Simple Interest and Compound Interest
What is interest?
- Interest is the rate at which money is borrowed. It is used in accounting and by banks and people who lend money. It is calculated by using a set percentage, generally pre-determined or decided by the party that is lending the money.
- The borrowed money is called Principal Amount. When we borrow and then pay back, we pay back the Principal Amount plus the additional Interest Amount, which has been calculated.
- The person borrowing the money is called a Borrower.
- The person giving the money is called a Lender.
- Interest is calculated as either Simple Interest or Compound Interest. And all banks or people who loan money use this.
What is simple interest?
Simple Interest is rate of interest calculated only on the principal amount, or on that portion of the principal amount that remains. It excludes the effect of compounding. Simple interest can be applied over a time period other than a year, for example every month or week, even every day.
Simple interest formula –
Simple Interest =
P x R x T
- P is the Principal Amount
- R is the Rate of Interest
- T is the Time
This type of interest usually applies to automobile loans or short-term loans, although some mortgages use this calculation method.
What is compound interest?
Compound Interest is the addition of interest to the principal amount of a loan or deposit, or in other words, interest on interest. It is the result of re-investing interest, rather than paying it out, so that interest in the next period is then earned on the principal sum plus previously-accumulated interest. Compound Interest is standard in finance and economics.
Compound interest formula –
Compound Interest (A) = P(1 + R/n)nT
A = the future value of the investment/loan, including interest
P = the principal investment amount (the initial deposit or loan amount)
R = the annual interest rate (decimal)
n = the number of times that interest is compounded per year
T= the number of years the money is invested or borrowed for
Have fun solving these simple interest exercises!
1. How much time will it take to yield Rs. 8892/- on Rs. 28,500/-, if the rate of interest is 7.8 percent?
- 2.5 years
- 4 years
- 2.3 years
- 3 years
Correct Answer: 4 years
2. What is the amount of interest paid on Rs. 5432/- for 2.8 years, at 9 percent?
- Rs. 610/- per annum
- Rs. 1030/- per annum
- Rs. 1368/- per annum
- Rs. 980/- per annum
Correct Answer: Rs. 1368/- per annum
Have fun solving these compound interest problems!
1. What is the time period if the calculated compound interest is Rs. 7299/- on a principal amount of Rs. 6285/-?
- 6 years
- 3 years
- 5 years
- 4 years
Correct Answer: 3 years
2. What is the per annum percentage of compound interest calculated if the principal amount is Rs. 17,852 and the amount returned is Rs. 27938/- after 5 years.
- 5 %
Correct Answer: 3. 9%