Chapter 3: Simple Interest
Key Takeaways
If you were to borrow money from an individual or a financial institution such as a Bank or Credit Union, you would expect to be charged a number of dollars for the use of this money. This amount of compensation is called interest, and is based on the amount of money borrowed (called the principal), the amount of time allotted for paying it off and the rate of interest.
By the same token, if you are to deposit some money in a financial institution, you would expect to get paid interest for allowing the financial institution to use your money. In reality, you are loaning money to the financial institution and they in tum earn an income on this money by either loaning it out or investing it.
The amount of simple interest is calculated by using the following relationship:
[latex]I = P\times r\times T[/latex]
Where:
- I is the amount of interest earned;
- P is the amount of money (principal) borrowed or deposited;
- r is the annual rate of simple interest; and
- t is the time period in years
Usually, r (rate) is quoted as a percent per year (percent per annum or percent pa) and the time (t) in years. The units of rate and time must match.
Money earned on an investment, or paid on a loan.
The original amount of money invested or borrowed.
Interest earned without any compounding, that is interest paid only on the principal.
