Simple and Compound Interest

Simple and Compound Interest
LESSON 6. Definition
What are some ways to take care of hard-

earned money?
•Buy only what you need
•Saving money
•Invest some money
•Borrow money
Borrow $1,000 from the Bank

Alex wants to borrow $1,000. The local bank says "10%
Interest". So to borrow the $1,000 for 1 year will cost:
$1,000 × 10% = $100
Of course, Alex will have to pay back the original
$1,000 after one year, so this is what happens:
Definition
Interest is the amount paid or earned for the use of
money. Simple interest means that the interest is calculated only
once for the entire rate of the loan. At the end of the time period,
the borrower repays the principal plus the interest.
Simple interest means “the investment of money at the rate of r
in t years”
The Simple Interest Formula:

Simple Interest (I) = Principal (P) x Rate (R) x Time (T)
Stated as a Stated in
Percent Years
An annual simple interest is based on the 3 factors:

a. Principal (P) which is the amount invested or borrowed
b. Simple interest rate (R), usually expressed in percent
c. Time or term of loan (T), in years
Warm Up:
• Find 6% of 400. 24
• Find 5% of 2,000. 100
• Find 4.5% of 700. 31.50
• Find 5.5% of 325. 17.88

Simple Interest
• When you first deposit money in a savings
account, your deposit is called
PRINCIPAL.
• The bank takes the money and invests it.
• In return, the bank pays you INTEREST
based on the INTEREST RATE.
• Simple interest is interest paid only on the
PRINCIPAL.
Simple Interest Formula
I = prt
• I = interest
• P = principal
• R = the interest rate per year
• T = the time in years.
Real-World
• Suppose you deposit $400 in a savings account.
The interest rate is 5% per year.
• Find the interest earned in 6 years. Find the total
of principal plus interest.
• I = PRT  Formula
• P = 400, R = 0.05 = 5%, T = 6 (in years)
• 400 x 0.05 = 20 = interest on one year
• 400 x 0.05 x 6 = 120 = interest on $400 over 6
years
• 400 + 120 = $520 = amount in account after 6
years.
Now Figure Interest In Months
• Remember that T = time in Years.
• So, Find the interest earned in three months. Find the
total of principal plus interest.
• What fraction of a year is 3 months?
T = 3/12 = ¼ or 0.25
I = PRT
I = 400 x 0.05 x 0.25
I = $5 = interest earned after 3 months
$5 + $400 = total amount in account
$405
Try These: Both
Find the Simple Interest
• Principal = $250
• Interest Rate = 4%
• Time = 3 Years $30
Reminder: Time is always
in terms of Years. So, if
you’re dealing with
• Principal = $250 months, you have to make
• Interest Rate = 3.5% your months a fraction of a
year.
• Time = 6 Months $4.38
Compound Interest
• Compound Interest is when the bank pays
interest on the Principal AND the Interest
already earned.
• The Balance is the Principal PLUS the
Interest.
• The Balance becomes the Principal on
which the bank figures the next interest
payment when doing Compound Interest.
How it works.
Simple interest is interest on the principle
amount.
Compound interest is when your principle

and any earned interest both earn interest.
Consider this example: You begin
with $100 invested at 10% annual interest.
After Simple Interest Compound

Interest
1 year 110 110
2 years 120 121
3 years 130 133
4 years 140 146
5 years 150 161
10 years 200 259
20 years 300 672
50 years 600 11,739
Compound Interest Wins!!
From this example, it is easy to see that if you
are saving money, you would prefer
compound interest.
Compound Interest Example
• You deposit $400 in an account that earns
5% interest compounded annually (once per
year). What is the balance in your account
after 4 years? In your last calculation, round
to the nearest cent.
Fill In This Chart
Principle @ Interest Balance at End
Beginning of (I = PRT) of Each Year
Year
Year 1:
$400.00
Year 2:
Year 3:
Year 4: $486.20
Compound Interest Formula
• You can find a balance using compound
interest in one step with the compound
interest formula.
• An INTEREST PERIOD is the length of
time over which interest is calculated.
• The Interest Period can be a year or less
than a year.
Compound Interest Formula
B = p(1 + r)n
B = the final balance

P = is the principal
R = the interest rate for each interest period
N = the number of interest periods.
Semi-Annual
• When interest is compounded semiannually
(twice per year), you must DIVIDE the
interest rate by the number of interest
periods, which is 2.
6% annual interest rate ÷ 2 interest periods
= 3% semiannual interest rate
To find the number of payment periods,
multiply the number of years by the number
of interest periods per year.
Example
• Find the balance on a deposit of $1,000,
earning 6% interest compounded
semiannually for 5 years.
• The interest rate R for compounding
semiannually is 0.06÷2, or 0.03. The
number of payment periods N is 5 years x 2
interest periods per year, or 10.
• Now plug it into the formula!
The Formula!
B = p (1 + R)n
B = $1,000 (1 + 0.03)10
B = $1,000 (1.03)10
B = $1,000 (1.34391638)
B = $1,343.92
Happy? You’ll actually get to use a

calculator for these =]
Try These: Both
• Find the balance for each account. Amount
Deposited: $900, Annual Interest Rate: 2%,
Time: 3 Years.
• Compounding Annually $955.09
• Compounding Semiannually $955.37

LESSON 6. Exact & Ordinary Interest and Maturity Value
The “Hand Calculator!”
y Ju n Sept
Jul A pr Nov Aug
Ma y
r Feb Oct
Ma Dec
Jan
Knuckles are ALL 31 days

Spaces are ALL 30 days except for February
which can be either 28 or 29 days in a Leap
year!

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Simple and Compound Interest

What are some ways to take care of hard-

Borrow $1,000 from the Bank

The Simple Interest Formula:

An annual simple interest is based on the 3 factors:

• Find 5% of 2,000. 100

• Find 4.5% of 700. 31.50

• Find 5.5% of 325. 17.88

Compound interest is when your principle

After Simple Interest Compound

B = the final balance

Happy? You’ll actually get to use a

• Compounding Annually $955.09

• Compounding Semiannually $955.37

The “Hand Calculator!”

Knuckles are ALL 31 days

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