Interest

Money management skills can be improved with simple theories of mathematics.

When you put money in a savings account, the bank pays you interest according to what you deposit. In effect, the bank is paying you for the privilege of "borrowing" your money.

What is interest and compound interest? What is its basis? Check out this article to find out why it is so important to know about interest and how it helps in saving.

Time Value of Money:

Introduction:
The value of money may change as time passes.

Example: The value of $1 at present may not be the same as the value of $1 in the future as the $1 now can earn you interest that will result in the growth of wealth in the future. 

This is the fundamental concept to understand what exactly interest is.

Interest:

Definition:
Interest is the return earned by or the amount paid to someone who has forgone current consumption pr alternative investment opportunities and “rented” money in a creditor relationship.

Simple Interest

Definition: Simple Interest is the interest paid or earned on the principal only.

Simple interest can be calculated by the following formula:

I = PV   x   i   x   n

Notation:
PV is Present value
FV is Future Value
I is Simple Interest
i is Interest rate per time period
n is Number of periods

 

Example:
What is the simple interest on $200 at 5 percent per annum for 6 months?
By using the formula 1.1 and substituting in the variables:

I = $200 x 0.05 x 0.5 (years) = $5

Hence, $5 is the simple interest earned for $200 at 5 percent per annum for 6 months.
It is also useful to know the following formula: FV = PV + I

 
Example:
Peter invested $2,000 in a venture that promises to pay 5 percent simple interest each year for 5 years. How much money will he have at the end of the fifth year?
By using both formula 1.1 and formula 1.2 and substituting in the variables:

FV = PV + (PV x i x 5)
          = $2,000 + ($2,000 x 0.05 x 5)
          = $2,000 + $500 = $2,500

Hence, $500 is the simple interest earned and the total value of $2,500 is accumulated when $2,000 is invested at 5 percent per annum for 5 years.