Quant04. Simple and Compound Interest Including Annuity – Applications

1. CPTSuccessRevision Notes – Quantitative AptitudeChapter 4. Simple and Compound Interest including Annuity – Applications

2. Chapter 4. Simple and Compound Interest including Annuity – ApplicationsWhy is interest paid?Time value of MoneyOpportunity CostInflationLiquidity PreferenceRisk FactorDefinitions

3. Interest – is the price paid by a borrower for the use of a lender’s money

4. Principal – is the initial value of lending

5. Rate of Interest – the percentage rate at which the interest is charged for a defined length of time for use of principal

6. Accumulated Amount – is the final value of an investment©Revision Notes – Quantitative AptitudeCPTSuccesswww.cptsuccess.com

7. Chapter 4. Simple and Compound Interest including Annuity – ApplicationsSimple InterestI = P.I.tA = P + I = P (1 + i.t)I = A – P Where A = Accumulated Amount P = Principal i = annual interest rate in decimalI = Amount of Interestt = time in years©Revision Notes – Quantitative AptitudeCPTSuccesswww.cptsuccess.com

8. Chapter 4. Simple and Compound Interest including Annuity – ApplicationsCompound InterestAn = P (1 + i)nwhere, i = Annual rate of interest / Number of conversion periods per year n = number of periods An = Accumulated Amount P = Principal Compound Interest = An – P = P [(1+i)n – 1]©Revision Notes – Quantitative AptitudeCPTSuccesswww.cptsuccess.com

9. Chapter 4. Simple and Compound Interest including Annuity – ApplicationsEffective Rate of Interest I = P.E.T.Where I = amount of interest E = Effective rate of interest in decimal T = time period P = Principal Amount E = (1+i)n – 1©Revision Notes – Quantitative AptitudeCPTSuccesswww.cptsuccess.com

10. Chapter 4. Simple and Compound Interest including Annuity – ApplicationsAnnuity - An annuity can be defined as a sequence of periodic payments (or receipts) regularly over a specified period of time. To be called annuity a series of payments (or receipts) must have the following features

11. Amount paid (received) must be constant over the period of annuity, and

12. Time interval between two consecutive payments (or receipts) must be the same©Revision Notes – Quantitative AptitudeCPTSuccesswww.cptsuccess.com

13. Chapter 4. Simple and Compound Interest including Annuity – ApplicationsAnnuity©Revision Notes – Quantitative AptitudeCPTSuccesswww.cptsuccess.com

14. Chapter 4. Simple and Compound Interest including Annuity – ApplicationsFuture ValueFuture value is the cash value of an investment at some time in the future. F = C.F. (1 + i)n where F = Future Value CF = Single Cash Flow©Revision Notes – Quantitative AptitudeCPTSuccesswww.cptsuccess.com

15. Chapter 4. Simple and Compound Interest including Annuity – Applications Future value of an annuity (regular)If A be the periodic payments the future value A(n i) of the annuity is given by A(n i) = Future value of Annuity (immediate)Calculating the future value of the annuity due involves two steps Step 1: Calculate the future value as though it was an ordinary annuity

16. Step 2: Multiply the result by 1 + i©Revision Notes – Quantitative AptitudeCPTSuccesswww.cptsuccess.com

17. Chapter 4. Simple and Compound Interest including Annuity – ApplicationsPresent ValuePresent value and future value are reciprocal to each other. The present value P of an amount An due at the end of n interest period at the rate of i per interest period may be obtained as: P = An / (1 + i)nPresent Value (V) of Annuity Regular (A) of n periods is the sum of the present value of payments V = A / (1 + i)1 + A / (1 + i)2 +A / (1 + i)3…. . +A / (1 + i)n Alternately A = V / P (n i)©Revision Notes – Quantitative AptitudeCPTSuccesswww.cptsuccess.com

18. Chapter 4. Simple and Compound Interest including Annuity – Applications Present value of an Annuity (immediate) is calculated in two stepsStep 1: Compute the present value of the annuity as if it were a annuity regular for one period short (n – 1)Step 2: Add initial cash payment / receipt to the Step 1 value ©Revision Notes – Quantitative AptitudeCPTSuccesswww.cptsuccess.com

19. Chapter 4. Simple and Compound Interest including Annuity – ApplicationsSinking FundSinking Fund is a fund credited for a specified purpose by way of sequence of periodic payments over a time period at a specified interest rate. Interest in compounded at the end of every period. Size of the sinking fund deposit is computed from A = P.A(n i) where A is the amount to be saved, P the periodic payment, n the payment period.©Revision Notes – Quantitative AptitudeCPTSuccesswww.cptsuccess.com

20. Chapter 4. Simple and Compound Interest including Annuity – ApplicationsApplications of Present Value

21. LeasingLeasing is a financial agreement under which the owner of the asset (lessor) allows the user of the asset (lessee) to use the asset for a defined period of time (lease period). Present Value concept can be used to find whether giving out an asset on lease is favorable for not. Capital Expenditure (investment decision)Purchase of an asset falls under capital expenditure. Present value concept can be used to calculate whether it is favorable to invest in an asset or not (if inflows from benefits > outflows for purchase)©Revision Notes – Quantitative AptitudeCPTSuccesswww.cptsuccess.com

22. Chapter 4. Simple and Compound Interest including Annuity – ApplicationsApplications of Present Value

23. Valuation of BondsA bond is a debt security in which the issuer owes the holder a debt and is obliged to repay the principal and interest. Present value concept helps to decide whether or at what rates bonds should be purchased to achieve a specified rate of return.©Revision Notes – Quantitative AptitudeCPTSuccesswww.cptsuccess.com

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Quant04. Simple and Compound Interest Including Annuity – Applications

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