Topic1: Simple Interest
INTRODUCTION
What do you do when you have extra money? Invest in the bank? Why so? To earn
extra money? How about when you have not enough money to purchase a car,
what do you do? Bank loan? What is going to happen when you are paying back
the loan? Do you have to pay the same amount as you borrowed or more?
We all know that, if we save money in the bank, at the end of a certain period, we
will receive an amount of money more than what we have saved in the first place.
Similarly, if we borrow money from the bank, we have to pay more than the
amount we borrow after certain period. The extra money we earned from our
savings account at the bank or paying the loan is called interest. There are
numerous methods used by the bank in calculating the interest.
As a start, we will look at simple interest in this first topic. The formulae used in
calculating simple interest and simple amount will be shown followed by some
examples. In addition, four basic concepts used in computing simple interest and
equation of value and its applications are also discussed.
1.1 SIMPLE INTEREST
Firstly, what does simple interest mean?
Simple interest is interest earned over a period of time at a certain rate on the
original amount called principal.
When do we use it? It is usually used in computing interest charges for short term
loan. In the Hire Purchase Act, simple interest rate is used to calculate the interest
charge for hire-purchase loan.
Now let us look at simple interest formula. The simple interest formula is given as
follows:
I = Prt
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Where I = Simple interest
P = Principal
r = Interest rate per annum
t = Time in years
Let us look at some examples.
Example 1.1:
Daud invested RM700.00 in a saving account that earned 6% simple interest. If he
kept the money in the account for eight years, how much interest did he earn?
Solution:
Given: P = RM700.00
r = 6% = 0.06
t = 8 years
From I = Prt, we will get
I = 700 0.06 8
= RM336
Example 1.2:
Fikri saves RM800.00 in an account. The account earns RM36.00 simple interest in
nine months. What is the annual interest rate?
Solution:
Given: P = RM800.00
I = RM36.00
t = 9/12 (must be in term of year)
From I = Prt, we get
36 = 800 r (9/12)
36 12
r =
800 9
= 0.06
= 6%
Example 1.3:
Khairul invested RMX at 4.5% per annum simple interest in a bank and obtained
RM216 after 24 months. Find X.
Solution:
Let P = RMX
Given r = 4.5% = 0.045
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I = RM216.00
t = 24 months = 24/12 = 2 years (t must be in term of years)
From I = Prt, we will get
216 = P 0.045 2
216
P =
0.045 2
= RM2,400.00
Therefore, X = 2,400
1.2 SIMPLE AMOUNT
What does simple amount mean?
Simple amount is the total of original amount of the investment/loan with
the simple interest earned/charged.
How about the formula for it? The formula for simple amount, S is given as
follow:
S = P + I(1)
Substitute I = Prt into (1), we get
S = P + Prt
or
S = P(1 + rt)
Here are some examples for simple amount.
Example 1.4:
Tom saves RM5,000.00 in a savings account for three years at the rate of 4% per
annum. How much money is in TomÊs account after the three years?
Solution:
Given: P = RM5,000.00
r = 4% = 0.04
t = 3 years
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From I = Prt, we will get
= 5,000 0.04 3
= RM600.00
Simple amount, S = P+I
= 5,000 + 600
= RM5,600.00
Or
Simple amount, S = P(1 + rt)
= 5,000 [1 + 0.04(3)]
= RM5,600.00
Example 1.5:
Joanne borrowed RM2,500.00 and paid RM2,600.00 after eight months. Find the
simple interest rate that she was charged?
Solution:
Given: P = RM2,500.00
S = RM2,600.00
t = 8 months = 8/12 years (t must be in years)
Let interest rate = r
From S = P + I, we get
2,600 = 2,500 + I
I = RM100.00
Using formula I = Prt, we get
100 = 2,500 r (8/12)
r = 0.06
= 6%
Example 1.6:
Selina invested RM35,000.00 for a period of five years and three months. She was
offered 6.5% per annum simple interest for the first three years and 7% for the
remaining period. Find the amount accumulated at the end of the period.
Solution:
From the first three years
P = RM35,000.00
r = 6.5% = 0.065
t = 3 years
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Using formula I = Prt, we will get
I = 35,000 0.065 3
= RM6,825
From the remaining two years and three months
P = RM35,000.00
r = 7% = 0.07
t = 2.25 years (t must be in years)
Using formula I = Prt, we get
I = 35,000 0.07 2.25
= RM5,512.50
Simple amount = Principal + Total interest earned
= 35,000 + (6,825 + 5,512.50)
= RM47,337.50
1.3 PRESENT VALUE
If you win $1,000.00 now and $1,000.00 five years later, do you think you will get
the same value of money? Does $5,000.00 now give you the same value as 10 years
later? This calls for present value. What does it mean?
Present value is what money is worth now in relation to what you think it
will be worth in the future based on expected earnings.
Hence, from the formula
S = P (1 + rt)
P is the present value; we can obtain P by rearranging the formula which gives
S
Pv =
(1 + i ) n
Let us look at Example 1.11.
Example 1.11:
Find the present value at 7% simple interest of a debt RM3,600.00 due in two years.
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Solution:
Given: S = RM3,600.00
r = 7% = 0.07
t = 2
Using formula, we will get
P = 3,600/(1 + 0.07)2
= RM3,157.89
Topic 2: Compound Interest
INTRODUCTION
Previously in Topic 1, we discussed simple interest which interest is calculated
only based on the original principal. How about this topic? Well, this topic
introduces compound interest which is commonly applied in finance and
economic. The compound interest formula and some relevant examples are also
provided. In addition, this topic discusses the difference between effective rate and
nominal rate followed by the computation of present value and the set-up of
equation of value.
2.1 COMPOUND INTEREST
Firstly, how do we calculate compound interest? Compound interest is calculated
based on the original principal plus the interest accumulated from the previous
period. It usually makes a deposit grows faster rate than simple interest. This is
because simple interest is always calculated based on the original principal. Let us
look at an example.
Example 2.1:
RM1,000.00 is invested for three years. Find the interest earned if the interest rate
is:
(a) 9% per annum simple interest; and
(b) 9% compounded annually.
Solution:
The calculation for Example 2.1 can be simplified into Table 2.1.
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Table 2.1: Calculation for Example 2.1
Compound
Year Simple Interest Amount Amount
Interest
1 1,000 0.09 1 1,000 + 90 = 1,000 0.09 1 = 1,000 + 90 = 1,090
= 90 1,090 90
2 1,000 0.09 1 1,090 + 90 = 1,090 0.09 1 = 1,090 + 98.1 = 1,188.10
= 90 1,180 98.1
3 1,000 0.09 1 1,180 + 90 = 1,188.1 0.09 1 1,188.10 + 106.93 =
= 90 1,270 = 106.93 1,295.03
(a) Total interest earned = 90 3 = RM270.00
(b) Total interest earned = 90 + 98.1 + 106.93 = RM295.03
* The results indicate that compound interest is more than the simple
interest.
There are some important terms commonly used in relation to compound
interest. They are listed in Table 2.2.
Table 2.2: Common Important Terms Used in Relation to Compound Interest
Term Description
Original principal, P The original amount deposited.
Annual interest rate, k The interest for a year together with the frequency in which
interest is calculated in a year.
Interest period or The length of time in which interest is calculated.
conversion period
Frequency of Number of times interest is calculated in a year.
conversions, m
Periodic interest rate, Interest rate for each interest period.
i = k/m
Number of interest n with n = mt (t is time in years).
periods in the
investment period
Example 2.2:
RM7,500.00 is invested at 12% compound quarterly for two years and three
months. Find:
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(a) Original principal, P;
(b) Annual interest rate, k;
(c) Interest period;
(d) Frequency of conversions, m;
(e) Periodic interest rate, i; and
(f) Number of interest periods in the investment period, n.
Solution:
(a) P = RM7,500.00
(b) k = 12% compounded quarterly
(c) The interest period is three months
(d) m=4
(e) i = k/m
= 0.12/4
(f) n = mt
= ( 4 2) +1
= 9 interest periods
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