You might have heard the term interest When it comes to banking. But this term is not particular to blanking only , It is widely used whenever one gets profit on the amount we invests. If you have even basic understanding of Profit and Loss chapter,it is going to be easier for you to grasp Simple interest and compund interest.
We deposite our money in the Bank for a period of time with a fixed interest rate from bank and when the period ends we get higher amount from the bank in return.So let's start with Simple interest.
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| simple and compound interest |
What is simple interest
When the interest is calculated only on the principal every time. It is called simple interest.Examples sound better so let's see it with an example.
Example 1 : Alex borrows $400 from Ann at a simple interest rate of 5% for 1 years.How much money will alex return to Ann after 1 years.
To find it ,let's first calculate 5% of $400
$400 × 5% = $400 × 5/100 = $20
⇒ Simple interest for 1 year = $20.
The amount of money that alex will return to Ann = Money Borrowed + 1 year simple interest.
= $400 + $20
= $420
Example 2 : Ann lends $420 to carry for 2 years then how much money will carry return back after 2 years?
Example 2 : Ann lends $420 to carry for 2 years then how much money will carry return back after 2 years?
Simple interest in 1 year = $420 × 5%
= $420×5/100
= $21
Simple interest for 2 year = $420 × 5%
= $420×5/100
= $21
Total simple interest = $21 +$21
=$42
The amount of money carry returns to Ann after 2 years
= $420+$42
= $462
What is Compound interest
When the interest is calculated on a new amount with a fixed/variable interest rate after every period of time. it is called compound interest.
Example 1 : Alexa deposits $500 in the bank for 2 years and the interest rate offered by the bank is 5%. How much money will Alexa be getting from bank after 2 years.
Compound interest for first year
= $500 × 5%
= $500× 5/100
= $25
Money after 1st year
= $500+$25
= $525
Compound interest for 2nd year
= $525×5%
= $525×5/100
= $26.25
Total Compound interest = $25+$26.25
=$51.25
Amount of money that Alexa gets from bank after 2 years
= $500+$51.25
= $551.25
Formulae related to Simple Interest and Compound interest
The formulas are listed below to find different terms involving simple and compound interest.
1. Simple interest = (Principal ×Rate ×Time)/100
2. Compound interest = ( 1+Rate/100)^Time-Principal
3. Principal = (Simple interest × 100)/Rate ×Time
4.Principal = Principal(1+Rate/100)^Time- Compound Interest
5. Rate = ( simple interest ×100)/Principal ×Time
6. Time = (simple interest × 100)/Principal ×Rate
7. Amount = Principal (1+Rate/100)^Time
Compound interest And Simple interest using Formulas
Example 1 : Wane borrowed £120 from Jane at the simple interest rate of 10% for 4 years. The amount of money Jane returned to Wane was?
Principal= £120
Rate =10%
Time =4
Amount Jane Returned to Wane =
Principal + Simple Interest
Simple interest = (120×10×4)/100
= £48
Amount = £120+£48
=£168
Example 2 : Wane borrowed £1200 from Jane at the simple interest rate of 10% for 2 years. The amount of money Jane returned to Wane was?
Amount = Principal(1+R/100)^Time
=1200(1+10/100)
= 1200×(11/10)(11/10)
= £1442
Jane returned £1442 to Wane after 2 years.
Simple Interest and compound interest FAQs
Q1: Which interest gives higher return simple interest or compound interest?
Ans : Compound interest always gives higher return.
Q 2 : Could Simple Interest and Principal could be Equal?
Ans : Yes, simple interest and Principal may sometimes be equal.
Q 3 : How to calculate interest rate If Principal and Simple interest are equal?
Rate = 100/T