Simple and Compound interest

Loans and investments are very similar financial transactions. Each involves:

 the flow of money from a source to another party

 the return of the money to its source

 the payment of a fee to the source for the use of the money.

When you make a deposit in your savings account, you are making an investment, but the bank views it
as a loan; you are lending the bank your money, which they will lend to another customer, perhaps to
buy a house. When you borrow money to buy a car, you view the transaction as a loan, but the bank
views it as an investment; the bank is investing its money in you in order to make a profit.

The amount of money that is invested is called the principal (P). The profit is the interest (I). How much
interest will be paid depends on the interest rate (r) (usually expressed as a percent per year); the term
(t), or length of time that the money is invested. The simple interest is calculated as I=Prt and the
simple interest future value is FV=P(1+rt).

On the other hand, if initial principal P earns compound interest at a periodic interest
rate i for n periods, the future value is FV=P(1+i)n

Credit card and finance charge

Credit cards have become part human's way of life. Purchases made with a credit card are subject to a
finance charge, but there is frequently a grace period, and no finance charge is assessed if full payment
is received by the payment due date. One of the most common methods of calculating credit card
interest is the average daily balance method. To find the average daily balance, the balance owed on the
account is found for each day in the billing period, and the results are averaged. The finance charge
consists of simple interest, charged on the result.

Finding the number of days, one has to take note of "TO" and "THROUGH".

 There are 4 days from June 1 to June 5.

 There are 5 days from June 1 through June 5.

When TO is used, it counts the days including the beginning day but not the ending day.
When THROUGH is used, it counts the days including the beginning day and the ending day.

Introduction: Annuity
Many people have long-term financial goals and limited means with which to accomplish them. Your
goal might be to save 500,000 over the next ten years for the down payment on a home, to save
3,000,000 over the next eighteen years to finance your new baby’s college education, or to save
10,000,000 over the next forty years for your retirement. It seems incredible, but each of these goals
can be achieved by saving only 3,000 a month (if interest rates are favorable)! All you need to do is start
an annuity.

What is an annuity?

An annuity is simply a sequence of equal, regular payments into an account in which each payment
receives compound interest. Because most annuities involve relatively small periodic payments, they are
affordable for the average person. Over longer periods of time, the payments themselves start to
amount to a significant sum, but it is really the power of compound interest that makes annuities so
amazing.

There are different kinds of annuity:

 Immediate Annuity

 Fixed Annuity

 Fixed Indexed Annuity

 Variable Annuity

How annuity of future values are computed?

The future value FV of an ordinary annuity with payment size pymt, a periodic rate i, and a term
of n payment is:

FV(ord)=pymt(1+i)n−1iFV(ord)=pymt(1+i)n−1i

Example: (USING AN ANNUITY TO SAVE FOR RETIREMENT)

Louis and Lanie decided that they should start saving for retirement through an ordinary annuity. They
arranged to have 500 taken out of each of Louis monthly pay, which will earn 8.75% interest. Louis just
had his thirtieth birthday, and his ordinary annuity will come to term when he is 65.
a) What is the future value of the annuity?
b) What is Louis' contribution and the interest portion?

Answer:

This is an ordinary annuity, with pymt=500, i=8.75%12=0.087512i=8.75%12=0.087512,

FV(ord)=pymt(1+i)n−1i
=500(1+0.087512)420−1
0.0875

12

≈1,381,350

b) The principal part of this 1,381,349.90 is Louis' contribution, and the rest is interest.

 Louis' contribution is 420 of 500 each = 210,000.

 The interest portion is 1,381,350 - 210,000 = 1,171,350

The interest portion is almost six times as large as Louis' contribution! The magnitude of the earnings
illustrates the amazing power of annuities and the effect of compound interest over a long period of
time.

To practice how calculation is done, you can use this online calculator and verify the answer above and
start planning for the future.
calculator

Stocks

(for illustration purpose only, not to promote a product, company or organization)

Stocks, bonds, and mutual funds are investment vehicles, but they differ in nature.

When owners of a company want to raise money, generally to expand their business, they may decide
to sell part of the company to investors. An investor who purchases a part of the company is said to
own stock in the company.

Stock is measured in shares; a share of stock in a company is a certificate that indicates partial
ownership in the company. The owners of the certificates are called stockholders or shareholders. As
owners, the stockholders share in the profits or losses of the corporation.

A company may distribute profits to its shareholders in the form of dividends. A dividend is usually
expressed as a per-share amount—for example, 80 per share.

How does the stock market work?

Bonds

(for illustration purpose only, not to promote a product, company or organization)

When a corporation issues stock, it is selling part of the company to the stock-holders. When it issues
a bond, the corporation is borrowing money from the bondholders; a bondholder lends money to a
corporation. Corporations, the government agencies, states, and cities all issue bonds. These entities
need money to operate.

The price paid for the bond is the face value. The issuer promises to repay the bondholder on a
particular day, called the maturity date, at a given rate of interest, called the coupon.

Mutual funds

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(for illustration purpose only, not to promote a product, company or organization)

When investors purchase shares in a mutual fund, they are adding their money to a pool along with
many other investors. The investments within a mutual fund are called the fund’s portfolio. The
investors in a mutual fund share the fund’s profits or losses from the investments in the portfolio.

An advantage of owning shares of a mutual fund is that your money is managed by full-time
professionals whose job it is to research and evaluate stocks; you own stocks with- out having to choose
which individual stocks to buy or to decide when to sell them. Another advantage is that by owning
shares in the fund, you have purchased shares of stock in many different companies. This diversification
helps to reduce some of the risks of investing.