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Interest

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What is Interest? The rate a financial institution charges for the money it lends The rate rises and falls (fluctuates) The “prime” interest rate Describes the standard interest rate set by The Bank of Canada

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**Changes in Interest Rate**

There are many reasons that the interest rates go up and down The Economy When the economy is doing well – people want to buy large items – they need to borrow money – the demand for money goes up and so does the interest rate When the economy is doing poorly (recession) – less borrowing leads to a lower interest rate

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**Interest Rates effect on Saving**

In a period of inflation - prices are increasing As such banks need to pay a higher interest rate to make up for the rising prices Example: In 2000 you put $1.00 in the bank. During the next couple of years inflation occurs and now that $1.00 can only buy $0.90 worth of goods/services. In a period of deflation – The cost of goods fall. As such banks do not need to pay a high interest rate and it falls Example: In 2000 you give the same investment. A couple years later you can now buy $1.10 worth of goods/servies

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**Interest Rates effect on Spending**

When interest rates are high – people are spending more money paying off their debts (mortgages) When interest rates are low – people don’t see a point in saving and can easily pay off their debts – so they will spend, spend, spend This is one of the reasons interest rates go down in a recession – as we learned the best way to get out of a recession is to spend

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**Interest Rates effect on Investing**

Bonds – will pay you interest on a principle that you invest for a said period of time The institution that issues the bond must pay a higher interest rate than the banks (otherwise people would just put their money in a bank) Bonds are transferable usually However, if the bank interest rate rises above the interest rate of the bond – the price you can sell it for now decreases

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**Interest Rate effect on Investing**

Example You put away $1000 into a bond for 6 years at 6% interest will pay you $ at the bond maturity date. So, that is the market value If the interest rate goes up to 7% you would have to sell it for a cheaper price to entice a buyer If the interest rate goes down you can charge a higher price

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**Interest Rates effect on Investing**

Stocks are risky and don’t offer a guaranteed return on your money As we have all found out in the stock market game So, when interest rates are high – people would rather play it safe and invest in things like bonds Stock prices then tend to fall When interest rates are low – more people look for a risky pay out Stock prices then tend to rise

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**Calculating Simple Interest**

Here comes the math!!! The formula for calculating interest is a simple one: I = Prt I = Interest P = Principle r= annual interest rate t = time

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**Calculating Simple Interest**

Example 1: If You were to invest $530 in a savings account that paid 1.5% interest for two years, how much interest would you make?

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**Calculating Simple Interest**

Example 2: If You were to invest $1000 in a GIC that paid you 5% interest for 5 years, how much money would you receive on the date the GIC matured?

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**Compounding Simple Interest**

If I invest $300 at an interest rate of 3.5% for 9 months and You invested $400 at an interest rate of 2.25% for 1 year – who would earn more interest?

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Compound Interest Compound interest is interest that is paid on both the principal and also on any interest from past years. It’s often used when someone reinvests any interest they gained back into the original investment.

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**Compound Interest and Formula**

Formula for Compound Interest FV = P( 1 + i )t FV is the final amount including the principal. P is the principal amount. i is the rate of interest per year. t is the number of years invested. Example If I got 2% interest on my $1000 investment, the first year and I reinvested the money back into the original investment, then in the second year, I would get 2% interest on $1000 and the $20 I reinvested. Over time, compound interest will make much more money than simple interest.

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**Compound Interest Examples Initial money being invested = $1000/month @2%**

Interest Rate Calculation Interest Earned Total Value Year 1 2.00% Year 2 Year 3 Year 4 Formula = M = P( 1 + i )n

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**Compound Interest Examples Initial money being invested = $1000/month @2%**

Interest Rate Calculation Interest Earned Total Value Year 1 2.00% 1000x0.02 20 1020 Year 2 1020x0.02 20.40 Year 3 x0.02 20.81 Year 4 x0.02 21.22 Formula = M = P( 1 + i )n

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**Compound Interest Examples Initial money being invested = $1000/month @ 2%**

FV = P(1+r)t

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**Compound Interest Examples Initial money being invested = $1000/month @ 2%**

FV = P(1+r)t FV = 1000 (1.02)4 FV = 1000( ) FV =

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Interest Assignment

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Page 1 Financial Institutions and Investments. Page 2.

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