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Illustrating Simple and Compound Interest

This document defines simple and compound interest and provides an example to illustrate the difference. Simple interest is calculated only on the principal amount, while compound interest is calculated on both the principal and accumulated past interest. In the example, investing $10,000 at 2% interest for 5 years would yield $11,000 with simple interest but $11,040.81 with compound interest, since the interest earned each year is added to the principal for the next period's calculation. Compound interest results in higher total return over time.

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Jerry Mae Ranes
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152 views7 pages

Illustrating Simple and Compound Interest

This document defines simple and compound interest and provides an example to illustrate the difference. Simple interest is calculated only on the principal amount, while compound interest is calculated on both the principal and accumulated past interest. In the example, investing $10,000 at 2% interest for 5 years would yield $11,000 with simple interest but $11,040.81 with compound interest, since the interest earned each year is added to the principal for the next period's calculation. Compound interest results in higher total return over time.

Uploaded by

Jerry Mae Ranes
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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ILLUSTRATING SIMPLE

AND COMPOUND
INTEREST
PREPARED BY: MR. JERRY MAE A. RANES
DEFINITION OF TERMS
• Lender or creditor – person (or institution) who invests the money
or makes the funds available
• Borrower or debtor – person (or institution) who owes the money or
avails of the funds from the lender
• Origin or loan date – date on which money is received by the
borrower
• Repayment date or maturity date – date on which the money
borrowed or loan is to be completely repaid
• Time or term (t) – amount of time in years the money is borrowed or
invested; length of time between the origin and maturity dates
• Principal (P) – amount of money borrowed or invested on the origin
date
DEFINITION OF TERMS
• Rate (r) – annual rate, usually in percent, charged by the lender,
or rate of increase of the investment
• Interest (I) – amount paid or earned for the use of money
• Simple Interest (Is) – interest that is computed on the principal
and then added to it
• Compound Interest (Ic) – interest is computed on the principal
and also on the accumulated past interests
• Maturity value or future value (F) – amount after t years that
the lender receives from the borrower on the maturity date
ILLUSTRATION OF SIMPLE AND
COMPOUND INTEREST
Example 1. Suppose you won 10,000 pesos and you plan to invest
it for 5 years. A cooperative group offers 2% simple interest rate
per year. A bank offers 2% compounded annually. Which will you
choose and why?
INVESTMENT 1: SIMPLE INTEREST
Simple Interest
Amount after t years
Time (t) Principal (P) Interest Rate
(Maturity Value)
Solution Answer

1 2% (10,000)(0.02)(1) 200 10,000 + 200 = 10,200.00

2 2% (10,000)(0.02)(2) 400 10,000 + 400 = 10,400.00

3 10,000 2% (10,000)(0.02)(3) 600 10,000 + 600 = 10,600.00

4 2% (10,000)(0.02)(4) 800 10,000 + 800 = 10,800.00

5 2% (10,000)(0.02)(5) 1,000 10,000 + 1,000 = 11,000.00


INVESTMENT 2: COMPOUND INTEREST
Simple Interest
Amount after t years (Maturity
Time (t) Principal (P) Interest Rate
Value)
Solution Answer

1 10,000 2% (10,000)(0.02)(1) 200 10,000 + 200 = 10,200.00

2 10,200 2% (10,200)(0.02)(1) 204 10,200 + 204 = 10,404.00

3 10,404 2% (10,404)(0.02)(1) 208.08 10,404 + 208.08 = 10,612.08

4 10,612.08 2% (10,612.08)(0.02)(1) 212.24 10,612.08 + 212.24 = 10,824.32

5 10,824.32 2% (10,824.32)(0.02)(1) 216.49 10,824.32 + 216.49 = 11,040.81


CONCLUSION
Simple interest remains constant throughout the investment
term. In compound interest, the interest from the previous year
also earns interest. Thus, the interest grows every year

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