# Simple and Compound Interest

# Introduction

## What you’ll learn to do: Calculate interest rate, time, initial deposit, and total balance of both simple and compound interest situations

We have to work with money every day. While balancing your checkbook or calculating your monthly expenditures on espresso requires only arithmetic, when we start saving, planning for retirement, or need a loan, we need to understand some mathematics.### Learning Outcomes

- Calculate one-time simple interest
- Calculate simple interest over time
- Determine APY given an interest scenario
- Calculate compound interest given an interest scenario
- Calculate the initial balance given an interest scenario

# Simple Interest

## Principal and Interest

Discussing interest starts with the**principal**, or amount your account starts with. This could be a starting investment or the starting amount of a loan. Interest, in its most simple form, is calculated as a percent of the principal. For example, if you borrowed $100 from a friend and agree to repay it with 5% interest, then the amount of interest you would pay would just be 5% of 100: $100(0.05) = $5. The total amount you would repay would be $105, the original principal plus the interest.

### recall converting percent to a decimal

To convert a percent to a decimal, remove the % symbol and move the decimal two places to the left. Ex. 5% = 0.05, 25% = 0.25, and 100% = 1.0 To take 5% of $100 as in the paragraph above:- write the percent as a decimal
- translate the word
*of*as multiplication.

### Simple One-time Interest

Begin by defining the following variables:*I*is the interest- [latex]\begin{align}{{P}_{0}}\\\end{align}[/latex] is the principal (starting amount)
*r*is the interest rate (written in decimal form. Example: 5% = 0.05)*A*is the end amount: principal plus interest

### Example

A friend asks to borrow $300 and agrees to repay it in 30 days with 3% interest. How much interest will you earn?Answer:

[latex]\begin{align}{{P}_{0}}\\\end{align}[/latex] = $300 | the principal |

r = 0.03 |
3% rate |

I = $300(0.03) = $9. |
You will earn $9 interest. |

### Exercises

Suppose your city is building a new park, and issues bonds to raise the money to build it. You obtain a $1,000 bond that pays 5% interest annually and matures in 5 years. How much interest will you earn?Answer: Each year, you would earn 5% interest: $1000(0.05) = $50 in interest. So over the course of five years, you would earn a total of $250 in interest. When the bond matures, you would receive back the $1,000 you originally paid plus the $250 in interest, leaving you with a total of $1,250.

Further explanation about solving this example can be seen here. https://youtu.be/rNOEYPCnGwg**simple interest over time**.

### Simple Interest over Time

Begin by defining the following variables:*I*is the interest- [latex]\begin{align}{{P}_{0}}\\\end{align}[/latex] is the principal (starting amount)
*r*is the interest rate (written in decimal form)*A*is the end amount: principal plus interest*t*is time

**Important Idea:**Observe that the formula given above to calculate the "Amount" when calculating

**simple interest over time**is a

*linear*

*equation*. Consider the previous example exploring the value of a certain bond at maturity. Here is a graph of the data for that problem:

### Annual Percentage Rate (APR)

Interest rates are often given in terms of the total interest that will be paid in the year. The**Annual Percentage Rate (APR)**refers to the

**simple**interest rate over a year's time. Note that, often, the interest is paid in smaller time increments (say quarters or months) and is these cases, the annual interest rates will be divided up. Ex.: A 6% APR paid monthly would be divided into twelve 0.5% payments because [latex]6\div{12}=0.5[/latex]. Ex.: A 5% annual rate paid quarterly would be divided into four 1.25% payments because [latex]5\div{4}=1.25[/latex]

### Example

Treasury Notes (T-notes) are bonds issued by the federal government to cover its expenses. Suppose you obtain a $1,000 T-note with a 4% annual percentage rate, paid semi-annually, with a maturity in 42 months. How much interest will you earn?Answer: Since interest is being paid semi-annually (twice a year), the 4% interest will be divided into two 2% payments.

[latex]\begin{align}{{P}_{0}}\\\end{align}[/latex] = $1000 | the principal |

r = 0.02 |
2% rate per half-year (or per "6 months") |

t = 8 |
42 months = 7 half-years (i.e.: 42/6 = 7) |

I = $1000(0.02)(7) = $140. |
You will earn $140 interest total over the 42 months. |

**similar**example. https://youtu.be/IfVn20go7-Y

### Example

A loan company charges $30 interest for a one month loan of $500. Find the annual rate they are charging.Answer:
I = $30 of interest
[latex]P_0[/latex] = $500 principal
r = unknown
t = 1 month
Using [latex]I = P_0rt[/latex], we get [latex]30 = 500·r·1[/latex]. Solving, we get r = 0.06, or 6%. Since the time was monthly, this is the *monthly* interest rate. The annual rate would be 12 times the monthly rate or 72% interest.

### Try It

[ohm_question]72467[/ohm_question]### Try It

[ohm_question]929[/ohm_question]## Licenses & Attributions

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**Authored by:**TheDigitalWay.**License:**CC0: No Rights Reserved. - One time simple interest.
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**Authored by:**OCLPhase2's channel.**License:**CC BY: Attribution. - Simple interest T-note example.
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