Simple Interest Calculation Basics

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Questions and Answers

What formula is used to calculate simple interest?

  • Interest = Principal × Rate × Time (correct)
  • Interest = (Principal × Rate) / Time
  • Interest = Principal / (Rate × Time)
  • Interest = Principal + Rate + Time

If a principal of $1000 is invested at a rate of 5% per annum for 3 years, what is the simple interest earned?

  • $100 (correct)
  • $50
  • $150
  • $75

Which of the following statements about simple interest is true?

  • Simple interest is calculated on the total amount year after year.
  • Simple interest can exceed the principal amount in a short period.
  • Simple interest can increase over time due to compounding.
  • Simple interest remains constant for each time period. (correct)

If an investment earns simple interest of $200 over 5 years, what could be the possible principal amount if the interest rate is 4% per annum?

<p>$1000 (D)</p> Signup and view all the answers

How does simple interest differ from compound interest?

<p>Simple interest is calculated on the principal, while compound interest is calculated on the principal plus accrued interest. (B)</p> Signup and view all the answers

Flashcards

Simple Interest

Interest calculated only on the principal amount.

Principal

The initial amount of money borrowed or invested.

Interest Rate

Percentage of the principal earned or paid over time.

Interest Formula

Simple Interest = Principal * Interest Rate * Time.

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Time

Duration of the loan or investment.

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Study Notes

Definition

  • Simple interest is a method of calculating interest on a principal amount.
  • It's calculated only on the original principal, not on any accumulated interest.

Formula

  • The simple interest (SI) formula is: SI = (P * r * t) / 100
  • P = Principal amount
  • r = Rate of interest per year (in percentage)
  • t = Time period (in years)

Calculation Example

  • Suppose a principal amount (P) of $1000 is invested at a rate of interest (r) of 5% per year for 2 years (t).
  • Using the formula: SI = (1000 * 5 * 2) / 100 = $100
  • The total amount after 2 years would be $1000 + $100 = $1100

Key Features

  • Simple interest is relatively easy to calculate.
  • The interest earned remains constant over the time period if the rate and principal do not change.
  • The interest doesn't earn any additional interest.

Applications

  • Simple interest is frequently used in short-term loans, simple savings plans, and some types of certificates of deposit (CDs).
  • It's simpler to understand compared to compound interest and can be more straightforward for calculations involving smaller time periods.

When Simple Interest is Useful

  • Situations where calculations are straightforward and the focus is on the earning of the interest on the principal for a specified time period.
  • For basic financial planning and comparison purposes when dealing with smaller time periods.

Comparison with Compound Interest

  • Compound interest is calculated on both the principal and the accumulated interest.
  • Unlike simple interest, compound interest generates a snowball effect of increasing earnings over time.
  • Compound interest generally yields higher returns over longer periods compared to simple interest, due to the compounding effect.

Key Differences

  • Simple Interest: Interest is calculated just on the principal amount.
  • Compound Interest: Interest is calculated on the principal plus accumulated interest from previous periods.

Simple Interest vs. Compound Interest Summary Table (Illustrative)

Feature Simple Interest Compound Interest
Calculation Only on the initial principal On principal plus accumulated interest
Growth Pattern Linear, consistent growth in interest Exponential growth—interest grows faster over time
Investment Value Lower investment value for long-term periods Higher investment value for long-term periods

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