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What is Simple Interest?

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Simple Interest

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Simple Interest (S.I.) is the technique of computing the amount of interest for a specific principal amount of money at some rate of interest. The whole theory of simple interest is dependent on the time value of money. This implies that money consists of a current value in the present, called a present value and another value in the future called the future value. Thus typically, it costs certain money to loan out or borrow some money. And similarly, you earn some money, if you invest money in a time deposit. This amount earned on the investment is known as interest.


Simple Interest Example

Take, for example, an entrepreneur Mr Alex wishes to commence a business and so he approached a bank to raise a loan. The bank turned satisfactory to comply. The bank agreed to lend him an amount of Rs 50,000/- for 3 years. Now at the end of three years, Alex will have to return the money to the bank. But he cannot just pay back the 50,000/-. Remember it costs to borrow/loan money. Bank charges a 7.5% interest. Thus, Mr Alex must pay interest at the agreed 7.5% per annum.


Simple Interest Formula

Before we begin to learn the formula for simple interest, let us get to know the terms related with the formula. Next is the rate of interest, mathematically represented by the symbol (R). The rate of interest is the rate at which interest will be charged annually. From the example above, we can determine that the rate is 7.5%. The next is time period which is represented by the symbol (T or N). The time period is the term or the time duration of the arrangement. It is usually expressed in years since the rate is charged annually. In the above example, the term is three years.


First, we have the principal amount which is denoted by the letter (P). This is actually the initial or original amount of the loan, or the initial amount invested.

Thus, the Simple Interest Formula = P × R × T / 100

From our above example, the principal amount is the initial amount of loan given to Mr Alex, which is 50,000/-. Then, we have the Future Value. The Future value that Mr Alex will be paying to the bank at the end of the term, i.e. after 3 years will be (50,000 + 937.5) This Amount includes the Principal and the calculated Simple Interest.


Difference Between Simple Interest and Compound Interest

Apart from simple interest, there is another kind of interest that is referred to as compound interest. The major difference between simple and compound interest is that simple interest is typically calculated on the basis of the principal amount of a deposit or a loan whereas the compound interest is calculated on the basis of the principal amount and interest that gathers in every tenure of time. Let’s solve some simple interest examples to understand the concept of simple interest in a better way.


Solved Examples

Example1: Evaluate the simple interest, when :

(i) Principal = Rs 12000 , Rate of interest = 10% per annum , and Time = 5 years

Solution:

Given-

Principal Amount (P) = Rs 12000

Rate of interest (R) = 10% per annum

Time = 5 years

Using the formula for Simple Interest = (P × R × T) ÷ 100

(12000 × 10 × 5) ÷ 100

= Rs. 6000


Example2: Evaluate the simple interest, when:

Principal = Rs .9000

Rate of interest = 7% per annum

Time = 8 months

Solution:

Given-

Principal Amount (P) = Rs 9000

Rate of interest (R) = 7% per annum

Time = 8months

Using the formula for Simple Interest = (P × R × T) ÷ 100

(9000 × 7 × 8/12) ÷ 100

= Rs. 420


Example3: Evaluate the simple interest, when:

Principal = Rs .2000

Rate of interest = 5% per annum , and

Time = 70 days

Solution:

Given-

Principal Amount (P) = Rs 2000

Rate of interest (R) = 5% per annum

Time = 70days

Using the formula for Simple Interest = (P × R × T) ÷ 100

(2000 × 5 × 70/365) ÷ 100

= Rs.134.25

FAQ (Frequently Asked Questions)

Q1. What are the Different Kinds of Simple Interest?

Answer: Simple interest can be regarded as two classifications when the time is conjectured in terms of days. They are exact and ordinary simple interests. Ordinary simple interest is a SI that takes only 360 days as the equal number of days in a year. While exact simple interest is a SI that considers the exact numbers of days in 365 for a normal year or 366 for a leap year.

In our daily lives, there are 2 types of interest we usually deal with are simple interest and compound interest.

Q2. What is FVA?

Answer: FV also known as final value and A is the amount that is finally calculated by adding simple interest to principal amount (sum of money borrowed). Thus A/FVA= Principal Amount + SI.

Q3. What is Meant by Investment?

Answer: For charging interest on investment, compound Interest can essentially work for you! Investment is an amount where you put money where it can grow, like a bank, financial institution or a business. If we invest your money at a good rate of interest, then it can grow greatly.