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SIMPLE AND COMPOUND INTERESTS

Part I: Simple Interests

Discussion:

1) Simple Interest – the interest is calculated only once for the entire rate of the loan.
a) Interest – the amount paid or earned for the use of money.
b) Principal – the amount invested or borrowed.
c) Rate – usually expressed in percent.
d) Time – time or term of the loan, in years.

𝑰 = 𝑷𝑹𝑻

I Interest
P Principal
R Rate
T Time

Examples:

1) Steve invested $10,000 in a savings bank account that earned 2% simple interest. Find the
interest earned if the amount was kept in the bank for 4 years.
2) Shelby borrowed $18,920 at 8% and paid $1,600 in interest. What was the length of the loan?
3) A total of $20,000 is invested. Part of it is at 6%, and part of it is at 6.5%. The total interest after
one year is $1,260. How much was invested at each rate?
4) A student purchases a computer by obtaining a simple interest loan. The computer costs $1,500,
and the interest rate on the loan is 12%. The loan is to be paid back in weekly installments after 2
years.
a) Calculate the amount of interest paid over the 2 years.
b) Calculate the total amount to be paid back.
c) Calculate the weekly payment amount.
5) In how much time will the simple interest on $3,500 at the rate of 9% per annum be the same as
the simple interest on $4,000 at 10.5% per annum for 4 years?

Part II: Compound Interests

Discussion:

1) Compound Interest – the interest is calculated more than once during the time period of the
loan. When compound interest is applied to a loan, each succeeding time period accumulates
interest on the previous interest, in addition to interest on the principal.

𝑰 = 𝑭𝑽 − 𝑷
I Compound Interest
FV Future Value
P Principal

2) Compound Amount (Future Value) – the total amount of principal and accumulated interest at
the end of a loan or investment.

𝒓 𝒏𝒕
𝑭𝑽 = 𝑷 (𝟏 + )
𝒏

FV Future Value
P Principal
r Rate
n Number of Times Compounded Per Year
t Time

TIME PERIOD n
Annually 1
Semi-Annually 2
Weekly 52
Monthly 12
Quarterly 4
Daily 360

3) Present Value – the amount of money that must be deposited today at compound interest to
provide a specified lump sum of money in the future.

Examples:

1) If you deposit $5,000 into an account paying 6% annual interest compounded monthly, how long
until there is $8,000 in the account?
2) John Anderson invested $1,200 in an account at 8% interest, compounded quarterly for 5 years.
a) What is the compound amount?
b) What is the amount of the compound interest?
3) Find the compound interest on $2,500 invested at 6%, compounded semi-annually for 8 years.
4) There is 80% increase in an amount in 8 years at simple interest. What will be the compound
interest of $14,000 after 3 years at the same rate?

Part III: Ordinary Interests, Exact Interests, and Maturity Value

Discussion:

1) Ordinary Interest (Banker’s Rule) – calculated on the basis of a 360-day year or a 30-day
month.

𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝑫𝒂𝒚𝒔 𝒐𝒇 𝒂 𝑳𝒐𝒂𝒏 𝑷𝑹𝑻


𝑰𝑶 = =
𝟑𝟔𝟎 𝟑𝟔𝟎
2) Exact Interest – calculated on the basis of a 365-day year.

𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝑫𝒂𝒚𝒔 𝒐𝒇 𝒂 𝑳𝒐𝒂𝒏 𝑷𝑹𝑻


𝑰𝑬 = =
𝟑𝟔𝟓 𝟑𝟔𝟓

3) Maturity Value – the total payback of principal and interest of an investment or a loan.

𝑴𝑽 = 𝑷 + 𝑰

𝑴𝑽 = 𝑷 + 𝑷𝑹𝑻

Examples:

1) On May 30, 2012, a businessman loans $15,000 in the bank for the expansion of his restaurant. It
was agreed that he will pay the amount with 6% rate of interest on August 10, 2012. What is the
ordinary simple interest to be paid?
2) Louie borrowed $1,800 from his aunt last December 25, 2010. He promised that he will pay his
aunt on February 14, 2011 at 8% interest.
a) Find the exact simple interest to be paid by Louie.
b) Find the maturity value.

Part IV: Annual Percentage Yield (APY) and Annual Percentage Rate (APR)

Discussion:

1) Annual Percentage Yield (APY) – a percentage rate reflecting the total amount of interest paid
on an account, based on the interest rate and the frequency of compounding for a 365-day
period. This is also known as the Effective Annual Rate (EAR), which takes compound interest
into account.

𝒓 𝒏
𝑨𝑷𝒀 = (𝟏 + ) − 𝟏
𝒏

𝑻𝒐𝒕𝒂𝒍 𝑪𝒐𝒎𝒑𝒐𝒖𝒏𝒅 𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕 𝑬𝒂𝒓𝒏𝒆𝒅 𝒊𝒏 𝟏 𝒀𝒆𝒂𝒓


𝑨𝑷𝒀 =
𝑷𝒓𝒊𝒏𝒄𝒊𝒑𝒂𝒍

2) Annual Percentage Rate (APR) – the annual rate charged for borrowing or earned through an
investment, and is expressed as a percentage that represents the actual yearly cost of funds over
a term of a loan. This only considers simple interest.

𝟕𝟐𝑰
𝑨𝑷𝑹 =
𝟑𝑷(𝒏 + 𝟏) + 𝑰(𝒏 − 𝟏)

I Finance Charge on a Loan


P Principal
n Number of Months of the Loan
Examples:

1) Jill Quinn invested $7,000 in a certificate of deposit for 1 year at 6% interest compounded
quarterly. What is the annual percentage yield of Jill’s investment? Use both formulas.
2) Christina Pitt repaid a $2,200 installment loan with 18 monthly payments. The total finance
charge on the loan was $320. Determine the annual percentage rate of Christina’s loan.
3) An initial of $17,400 was borrowed, with 24 monthly payments. If the loan yielded to an annual
percentage rate of 7.12%, calculate the finance charge on the loan.