Simple and Compound Interest

What’s the Use of It?
The Math of Money
Table of Contents
Objectives
Competences
Simple Interest
Compound Interest
Compound vs Simple Interest
Continuous compounding
Installment Buying
Annual Percentage Rate ( APR)
Loans in Daily Life
Bibliography/Sources
Learning Objectives#“ A wise man should have money in his head, but not in his
heart.” #
Jonathan Swift
Understand the concept of the time value of the money
Calculate the amount of simple and compound interest
Recognize the difference between simple and compound interest
Compare different offers, both loan and credit card
Apply these skills and concepts to real-world financial
situations
##Competences#“There are people who have money and people who are rich.”#
Coco Chanel #
Recognize and solve routine problems readily and find ways to reach a solution or
goal where no routine path is apparent
Make precise calculations and check the validity of the results in the context of
the problem
Formulate questions, conjectures, definitions, and generalizations about data,
information, and problem situations
Be aware of the usefulness of mathematics, also be able to bridge the concrete and
the abstract and enable deeper understanding of important ideas
loan
Simple Interest
Compound Interest
Installment Buying
Loans in Daily Life
##What is an Interest and how does it work?#
Interest is the “rent” that a borrower pays a lender

to use the lender’s money.
#“Money makes money, and the money #that money makes, makes more money.”#
Benjamin Franklin#
There are basically TWO types of Interest.

They are:
Simple Interest
Compound Interest
#Simple Interest#I = Prt ; A = P+I = P(1 + rt)#

where
I = amount of interest
P = present value (called "Principal")
r = interest rate
t = time (in years)
A = future value
Check your understanding

1) ₱ 3000 earning Simple Interest at
6% per year for 2 years
Total Simple Interest =
₱ 3000
x
0.06
x
2
= ₱ 360 Interest
So at the end of two years we get:
₱ 3000 + ₱ 360 = ₱ 3360

2) How much would you need to have on an account
to earn ₱ 100 simple interest in four months,
assuming that the simple interest rate is 6.4 %?
I = Prt
100= P∙0.064∙(4/12)
P= ₱ 4 687.50
#Remember…#
Simple interest is a type of interest that is

paid only on the original amount deposit
and not on past interest paid.
#Want to Be a Millionaire? #You Can!#

If you leave your money to grow for a long time,
₱ 100 can turn into a million euros. No, seriously.
How?
Through compounding.
Compound Interest
Compounding interest is "interest on interest."
It is a method of calculating interest where the
interest is added to the original principal.
This new value is now our principal for the

next time period. In this method the interest
earned in past terms can earn interest in
future terms.
Compound Interest Formula
# Compound vs Simple Interest#
INTEREST ing Comparison :

Period/years
Simple Interest
Compound Interest
0
1.000,00
1.000,00
1
1.070,00
1.070,00
2
1.140,00
1.144,90
3
1.210,00
1.225,04
4
1.280,00
1.310,80
5
1.350,00
1.402,55
6
1.420,00
1.500,73
7
1.490,00
1.605,78
…
…
P= ₱ 1000; r=7%
P= € 1000; r =7%
Period/years
Simple Interest
Compound Interest
23
2.610,00
4.740,53
24
2.680,00
5.072,37
25
2.750,00
5.427,43
26
2.820,00
5.807,35
27
2.890,00
6.213,87
28
2.960,00
6.648,84
29
3.030,00
7.114,26
30
3.100,00
7.612,26
#Simple and Compound Interest Graph#
So, after this research,

Would you rather earn compound
or simple interest?
Would you rather pay compound

or simple interest?
Time is on Your Side

The longer you save, the greater the
effect of compound interest.
But also…
The longer you borrow, the quicker

your debts grow.
Compounding Periods
When calculating compound interest, the
number of calculating periods makes a
significant difference.
The basic rule is that the higher the
number of calculating periods, the greater
the amount of compound interest.
A bank may pay interest as follows:

Semi-annually: twice a year or every 180 days
Quarterly: 4 times a year or every 90 days
Monthly: 12 times a year or every 30 days
Daily: 360 times a year
3) Find the future value of € 1000 invested for 10
years at 7% interest :
compounded annually
compounded semi-annually
compounded quarterly
compounded daily
Solution
Identify the variables: P= € 1000, r = 0.07, t = 10
n =1 ;
n =2 ;
n =4 ;
n =360 ;
Continuous compounding
An interest is constantly computed and added to
the balance of an account , leading to an infinite
amount of compounding periods.
A final amount
P principal or original amount
r rate of interest per year
t time, in years
#Keep in mind…#
Any discussion of compound interest is

incomplete without a discussion on inflation.
The inflation rates can vary

tremendously but in all our
examples we will ignore it.
#Installment Buying#
An installment usually refers to either:
a sum of money paid in small parts in a

fixed period of time.
a single payment within a staged

payment plan of a loan or a
hire purchase (installment plan)
Add-On Interest
The simplest method for calculating
interests is called Add-On Interest:
It is nothing more than an

application of the simple interest
formula.
Installment Loan Formulas

AMOUNT OF INTEREST:
AMOUNT TO BE REPAID:
NUMBER OF PAYMENTS:
AMOUNT OF EACH PAYMENT:
I = Prt
A = P+I = P(1 + rt)#
N = 12t
m =

4) Say, you are interested in buying a new car,
and need to come up with € 25. 000,00 in
financing. The dealership offers you an
installment plan with an add-on interest rate of
3.5% over 5 years. What, then, will be the size of
your monthly payments?
Solution
Identify the variables: P= € 25.000,00; r = 0.035, t = 5 years

The total number of payment periods is:
The total amount to be paid back to the

dealer will be:
Thus, the amount of each monthly payment is:
N = (2 per year)∙(5 years)= 60

A = P+I = P(1 + rt) = € 25.000,00∙(1+0.035∙5)= € 29.375,00
m =
But…
In the add-on interest method you are not keeping the entire
borrowed amount for the entire time of the loan period,
which makes us wonder if the annual interest rate that we were told
is actually correct.
So, in reality the true interest rate of the loan is

called the Annual Percentage Rate or APR .#
#
APR
Formula to approximate the Annual Percentage Rate

for an add-on interest loan is
where,
r – annual interest rate

N – total number of payments
34
#Why Use APR?#

Loans can be confusing. Lenders quote a lot of different
numbers that mean different things.
They might include certain costs that you are likely to pay, or
they might conveniently omit those costs in advertisements and
brochures. You might even get completely transparent quotes from
different lenders, but be unsure which one is less expensive
(because the interest rates and closing costs are different).
APR helps you (more or less) get comparison of loans by

accounting for all of the costs related to borrowing.
Comparison
In Example 4,
we considered the purchase of a car with a price of
€ 25. 000,00, paid in installments for over 5 years at an
add-on rate of 3.5%. What is the APR?
The APR is 6.89%.
This is almost twice as much as the add-on rate!
#Open-End Credit or A Credit Card Loan#

This type of loan allows purchase or cash
advances up to a specified maximum line of a
credit and has a flexible repayment schedule.
But, be careful!
#Loans in Daily Life#
#Bibliography/Sources#
Books:
Erceg, Metode gospodarskog računa, Element, 2009.
Rockswold, Gary K. , Algebra and Trigonometry,
Pearson Education 2010., Edition.
Web site:
https://www.google.hr/imghp
At the end…
Have a nice day!

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What’s the Use of It?

The Math of Money

##What is an Interest and how does it work?#

Interest is the “rent” that a borrower pays a lender

There are basically TWO types of Interest.

#Simple Interest#I = Prt ; A = P+I = P(1 + rt)#

Check your understanding

₱ 3000 + ₱ 360 = ₱ 3360

Check your understanding

Simple interest is a type of interest that is

#Want to Be a Millionaire? #You Can!#

This new value is now our principal for the

Compound Interest Formula

# Compound vs Simple Interest#

INTEREST ing Comparison :

#Simple and Compound Interest Graph#

So, after this research,

Would you rather pay compound

Time is on Your Side

The longer you borrow, the quicker

A bank may pay interest as follows:

Any discussion of compound interest is

The inflation rates can vary

a sum of money paid in small parts in a

a single payment within a staged

It is nothing more than an

Installment Loan Formulas

Check your understanding

Identify the variables: P= € 25.000,00; r = 0.035, t = 5 years

The total amount to be paid back to the

Thus, the amount of each monthly payment is:

N = (2 per year)∙(5 years)= 60

So, in reality the true interest rate of the loan is

Formula to approximate the Annual Percentage Rate

r – annual interest rate

#Why Use APR?#

APR helps you (more or less) get comparison of loans by

The APR is 6.89%.

This is almost twice as much as the add-on rate!

#Open-End Credit or A Credit Card Loan#

#Loans in Daily Life#

Have a nice day!

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