Interest plays a crucial role in finance, determining the cost of borrowing and the return on investments. Simple interest is calculated on the principal alone, while compound interest grows exponentially by earning interest on accumulated interest. This text explores the formulas for both, their applications in real-world scenarios, and their significance in financial decision-making. Understanding these concepts is key for managing loans, savings, and investment strategies effectively.
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Interest is a crucial factor in finance, representing the cost for borrowing or the return on investment
Formula for simple interest
Simple interest is calculated using the formula I = PRT, where I is the interest, P is the principal, R is the annual interest rate, and T is the time in years
Application of simple interest
Simple interest is typically used for short-term loans or investments, where interest is not compounded at regular intervals
Formula for compound interest
Compound interest is calculated using the formula A = P(1 + r/n)^(nt), where A is the future value, P is the principal, r is the annual interest rate, n is the number of times interest is compounded per year, and t is the time in years
Impact of compound interest
Compound interest can lead to exponential growth, especially over long periods, due to the effect of earning "interest on interest."
Interest is applied to borrowing, where the borrower pays the lender a percentage of the principal as a cost for using the borrowed funds
Interest is also applied to investments, where the investor earns a return on their initial capital as a reward for their investment
Interest is also applied to savings, where the bank pays the depositor interest on their initial deposit, increasing its value over time
Simple interest is calculated on the principal amount alone and does not compound
Compound interest is calculated on the principal amount as well as on the accumulated interest of previous periods, leading to exponential growth over time
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When £500 is loaned with a 2% annual ______ rate, after one year, the total amount owed becomes £______.
interest
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Simple Interest Formula Components
I = PRT; I = interest, P = principal, R = rate, T = time.
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Total Amount Due with Simple Interest
A = P + I; A = total amount, P = principal, I = interest.
