Step-by-step explanation:
Simple Interest
Discussing interest starts with the principal, or amount your account starts with. This could be a starting investment, or the starting amount of a loan. Interest, in its most simple form, is calculated as a percent of the principal. For example, if you borrowed $100 from a friend and agree to repay it with 5% interest, then the amount of interest you would pay would just be 5% of 100: $100(0.05) = $5. The total amount you would repay would be $105, the original principal plus the interest.
four rolled-up dollar bills seeming to grow out of dirt, with a miniature rake lying in between them
SIMPLE ONE-TIME INTEREST
I
=
P
0
r
A
=
P
0
+
I
=
P
0
+
P
0
r
=
P
0
(
1
+
r
)
I is the interest
A is the end amount: principal plus interest
P
0
is the principal (starting amount)
r is the interest rate (in decimal form. Example: 5% = 0.05)
EXAMPLES
A friend asks to borrow $300 and agrees to repay it in 30 days with 3% interest. How much interest will you earn?
Show Solution
The following video works through this example in detail.
One-time simple interest is only common for extremely short-term loans. For longer term loans, it is common for interest to be paid on a daily, monthly, quarterly, or annual basis. In that case, interest would be earned regularly.
For example, bonds are essentially a loan made to the bond issuer (a company or government) by you, the bond holder. In return for the loan, the issuer agrees to pay interest, often annually. Bonds have a maturity date, at which time the issuer pays back the original bond value.
EXERCISES
Suppose your city is building a new park, and issues bonds to raise the money to build it. You obtain a $1,000 bond that pays 5% interest annually that matures in 5 years. How much interest will you earn?
Show Solution
Further explanation about solving this example can be seen here.
