1.2 Financial Mathematics: Where does it apply?

Financial mathematics helps in evaluating any financial decision that may be related to economic conditions. For example, borrowers need to consider the interest rate given when making a loan. Meanwhile, the interest rate is closely related to the inflation rates. The inflation rate increases if the currency rate for the home country depreciates caused by economic uncertainties such as political instability in the country. Finally, the depreciation causes economic gains for individuals or firms to decrease.

Financial mathematics also is needed for many kinds of decision-making. For instance, buying a car. Given two alternatives, $18,000 now, or $600 per month for 3 years. Which is better? It depends! The issue is how much is money now worth compared to money in the future. It leads to the key concept of the time value of money.

Finally, financial mathematics applies in your personal life. In general, approaches to problem solving are: i) understand the problem; ii) collect all relevant data or information; iii) define the feasible alternatives; iv) evaluate each alternative; v) select the “best” alternative; vi) implement and monitor the decision. The major role of financial mathematics is applied to approach vi which is to evaluate different alternatives. It involves techniques of formulating, estimating, and evaluating economic outcomes where choices or alternatives are available. Using specific mathematical relationships, individuals will compare the cash flows of the different alternatives. As a resolver, a sensitivity analysis can be performed to explore how the decision changes as the estimates change.