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SIMPLE INTEREST – COMPOUND INTEREST

INTEREST
Interest is money paid to the lender by the borrower for using his money for a specified period of
time.

Various terms and their general representation are as follows:

(a) INTEREST
Interest is the money paid by borrower for using the lender’s money. It is denoted by ‘I’.
(b) PRINCIPAL
Principal is the original sum borrowed. It is denoted by ‘P’.
(c) TIME
Time here refers to the time for which money is borrowed and it is denoted by n. (n is expressed in
number of periods, which is normally one year).
(d) RATE OF INTEREST
Rate at which interest is calculated on the original sum. It is denoted by ‘r’ and is expressed as a
percentage or decimal fraction.
(e) AMOUNT
Amount is the sum of Principal and Interest and it is denoted by ‘A’.

SIMPLE INTEREST (SI)


When interest is calculated every year (or every time period) on the original principal, i.e., the sum
at the beginning of first year, such interest is called Simple Interest.
Here, year after year, even though the interest gets accumulated and is due to the lender, this
accumulated interest is not taken into account for the purpose of calculating interest for latter years.

The formula for calculating Simple Interest is –

𝑷𝑷𝑷𝑷𝑷𝑷
SI =
𝟏𝟏𝟏𝟏𝟏𝟏
where, P = principal
n = time period
r = rate of interest
𝑷𝑷𝑷𝑷𝑷𝑷
Total Amount, A = P +
𝟏𝟏𝟏𝟏𝟏𝟏
𝒏𝒏𝒏𝒏
= P �𝟏𝟏 + �
𝟏𝟏𝟏𝟏𝟏𝟏

COMPOUND INTEREST (CI)

In case of CI, the interest is added to the principal at the end of each period to arrive at the
new principal for the next period.
In easier words, the amount at the end of the first year/period will be the principal for the
second year/period and the amount at the end of the second year/period will be the
principal for the third year/period and so on.

The formula for finding the amount under CI is :

𝒓𝒓 𝒏𝒏
A = P (𝟏𝟏 + )
𝟏𝟏𝟏𝟏𝟏𝟏

where, A = amount
P = principal
r = rate of interest for a period
n = time periods

In general, if compounding is done k times a year (i.e., once every 12/k months), at the rate
𝒓𝒓 𝒌𝒌𝒌𝒌
of r% per annum then in n years, the principal of P will amount to = P (𝟏𝟏 + )
𝒌𝒌.𝟏𝟏𝟏𝟏𝟏𝟏

¿ Calculate the SI and CI for first three years. Arrange them in tabular form and

observe them and figure out the difference.


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