Simple Interest Calculation Quiz

Definition

• Simple interest is a method of calculating interest on a principal amount, where the interest earned is not added to the principal to determine the interest for subsequent periods.
• It is calculated only on the initial principal amount.
• The interest earned remains constant over the entire investment period.

Formula

• The formula for simple interest is: Simple Interest = (Principal × Rate × Time) / 100
• Where:
  • Principal (P) is the initial amount of money.
  • Rate (R) is the interest rate per year (expressed as a percentage).
  • Time (T) is the duration of the investment in years.

Calculation Example

• Suppose you invest $1000 at a simple interest rate of 5% for 2 years.
• Simple Interest = (1000 × 5 × 2) / 100 = $100
• The total amount at the end of 2 years would be $1000 + $100 = $1100

Key Characteristics

• Simple interest is straightforward to calculate.
• It is a relatively low-return investment.
• It is easier to understand than compound interest.
• The total interest earned is fixed over the loan or investment period.
• Interest is calculated only on the principal amount borrowed or invested.

Applications

• Simple interest is frequently used in:
  • Short-term loans
  • Simple savings accounts
  • Certificates of deposit for short maturities
  • Some educational loans
  • Payroll calculations for short-term advances/payments

Differences from Compound Interest

• In compound interest, the interest earned in each period is added to the principal, and interest is calculated on this new, larger principal amount.
• Simple interest calculates interest only on the initial principal.
• Compound interest typically yields a higher return than simple interest in the long term.