Calculating interest You can calculate the time value of your savings by figuring out how much interest you will earn. Principal – the original amount.

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Presentation transcript:

Calculating interest You can calculate the time value of your savings by figuring out how much interest you will earn. Principal – the original amount of money on deposit Annual Interest Rate – interest rate when opening an account, given as a percentage, extra money earned FORMULA: Principal x Annual Interest Rate = Interest Earned for One Year

Example: Annual Interest You just deposited $1,000 in a savings account. The bank will pay you 3 percent annual interest. How much interest will you earn if you keep your money in the bank for one year? FORMULA $1,000 x .03 = $30 How much will you earn in interest? $30 Multiplying the principal by the annual interest rate and then adding that interest amount to the principal (compounding).

Example: Compounding Interest You just deposited $1,000 in a savings account that will pay you 3 percent annual interest. You earned $30 in interest after the first year. How much will you earn after two years? FORMULA: (Principal + Previously Earned Interest) x Annual Interest Rate = Interest Earned for the Second Year SOLUTION: ($1,000 + $30) x .03 = $30.90 $1,030 + $30.90 = $1,060.90 The future value of your original deposit will be $1,060.90 after two years.

Future values of a series of Equal deposits Some savers like to make regular deposits into their savings. A series of equal regular deposits is called an annuity. Example: Determine the future value of $1,000 a year at 5 percent annual interest for six years. page 79 Part B of Figure 4

Present value of a single deposit Present value – the amount of money you would need to deposit now in order to have a desired amount in the future. Example: If you want to have $1,000 in five years for a down payment on a car, and your savings account pays 5% annual interest, how much money will you need to deposit now to accumulate $1,000? page 79 Part C of Figure 4

Present value of a series of deposits Used to determine how much you would need to deposit so you can take a specific amount of money out of your savings account for a certain number of years. Example: if you want to take $400 out of your account each year for nine years, and your money is earning interest at 8 percent a year, how much money would you need to deposit now? page 79 Part D of Figure 4