Interests from deposits

S R Balachandran, BSc, FCA, FCMA (Sri Lanka)

Council Member The National Chamber of Commerce of Sri Lanka

At present we derive interests from deposits made in

(a) Government - treasury bills, treasury bonds

(b) Commercial Banks - fixed deposits, fixed deposits certificates and savings account

(c) Finance Companies - fixed deposits, fixed deposits certificates and saving accounts

It is seen that when interest rates are quoted or advertised by finance companies two types of rates are given

(a) Actual interest - simple earning rate (SER)

(b) Compound interest - average earning rate (AER)

This fact has to be understood before making deposits in finance companies

(A) When deposits are made for a period of more than one year with interest payable on maturity, AER is computed on the assumption that the deposits are reinvested with accumulated interest (AER) annually till the period of maturity ends

(B) When deposits are made for a period less than a year AER is computed on the assumption that the deposit matured are reinvested with accumulated interest earned on maturity till the period of one year ends.

(C) Deposits are made for one year or more but interest is paid monthly. AER is computed assuming that the monthly interest earned is reinvested regularly till the year of maturity ends.

(D) Monthly payments are made for a period even more than one year and a lump sum is paid on maturity. AER is computed on the basis of loss of interest on monthly payment till the end of maturity period.

I quote below the following example.

a) Say and investment of Rs 100,000 is made for two years at the rate of 20 percent per year. Therefore after two years you would be receiving Rs 140,000 (capital and accumulated income)

Now, if investments are made every year with accumulated interests (AER) still we could earn Rs 140,000 at maturity.

The AER Rate is Rs 18.325 percent

118.325.00 x 118.325 - 100.00 = 40.00 percent

----

100.00

Now AER is less than SER

b) Deposits of Rs 100,000 made for one month, three months, six month and one year at the rate of 12 percent. (Monthly rate 1 percent) AER would be

SER		AER

1   month	12.00%	12.68%	 ((1.01) 12 - 1.00)   x 100
2   months	12.00%    12.55% ((1.03) 4 - 1.00)    x 100
6   months	12.00%	12.36%	 ((1.06) 2 - 1.00)    x 100
12 months	12.00%	12.00%	 (1.12)   1 - 1.00)   x 100

It could be seen that AER is on the descending side when SER is fixed. A standard offer of rates is published below.

SER		 AER 
1 month 	10.25% 10.75% 
3 months 	12.50% 13.10% 
6 months 	13.00% 13.42% 
12 months 	13.50% 13.50% 

Now AER is more than SER

c) Rs 100,000 is deposited @ 12.50 percent for one year but interests are paid monthly.

Annual interest 12500.00

Monthly interest 1041.67

Interest on 12 monthly deposits of 1041.67 @ 12.50%

For accumulated period (0,1,2,3,4,...11 - total 66 months) Rs 716.00

Therefore the total interest is 13216.00

AER ................. 13.216%

Similarly if deposit is made for two years @ 12.50% with interests payable monthly

AER ................. 13.134%

AER is more than SER

d) Rs 15,000 monthly payment is made for 24 months and a lump sum of Rs 450,000 is payable on maturity.

Total investment (15,000/-x24) 360,000

Interest earned 90,000

Therefore SER 25.00 percent

(12.50

percent p.a)

Now interest lost @ 24% on monthly payment of 15,000

For accumulated period (1,2,3,4,...24) = (300 months) is Rs 90,000

Therefore AER 24.00 percent

(11.36

percent p.a)

Now AER is less than SER

In conclusion I wish to state that those who are interested to participate in the active deposit scheme should pay attention to the AER. Others should consider only SER.

I hope the public will benefit from this information.