CHAPTER 3: SIMPLE INTEREST

AND APPLICATIONS
LEARNING OBJECTIVES

• Demonstrate the concept of simple interest

• Determine the number of days between two calendar dates using
different methods
• Calculate the amount of interest, principal, time, interest rate, and
maturity value of investments and loans
• Calculate equivalent payments that replace another payment or a
series of payments
• Use simple interest in solving problems involving business applications
such as demand loans, promissory notes, discounting, treasury bills,
and commercial papers
CHAPTER OUTLINE

3.1 Calculating the Amount of Simple Interest

3.2 Calculating Principal, Interest Rate, Time, and Maturity Value

3.3 Calculating Equivalent Payments

3.4 Applications of Simple Interst

INTRODUCTION

Q: would you prefer to receive $1000 today or $1000 in 1 year?

Q: what is “interest”?
• Interest is a fee paid by borrowers to lenders for using money
temporarily
• Interest is an expense when we borrow money and an income when
we invest money
• Many business transactions involve either lending money to or
borrowing money from a financial institution, such as a bank or a credit
union
THE TIME VALUE OF MONEY

• When we invest money, a financial institution uses our money, and

therefore pays us interest for the use of the money for the time period
it has been invested
• When we borrow money from a financial institution, we pay interest to
them for the use of the money for the time period borrowed
=> In both cases, when money is returned after a period of time, interest
is added to the original amount borrowed
=> As time goes by, the value of money increases by the amount of
interest earned for that period. This is called the time value of money
SIMPLE INTERST

• In simple interest calculations, interest is calculated only on the initial

amount invested or borrowed at the specified simple interest rate for
the whole term
• Simple interest is usually used for short-term investments or loans
• We will learn the fundamental relationship between the time value of
money and the amount of simple interest charged or earned
• For long-term investments or loans, compound interest is used, where
interest is calculated on the amount borrowed or invested in addition
to the interest earned periodically
VALUE OF INVESTMENT
3.1 CALCULATING THE AMOUNT OF SIMPLE INTEREST

• In simple interest calculations, the amount of interest, for a period of

time, is calculated as a percent of the amount invested or borrowed
• This percent is referred to as the rate of interest (or interest rate),
which is always stated for a unit period of time; ie., x% per annum (x%
p.a. or x% per year)
• For example:
• The amount of interest for $1000 at 10% p.a. for 1 year
• The amount of interest for $1000 at 10% p.a. for 3 years
FORMULA

Amount of Interest = Principal × Rate × Time Period

𝑰=𝑷×𝒓×𝒕
• I = Amount of interest is the amount charged or earned for borrowing
or investing the principal amount for a period of time
• P = Principal (or Present Value) is the amount borrowed or invested (or
the discounted value or the proceeds) at the beginning of a period
• r = Simple interest rate is the rate at which the principal is borrowed or
invested
• t = Time period is the period of time for which the principal amount is
borrowed or invested during which interest is charged or earned
MATCHING TIME

• The units for r and t have to match

• If 'y' is per annum (p.a.), then 't’ should be in years
• If ‘r’ is per month (p.m.), then 't’ should be in months
• The interest rate r is usually expressed as a percent per year and the
time period t is usually calculated in years
• When the time period is given in months, convert it to years by dividing it by
12. For example: if the time period is 17 months, then t = 17/12 years
• When the time period is given in days, convert it to years by dividing it by 365.
For example: if the time period is 215 days, then t = 215/365 years
EXAMPLES

1. Sabrina borrowed $4250 from her friend for 2 years. If she was
charged a simple interest rate of 6% p.a., how much interest would
she have to pay on the loan?
2. Calculate the amount of interest earned from an investment of
$1750 for 9 months at 4.5% p.a.
3. Calculate the amount of interest charged on a loan of $3200 at 6%
p.a. for 125 days
4. Calculate the amount of interest earned on an investment of $2275
earning interest at 0.75% p.m. for 90 days
5. Calculate the amount of interest earned on an investment of $5680
!
at 0.25% p.m. for 1 " years
DETERMINING THE TIME PERIOD IN DAYS BETWEEN DATES

• Since simple interest is mostly used for loans or investments with short
time periods, it is necessary to calculate the time period in days
• The time period in days is then converted to its equivalent in years to
use as t in the simple interest formula
• Rules:
• Thirty days have September, April, June, and November
• All the rest have thirty-one excepting February alone, which has twenty-eight
clear, and twenty-nine in leap year
• Leap years occur every 4 years. For example: 2016, 2020, 2024, ... etc. are leap
years
• Century years can be leap years only if they are divisible by 400. For example:
2200, and 2300 are not leap years; however, 2000 and 2400 are leap years
DETERMINING THE TIME PERIOD IN DAYS BETWEEN DATES

• Method 1: Determining the Number of Days Using Calendar Days in

Each Month

• Method 2: Determining the Number of Days Using a Days Table

METHOD 1

• While counting the number of days in a time period, we include either

the first day or the last day of the investment or loan, but not both
days
• For example, the number of days between January 25 and February 05
is:
• January 25 to January 31: 7 days (First day included)
• February 01 to February 05: 4 days (Last day excluded)
• Examples:
1. Calculate the number of days in the time period from October 18, 2016 to
April 05, 2017
2. Calculate the number of days in the time period from January 15, 2016 to
March 20, 2016
METHOD 2
3.2 CALCULATING PRINCIPAL, INTEREST RATE, TIME, AND MATURITY VALUE

In simple interest calculations, depending on the information provided,

the simple interest formula can be rearranged to solve for the unknown
variable
• 𝐼 = 𝑃𝑟𝑡
#
•𝑃=
$%
#
• 𝑟 = &%
#
•𝑡=
&$
EXAMPLES

1. A 5-month term deposit at Andrew's bank offers a simple interest

rate of 3.5% p.a. If Andrew earned an interest amount of $75 over
the 5-month period, how much did he deposit in this term deposit?
2. The simple interest charged on a short-term loan of $30,000 at 8.1%
p.a. was $1900.
a. What was the term expressed in months?
b. What was the term expressed in days (rounded up to the next day)?
3. Calculate the rate of simple interest per annum offered on savings of
$2900 fi the interest earned is $170 over a period of 8 months.
CALCULATING THE MATURITY VALUE

• Maturity value (S) is the accumulated value (or future value) of the
principal over a period of time
• It is the sum of the principal amount and the amount of interest
Maturity Value = Principal + Amount of Interest
𝑆 = 𝑃 + 𝐼 = 𝑃 + 𝑃𝑟𝑡 = 𝑃 × (1 + 𝑟𝑡)

𝑆
𝑃= = 𝑆×(1 + 𝑟𝑡)'!
(1 + 𝑟𝑡)
EXAMPLES

1. Selena received an amount of $700 from a pawnbroker at an interest

rate of 1.5% p.m. Calculate the maturity value of her loan and
amount of interest she would have to pay at the end of four months
2. At the end of ten months, Gwyneth had $2264.50 in a fund that was
growing at a simple interest rate of 8% p.a.
a. What was the principal amount invested?
b. What was the interest earned?
3. Peter obtained a loan on April 13, 2017 for $4200 at 4.1% p.a. simple
interest. On June 01, 2017, the prime rate increased and the rate on
the loan changed to 4.35% p.a. If the loan was repaid on July 15,
2017, what was the interest paid on the loan? What was the maturity
value of the loan on this date?
3.3 CALCULATING EQUIVALENT PAYMENTS

• There may be times when it is necessary to change or reschedule the

due date of a payment for various reasons
• When the due date is changed, the value of money on the new date is
called the equivalent value; i.e., a new value equivalent to the value of
money on the old date
EQUIVALENT PAYMENT OF A SINGLE PAYMENT

• If the rescheduled date of a

payment is after the due date, it
is similar to moving money in
the forward direction (left to
right)
• Therefore, the equivalent value
of the payment on the
rescheduled date is calculated
using formula:

𝑆 = 𝑃(1 + 𝑟𝑡)
EQUIVALENT PAYMENT OF A SINGLE PAYMENT

• If the rescheduled date of a

payment is before the due date, it
is similar to moving money in the
reverse direction (right to left)
• Therefore, the equivalent value of
the payment on the rescheduled
date is calculated using formula:

𝑆
𝑃= 𝑜𝑟 𝑃 = 𝑆(1 + 𝑟𝑡)'!
(1 + 𝑟𝑡)
EXAMPLES

1. Phil realizes that he is unable to repay a matured loan amount of

$2500 that is due today. If he is charged 5% p.a. (simple interest) for
this loan, what equivalent payment is required to repay this amount
in 6 months?
2. Grace is required to repay a matured loan amount of $1500 in nine
months. However, she realized that she can clear the loan amount in
six months instead. How much would she have to pay to clear the
loan in six months if the interest rate charged is 4.5% p.a. (simple
interest)?
EQUIVALENT PAYMENT OF A SERIES OF PAYMENTS

• Since the value of money will be different at different points of time,

equivalent payment calculations involving more than one payment will
require a defined comparison point, known as the focal date
• It is a reference date for calculating and equating the equivalent values
of all payments
• A timeline diagram will assist in calculating the equivalent value of a
series of payments
EXAMPLES

1. Abdul was supposed to pay $500 six months ago and is supposed to
pay $900 in 10 months. He did not make the first payment as scheduled
and will not make the scheduled payment in 10 months. Instead, he
would like to clear the loan 18 months from now. What would the value
of this single payment in 18 months be if the interest rate on the loan is
9% p.a.? Use 18 months from now as the focal date
2. A payment of $5000 is due in three months and another payment of
$8000 is due in nine months. Calculate the value of a single payment to
be made in five months that is equivalent to these two payments if
money earns 6% p.a. simple interest. Use five months from now as the
focal date.
EXAMPLES

3. A furniture supplier sold some furniture to a clothing store and

provided them with two options to make a payment for the purchase:
Option A: $4000 in two months and $1800 in six months
Option B: $2150 in four months and $3732 in eight months
If the rate of interest is 6% p.a. simple interest, calculate which option is
economically better for the store. Use today as the focal date
4. Cathleen has to repay a personal loan in two installments, one of
$1280 in 5 months and one of $2193 in 15 months. If she wants to
reschedule these payments with two equal payments, one in 8 months
and the other in 12 months, what will be the amount of each of her new
payments? Assume money is earning 8% p.a. simple interest, and use 15
months from now as the focal date
EXAMPLES

5. Sam obtained a loan of $9000 at 6% p.a. He agreed to settle the loan

in three payments: a first payment of $3000 to be made in 4 months, a
second payment in 8 months, and a third payment in 12 months. If the
third payment is to be twice the amount of the second payment,
calculate the amounts of the second and third payments needed to
settle the loan. Use 4 months from now as the focal date.
3.4 APPLICATIONS OF SIMPLE INTEREST

Some common applications of simple interest are seen in:

• Savings accounts, Term Deposits, and Guaranteed Investment
Certificates
• Demand loans and partial payments of demand loans
• Promissory notes
• Discounting and proceeds
• Treasury bills and Commercial Papers
SAVINGS ACCOUNTS

• A savings account provides people with a safe place to deposit their money

• People can deposit and withdraw money from a savings account at any
convenient time

• In a savings account, the interest is often calculated on a daily balance and

posted monthly

• For example: invest 1000$ in a saving account for the month of March at a
bank that is offering an interest rate of 1%/year
TERM DEPOSITS

• Term deposits, also known as fixed deposits or time deposits, are

investment options where money is invested for a fixed period of time

• If investors want to withdraw their money from a term deposit prior at

the end of the term, they may have to pay a penalty as determined by
the financial institution

• The interest rate is usually higher than that of a savings account

GUARANTEED INVESTMENT CERTIFICATES (GIC)

• Purchasing a GIC refers to investing a sum of money for a specific

period of time
• The investor is guaranteed to receive the full principal investment plus
interest at the end of the specified time period
• The time period for a GIC can range from a few days to five years or
even ten years
• The interest rate for a longer investment period or a larger amount of
investment will be higher than that of a shorter period or smaller
amount of investment
• GICs can also be redeemable or non-redeemable
EXAMPLE

A bank offers 1.75% p.a. on investments of $5000 to $99,999 and

1.95% on investments of $100,000 to $249,000 for three-year GICs.
What additional amount will Harold earn from investing in a $160,000
three-year GIC instead of two $80,000 three-year GICs?
DEMAND LOANS

• A demand loan is a loan that is payable when it is demanded by the lender

who issues the loan. The borrower signs a demand note agreeing to pay the
interest and the principal on demand, the lender has the right to ask for full
payment at any time for any reason
• Requires no regular repayments of the principal amount, but the lender may
request for regular payments to cover the interest on the loan
• The borrower has an option to make a payment to settle the loan either in
part (partial payment) or in full anytime without paying a penalty
• Usually not a secured loan; i.e., no protection (collateral) is required with
assets to obtain the loan => high risk loan and high interest rate
PARTIAL PAYMENTS OF DEMAND LOANS

• When partial payments are made to reduce a loan, each payment amount is first used to
reduce the interest on the loan and the remainder is used to reduce the amount of
principal
• This method of dealing with repayments is called the declining balance method
• Note: Partial payments can be greater or less than the interest that is due at the time of
making the payment
• If the partial payment is greater than the interest due at the time of the payment, the
interest on the loan is first reduced. The remaining amount from the partial payment is
then used to reduce the principal
• If the payment is insufficient to cover the interest charges at the time of partial
payment, then the payment is held aside with no interest credit until another partial
payment is made in an amount that exceeds the interest due at the time of the new
partial payment, i.e
EXAMPLE

A demand loan of $20,000 at 18% p.a. simple interest was settled by a

payment of $5000 in 2 months, another small payment of $500 in 5
months, and the outstanding balance in 6 months. Using the declining
balance method, calculate the amount of the last payment
PROMISSORY NOTES

• A promissory note is a written promise to repay a borrowed amount to

the lender on an agreed date
• The borrower of the amount is called the 'maker' of the note (as the
borrower is making a promise to pay the amount) and the lender is
called the 'payee' (as the borrower promises to pay the lender the
amount)
• Promissory notes are generally used to record the financial details of
personal loans:
• The amount shown on the promissory note is called the 'face value' of the note
• The time period negotiated is known as the 'term' or the maturity date', which
may be in days, months, or years
• There are two types of promissory notes: interest-bearing notes and
non-interest-bearing notes
INTEREST-BEARING PROMISSORY NOTE

• The face value of the note is the amount of loan that must be repaid
with the interest calculated based on the interest rate specified on the
note
• Example:
• Tony signs an interest-bearing promissory note for $100,000 at an interest rate
of 6% p.a. The date of the note is April 15, 2020 and the term is 60 days.
Determine the maturity date and the maturity value
• Compute the face value of a 90-day promissory note dated October 25, 2020
that has a maturity value of $76,386.99 and an interest rate of 7.5% p.a.
NON-INTEREST-BEARING PROMISSORY NOTE

• The face value of a non-interest-bearing promissory note is the

maturity value of the note; i.e., interest is calculated and included in
the face value
• The interest rate may not be specified on the note and the lender
usually agrees on the interest rate on the loan
• Example: A 90-day non-interest-bearing promissory note dated March
25, 2020 has a face value of $40,000. If the note is discounted at 5.5%
p.a. on the date of issue, calculate the amount of the loan
DISCOUNTING AND PROCEEDS

• Discounting a promissory note refers to the process of finding the value of a note
on a specific date before its specific legal due date
• The amount received by the owner of the note at the time of the discount is called
proceeds
• The interest rate used or agreed to calculate the proceeds is called the discount
rate
• Note: The discount rate may not be the same as the rate of interest on the note
at the time of purchase
• It is necessary to find its maturity value first before calculating the proceeds
• For non-interest-bearing notes, the face value is the maturity value. The
maturity value is discounted using the discount rate to calculate the proceeds.
• For interest-bearing notes, the face value is the amount of loan and the
maturity value is to be calculated using S = P(1 + rt). The maturity value is
discounted using the discount rate to calculate the proceeds.
EXAMPLES

1. A non-interest-bearing note with a face value of $30,000 is due in

120 days. If the note is discounted 30 days from the date of issue at
a rate of 9% p.a., calculate the amount of proceeds and the amount
of discount.
2. An interest-bearing note for 90 days at 8% p.a. has a face value of
$80,000. If the note is discounted 70 days from maturity at a rate of
10% p.a., calculate the amount of proceeds and the amount of
discount.
TREASURY BILLS AND COMMERCIAL PAPERS

• Treasury bills, also known as T-bills, are written agreements or contracts

issued to individuals, institutions, or corporate investors for a short term
(less than a year) and are issued by the government
• T-bills are similar to non-interest-bearing promissory notes. The face value
of a T-bill is the amount shown on it and it is the maturity value that the
government guarantees to pay on the maturity date => the purchase price
of a T-bill is calculated as a principal amount of the face value shown
(maturity value) using the interest rate (called discount rate) offered at the
time of purchase, which is based on market conditions
• T-bills are transferable and their value is determined at the time of selling or
buying.
• Commercial papers are similar to T-bills, except that they are issued by large
corporations
EXAMPLES

1. Benjamin, an investor, purchased a 182-day T-bill that had an

interest rate of 3.5% p.a. and face value of $25,000. Calculate the
price he paid for the T-bill.
2. An investor purchased a 91-day T-bill with a face value of $5000
discounted at 3% p.a.
a. Calculate the purchase price of the T-bill.
b. In 30 days, he needed the money, and therefore sold the T-bill to another
investor. The rate for this investment in the market was 2.8% p.a. at the time
of the sale. Calculate his selling price and profit or loss on the transaction.
c. What annual rate of return did he realize while holding the T-bill?
THANK YOU !