Simple Interest And Compound Interest

Interest

Interest is the money paid to the lender by the borrower for using his money for a specified
period of time. Various terms and their general representation are as follows:

a) Interest: It is denoted by I. It is the money paid by the borrower for using the lenders money
for a specific ttime period.

b) Principal: It is the original sum borrowed. It is denoted by P.

c) Time: The time for which money is burrowed. Denoted by n.

d) Rate of interest: Rate at which interest is calculated on the original sum. It is denoted by r.

e) Amount: It is the sum of principal and interest. It is denoted by A.

Simple Interest(S.I)

The interest calculated every year on the sum that is borrowed is called simple interest. Here
interest is calculated only on the sum burrowed but not on the accumilated interest. For each
year the principal is same unless the burrower burrowed additional amount from the lender.

I = Pnr/100.

A = P +Pnr/100

=> A = P(1 + nr/100)

Ex-1) Find the simple interest on a principal of 3000 at 6% per annum for a period of 4 years?

Sol) Simple Interest is given by Pnr/100, where P is principal, n is number of years and r is rate of
interest.

=> I = 3000 * 6 * 4/100

=> I = 72000/100

=> I = 720

Hence the interest is rs720.

Ex-2) If rs6000 becomes rs9000 in 3 years, what is the rate of interest?

Sol) We know that amount = A = P(1 + nr/100)

=> 9000 = 6000(1 + 3r/100)

=> 1/2 = 3r/100

=> r = 100/6 = 16.66%

Therefore the rate of interest is 16.66%

Ex-3) If 'x' becomes '3x' in 4 years, how much can 3000 become in 6 years?

Sol) A = P(1 + nr/100)

=> 3x = x(1 + 4r/100)

=> 3 = 1 + 4r/100

=> 2 = 4r/100

=> r = 50%

A = 3000(1 + 6 *50/100)

=> A = 3000(1 + 3)

=> A = rs12000

Hence the amount is 12000.

Compound Interest(C.I)

The interest calculated on not only the sum burrowed but also the interest accumulated is called
Compound Interest. Under compound interest, the interest is added to the principal at the end
of each period to arrive at a new principal for the next year.

If P denotes the principal at the begining of period 1, then principal at the begining of period2 is:

= P(1 + r/100),

principal on the begining of period 3 is:

= P(1 + r/100)2

principal on the begining of period 4 is:

= P(1 + r/100)3

principal on the begining of period n+1 is:

= P(1 + r/100)n
Interest at the end of n+1 years is:

I=A-P

= P[(1 + r/100)n - 1]

Ex-4) What is the amount under compound interest at the end of three years on a sum of 10000
at 20% per annum?

Sol) If P is the principal and n, r be the time(years) and rate of interest then the amount is given
by: A = P(1 + r/100)n

Therefore, A = 10000(1 + 20/100)3

=> A = 10000(1.2) * (1.2) * (1.2)

=> A = 10000(1728)/1000

=> A = 17280

Therefore the amount is rs17280.

Ex-5) A certain sum triples itself in 3 years under compound interest, in 9 years how much will
the money amounts?

Sol) A = P(1 + nr/100)

Let the sum be 'x'. Therefore:

=> 3x = x(1 + r/100)3

=> 3 = (1 + r/100)3

In 9 years the principal amounts to

A = x(1 + r/100)9

=> A = x((1 + r/100)3)3

=> A = x(3)3

=> A = 27x.

Hence in 9 years the sum be 27 times the principal.

Compounding more than once a year

Until now we just looked at calculating SI and CI for certain number of years. What if the interest
is compounded n times in a year.For suppose what if the sum is compounded for twice or thrice
a year.

Let's suppose take a scenario in which the sum is compounded for thrice a year at r% per
annum. Then what will be the total amount at the end of 2 years. The rate of interest is given for
an year so for every four months(thrice an year) the rate will be r/3%. The amount is
compounding not just 2 times but for 6 times. Therefore:

A = P(1 + r/(3 * 100))2 * 3

If compounding is done k times a year, then in n years the amount will be

A = P(1 + r/(k*100))k*n

Important Note

·0 If the number of times compounding is done in a year is increased to infinity, we say that
the compounding is done every moment and the amount is given by P.e nr/100, where r is
the rate of interest per annum and n is the number of years.

·1 The difference between the CI and SI on a certain sum for 2 years is equal to the interest
calculated for one year on one years simple interest.

The difference between Ci and SI on a sum for 2 years is p(r/100) 2, which is equal to p(r/100)
(r/100). We know that p(r/100) is the simple interest for one year and it is multiplied with
(r/100), which is a rate of interest. It gives interest for one ayear on pr/100 i.e., interesrt for one
year on one years simple interest.

·2 The difference between the compound interest for the K th year and the compound
interest for the (k + 1)th year is equal to the interest for one year on the compound
interest for the Kth year.

Ex-6) If 6000 has been lent at 20% p.a. the interest being compounded annually, what is the
interest for the 4th year?

Sol) The amount at the end of 3rd year will be principal for the 4th year. Therefore amount at the
end of 3rd year is:

A = 6000(1 + 20/100)3

=> A = 6000(1.2)(1.2)(1.2) = rs10368

Therefore the interest for the 4th year is 20(10368)/100

= 2073.6.

Ex-7) How much will rs40000 amount in 2 years at 20% p.a the interest being compounded every
4 months?
Sol) If the interest is compounded quarterly, then the amount is given by P(1 + r/100k) nk.

Therefore the amount will be- 40000(1 + 20/(100 * 3)) 3*2

=> A = 40000(1 + 20/(100 * 3))6

=> A = 40000(1.47) = rs58915(approximate)

Ex-8) A certain sum amounts to rs6400 after 2 years and to rs8000 after 3 years, interest being
compounded annually. Find the principal and the rate of interest?

Sol) We know that the difference between the amounts at the end of the nth year and (n+1)th
year.

Therefore the difference between 8000 - 6400 = rs1600.

This difference is the interest for the 3rd year. Therefore: 1600 = 6400 * r/100

=> r = 25%

If p is the principal, P(1 + 20/100)2 = 6400

=> p = 6400/2.25 = 2844(approximate)

Present value under simple interest

The principal P is amounting to X in n periods. From this we know that

X = P(1 + nr/100) => P = X/(1 + nr/100)

Hence, in general the present value P of an amount X coming(or due) after n periods is given by:

P = X/(1 + nr/100)

Present value under compound interest

The principal P is amounting to X in n periods. From this we know that

X = P(1 + r/100)n => P = X/(1 + r/100)n

Hence, in general the present value P of an amount X coming(or due) after n periods is given by:

P = X/(1 + r/100)n

Quiz

1) A sum of money invested at simple interest amounts to rs2400 at the end of 2 years and
rs3600 at the end of 4 years. Find the principal?

a) 1200 b) 1500 c) 1600 d) 2000 e) None of these

Therefore, 2400 = P(1 + 2r/100).............(eq-1)

3600 = P(1 + 4r/100)............(eq-2)

eq-1/eq-2 = 2400/3600 = P(1 + 2r/100)/P(1 + 4r/100)

=> 2/3 = (100 + 2r)/100 + 4r)

=> r = 50%

From eq-1, 2400 = P(1 + 2 * 50/100)

=> 2400 = P(1 + 1)

=> 2400/2 = P

=> P = 1200

The principal is rs1200 and the answer is A.

2) The difference between SI and CI for 2 years @ 10% per annum is Rs 200. What is the
principal?

a) 2000 b) 20000 c) 4000 d) 1500 e) None of these.

Sol) The difference between SI and CI = p(r/100) 2

=> 200 = P(10/100)2

=> 200 = P(0.01)

=> P = rs20000

3) The CI on a sum of Rs 576 in 2 years is Rs 49. Find the rate of interest?

a) 4% b) 5.6 c) 4.16 d) 6 e) None of these

Sol) We know that A = P + I

=> A = 576 + 49 = 625

=> 625 = 576(1 + r/100)2

=> 625/576 = (1 + r/100)2

=> 25/24 = (1 + r/100)

=> 1/24 = r/100

=> r = 4.16%

Hence the answer is C.

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