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Simple Interest

The document discusses simple interest calculations. It defines key terms like principal, interest rate, time and simple interest formula. It provides examples of using the simple interest formula to calculate interest earned, interest due, finding the principal, rate or time. It also discusses converting between months and fractions of years for time periods and calculating actual versus approximate time and interest.

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45 views6 pages

Simple Interest

The document discusses simple interest calculations. It defines key terms like principal, interest rate, time and simple interest formula. It provides examples of using the simple interest formula to calculate interest earned, interest due, finding the principal, rate or time. It also discusses converting between months and fractions of years for time periods and calculating actual versus approximate time and interest.

Uploaded by

mistica.baronnino
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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CHAPTER IV

Mathematics of
Finance

4.1 Simple Interest


When you deposit money in a bank—for example, in a savings account—you are
permitting the bank to use your money. The bank may lend the deposited money to customers to
buy cars or make renovations on their homes. The bank pays you for the privilege of using your
money. The amount paid to you is called interest. If you are the one borrowing money from a
bank, the amount you pay for the privilege of using that money is also called interest. The amount
deposited in a bank or borrowed from a bank is called the principal. The amount of interest paid
is usually given as a percent of the principal. The percent used to determine the amount of interest
is called the interest rate. If you deposit $1000 in a savings account paying 5% interest per year,
$1000 is the principal and the annual interest rate is 5%. Interest paid on the original principal is
called simple interest. The formula used to calculate simple interest is given below

Simple Interest Formula


The interest formula shows how interest, rate, and time are related and gives us a way of
finding one of these values if the other three values are known.
In the simple interest formula, the time t is expressed in the same period as the rate. For
example, if the rate is given as an annual interest rate, then the time is measured in years; if the
rate is given as a monthly interest rate, then the time must be expressed in months. Interest rates
are most commonly expressed as annual interest rates. Therefore, unless stated otherwise, we will
assume the interest rate is an annual interest rate. Interest rates are generally given as percent.
Before performing calculations involving an interest rate, write the interest rate as a decimal.
Example 1
Calculate the simple interest earned in 1 year on a deposit of $1000 if the interest rate
is 5%.

Solution:
Use the simple interest formula. Substitute the following values into the formula:

P = 1000, r = 5% = 0.05, and t = 1.


I = Prt
I = 1000(0.05) (1)
I = 50
The simple interest earned is $50

Example 2
Calculate the simple interest due on a 2-month loan of $500 if the interest rate is 1.5%
per month.

Solution:
Use the simple interest formula. Substitute the values P = 500 and r = 1.5% = 0.015
into the formula. Because the interest rate is per month, the time period of the loan is
expressed as the number of months: t = 2.

I = Prt
I = 500(0.015) (2)
I = 15
The simple interest due is $15.

Example 3
Calculate the simple interest due on a 45-day loan of $3500 if the annual interest rate is
8%.
Solution:
Use the simple interest formula. Substitute the following values into the formula:
P = 3500, r = 8% = 0.08, and t = number of days/360 = 45/360

I = Prt
I = 3500(0.08) (45/360)
I = 35
The simple interest due is $35
Convert Months to a Fractional or Decimal Part of a Year
O Write the number of months as the numerator of a fraction.
O Write 12 as the denominator of the fraction.
O Reduce the fraction to lowest terms if using the fractional equivalent.
O Divide the numerator by the denominator to get the decimal equivalent of the fraction.

Example 1
Convert 9 months and 15 months, respectively, to years, expressing both as fractions and
decimals.
9/12 = ¾ = 0.75
9 months = ¾ or 0.75 of a year
15/12 = 1 3/12 = 1 ¼ = 1.25
15 months = 1 ¼ or 1.25 of a year.

Example 2
To save money, Stan Wright invested $2,500 for 42 months at 4 ½ % simple interest. How much
interest did he earn?
42 months = 42/12 = 3.5
I=PxRxT
I = $2,500 x 0.045 x 3.5
I = $393.75
Stan will earn $393.75

Find the Principal, Rate or Time Using the Simple Interest Formula

A. Find the principal using the simple interest formula:


Judy paid $108 in interest on a loan that she had for 6 months. The interest rate was 12%. How
much was the principal? Substitute the known values and solve.

P = I / RT
P = 108/ 0.12 x 0.5
P = $1,800

Therefore, the principal is $1,800


B. Find the rate using the simple interest formula:
Sam wants to borrow $1,500 for 15 months and will have to pay $225 in interest. What is the
rate he is being charged? Substitute the known values and solve.

R = I / PT
R = 225/ $1,500 x 1.25
R = .12 or 12%
The rate Sam will pay is 12%.

C. Find the time using the simple interest formula:


Shelby borrowed $10,000 at 8% and paid $1,600 in interest. What was the length of the loan?
Substitute the known values and solve.

T = I / RP
T = $1,600/0.08 x $10,000
T=2

The length of the loan was two years.

If two transactions dates are given, the following simple interests can be computed:

a.) ordinary interest using actual time


b.) ordinary interest using approximate time
c.) exact interest using actual time
d.) exact interest using approximate time

Find Approximate Time and Actual Time:

Approximate time: time that is based on counting 30 days in each month. Actual
time: time that is based on counting the exact number of days in a time period.

“Days in Each Month”


Use your knuckles
• start on the left hand and work your way
through your hands using your knuckles
and the space between your knuckles
• on the knuckle - 31 days
• between the knuckles - 30 days
• exception - February
“Calendar”
Example:
The approximate time from July 12 to September 12 is 60 days.
To find the actual time from July 12 to September 12, add the following:
Days in July (31 - 12 =) 19
Days in August 31
Days in September +12
62 days

Find the Ordinary Interest and the Exact Interest:

Ordinary interest: a rate per day that assumes 360 days per year.
Ordinary interest rate per day = Interest rate per year
360

Exact interest: a rate per day that assumes 365 days per year.
Exact interest rate per day = Interest rate per year
365

Banker’s rule: calculating interest on a loan based on ordinary interest and exact time which
yields a slightly higher amount of interest

Example:
Find the interest on Php28,700 at 7.3% from March 14, 2017, to August 16, 2017, using
the following:

a.) Ordinary Interest using Actual Time


b.) Ordinary Interest using Approximate Time
c.) Exact interest using Actual Time
d.) Exact interest using Approximate Time

Solution:
Given: P = Php 28,700 r = 7.3%= 0.073
Step 1: Determine the approximate and actual time of the term
Month Actual Time Approximate Time

March 14, 2017 31-14 = 17 30-14=16

April 31 30

May 31 30

June 30 30

July 31 30
August 16, 2017 16 16

Total 155 152

There are 155 days in actual time while 152 days in approximate time.
Step 2: Compute for the Ordinary Interest and Exact Interest using the formula I= Prt.

a.) Ordinary Interest using Actual Time: t = 155 days


I= Prt.
I = 28,700 (0.073) (155/360) = P902.06

b.) Ordinary Interest using Approximate Time: t = 152 days


I= Prt.
I = 28,700 (0.073) (152/360) = P884.60

c.) Exact interest using Actual Time: t = 155 days


I= Prt.
I = 28,700 (0.073) (155/365) = P889.70

d.) Exact interest using Approximate Time: t = 152 days


I= Prt.
I = 28,700 (0.073) (155/365) = P872.48

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