simple interest

(noun)

interest paid only on the principal.

Related Terms

Examples of simple interest in the following topics:

  • Multi-Period Investment

    • They can either accrue simple or compound interest.
    • The first concept of accruing (or earning) interest is called "simple interest. " Simple interest means that you earn interest only on the principal.
    • Simple interest is expressed through the formula in.
    • In simple interest, it is only how much the principal is that matters.
    • Compare compound interest to simple interest.

  • Calculating Present Value

    • But first, you must determine whether the type of interest is simple or compound interest.
    • If the interest is simple interest, you plug the numbers into the simple interest formula.
    • Simple interest is pretty rare.
    • Simple interest is when interest is only paid on the amount you originally invested (the principal).
    • Distinguish between the formula used for calculating present value with simple interest and the formula used for present value with compound interest

  • Calculating Future Value

    • But recall that there are two different formulas for the two different types of interest, simple interest and compound interest .
    • Unless the problem states otherwise, it is safe to make these assumptions - you will be told if there are payments during the 10 year period or if it is simple interest.
    • Simple interest is when interest is only paid on the amount you originally invested (the principal).
    • You don't earn interest on interest you previously earned.
    • Distinguish between calculating future value with simple interest and with compound interest

  • Approaches to Calculating Future Value

    • Calculating FV is a matter of identifying PV, i (or r), and t (or n), and then plugging them into the compound or simple interest formula.
    • Is it simple or compounding interest?
    • This time, the interest is 5% per year and it is explicitly stated to be simple interest.
    • Simple interest is when interest is only paid on the amount you originally invested (the principal).
    • You don't earn interest on interest you previously earned.

  • Number of Periods

    • The number of periods corresponds to the number of times the interest is accrued.
    • In the case of simple interest the number of periods, t, is multiplied by their interest rate.
    • This makes sense because if you earn $30 of interest in the first period, you also earn $30 of interest in the last period, so the total amount of interest earned is simple t x $30.
    • Simple interest is rarely used in comparison to compound interest .
    • In compound interest, the interest in one period is also paid on all interest accrued in previous periods.

  • The Relationship Between Present and Future Value

    • PV and FV are related , which reflects compounding interest (simple interest has n multiplied by i, instead of as the exponent).
    • Since it's really rare to use simple interest, this formula is the important one.
    • The interest rate (or discount rate) and the number of periods are the two other variables that affect the FV and PV.
    • The higher the interest rate, the lower the PV and the higher the FV.
    • The more time that passes, or the more interest accrued per period, the higher the FV will be if the PV is constant, and vice versa.

  • Single-Period Investment

    • Since the number of periods (n or t) is one, FV=PV(1+i), where i is the interest rate.
    • What is the value of a single-period, $100 investment at a 5% interest rate?
    • Interest Rate (i or r) [Note: for all formulas, express interest in it's decimal form, not as a whole number. 7% is .07, 12% is .12, and so on. ]
    • For example, suppose you deposit $100 into a bank account that pays 3% interest.
    • In this case, your PV is $100 and your interest is 3%.

  • Comparing Interest Rates

    • Since interest compounds, the amount of interest actually accrued may be different than the nominal amount.
    • It provides an annual interest rate that accounts for compounded interest during the year.
    • The Fisher Equation is a simple way of determining the real interest rate, or the interest rate accrued after accounting for inflation.
    • The nominal interest rate is approximately the sum of the real interest rate and inflation.
    • Discuss the differences between effective interest rates, real interest rates, and cost of capital

  • Macroeconomic Factors Influencing the Interest Rate

    • Taylor explained the rule of determining interest rates using three variables: inflation rate, GDP growth, and the real interest rate.
    • An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender in the market.
    • The interest rates are influenced by macroeconomic factors.
    • In other words, (πt - π*t)is inflation expectations that influence interest rates.
    • Taylor explained the rule in simple terms using three variables: inflation rate, GDP growth, and the equilibrium real interest rate.

  • Calculating Values for Different Durations of Compounding Periods

    • But suppose you want to convert the interest rate into an annual rate.
    • Since interest generally compounds, it is not as simple as multiplying 1% by 12 (1% compounded each month).
    • The EAR can be found through the formula in where i is the nominal interest rate and n is the number of times the interest compounds per year (for continuous compounding, see ).
    • You can think of it as 2% interest accruing every quarter, but since the interest compounds, the amount of interest that actually accrues is slightly more than 8%.
    • The effective annual rate for interest that compounds more than once per year.