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Interest in Finance

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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.

The Role of Interest in Finance

Interest is a key element in finance, representing the cost for the use of borrowed funds or the return on invested capital. The original sum, known as the principal, accrues interest over time at a rate agreed upon by the lender and borrower. This rate is typically an annual percentage of the principal. For instance, if £500 is borrowed at an annual interest rate of 2%, after one year, the borrower would owe the original amount plus 2% of £500, which is £510 in total. Conversely, when depositing money in a savings account, the bank pays interest to the depositor, thereby increasing the value of their initial deposit over time as a reward for their investment.
Close-up view of a ceramic pink piggy bank with a coin slot, beside a stack of various international coins and a blurred jar of coins in the background.

Calculating Simple Interest

Simple interest is calculated on the principal amount alone and does not compound. The formula for simple interest is I = PRT, where I is the interest, P is the principal amount, R is the annual interest rate, and T is the time in years. The total amount due, including both the principal and the interest, is A = P + I. Simple interest is typically applied to short-term loans or investments, where the interest is not compounded at regular intervals.

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00

When £500 is loaned with a 2% annual ______ rate, after one year, the total amount owed becomes £______.

interest

510

01

Simple Interest Formula Components

I = PRT; I = interest, P = principal, R = rate, T = time.

02

Total Amount Due with Simple Interest

A = P + I; A = total amount, P = principal, I = interest.

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