,545
• 2.At 10% p.a. 2 year discount factor is
– 0.826
– 1.00
– 0.909
– 0.814
• 3.If 1 year discount is 0.8333, what is the discount rate?
– 10%
– 20%
– 30%
– 15%
 Sample questions
• 4.Present Value is defined as
– Future cash flows discounted to the present at an appropriate
discount rate
– Inverse of future cash flows
– Present cash flows compounded into the future
– Discounting of compounded future cash flows
• 5.Annuity is defined as
– Equal cash flows at equal intervals forever
– Equal cash flows at equal intervals for a specified period
– Unequal cash flows at equal intervals for specified period
– Unequal cash flows at equal intervals forever
 Sample questions
• 6.What is the N P V of the following at 15%
• t=0 t=1 t=2
-120,000 -100,000 300,000
• 19,887
• 80,000
• 26,300
• 40,000
• 7.A bond holder of a company has one of the following relationshi
p with
• It .Identify
– shareholder
– depositor
– creditor
– employee
•
 Sample questions
• 8.The yield to maturity is a rate of return which
– gives the current yield
– Is the discount rate at which the present value, of the coupons
• and the final payment at face value, eq
uals the current price
– gives the return at maturity on the bond for the original holder
– b) or c)
• 9.The relationship between the bond prices and interes
t rates is one of the
• Following
– direct & linear
– inverse & linear
– direct and curvilinear
– no relationship
 Sample questions
• 13) What does the rate of return equal to if interest rates do n
ot change during the pendency of the bond ?
– yield to maturity
– coupon rate
– compounded rate
– current yield
14.A Bond of face value Rs.5000 carries a coupon interest rate of 12%. It is
quoted in the market at Rs.4500. What is the current yield of the bon
d?
– 12%
– 10%
– 13.3%
– 14.2%
 Sample questions
• 15.Which of the following investment rules
does not use the time value of the money
concept?
• A.The payback period
• B.Internal rate of return
• C.Net present value
• D.All of the above use the time value conc
ept
 Sample questions
• 16.A capital equipment costing Rs200,000 today hasRs 50,000 sla
vage value at the end of 5 years. If the straight line depreciation m
ethod is used, what is the book value of the equipment at the end
of 2 years?
• Rs200,000
• Rs170,000
• Rs140,000
• Rs50,000
17.Cost of Car is Rs. 300,000, Depn. Rate is 10% on WDV. What is the
book value of car after 3 years.
• 210,000
• 220,00
• 214,300
• 218,700
 Sample questions
• 18.If P=principal, r = rate of interest , n=
number of instalments
• Then formula for equated monthly i
nstalment (EMI) is
(p*r)(i+r)n
• (1+r)n – 1
 Sample questions
• 19.If the rates in Mumbai are US $1=Rs.
42.850 .In London market are US $ 1=Eu
ros 0.7580 Therefore for one Euro we wil
l get
• a) Rs.56.45
• b Rs.56.53
• c) Rs.56.38
• d) Rs.56.50