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Published byBasil Stephens Modified over 8 years ago

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Understanding Interest Business Economics

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Why Interest? Nothing in this world is free. Banks wouldn’t make money People wouldn’t make money Businesses wouldn’t make money

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Simple Interest Interest = prt – P = principal (loan, amount) – R = interest rate – T = time (days, months, years) – Ordinary interest 360 days – Exact interest 365 days

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Example of Simple Interest $100 principal 3% interest rate 3 years – 100 x.03 x 3 – $9 Interest If you borrowed the $100, you would now owe $109 If you loaned someone $100, you would now be due $109 If you owned something, like a $100 bond, it would be worth $109

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Example of Simple Interest $500 principal 5% interest rate 6 months – $500 x.05 x (6/12) – $12.50 interest If you borrowed the $500, you would now owe $512.50 If you loaned someone $500, you would now be due $512.50 If you owned something, like a $500 bond, it would be worth $512.50

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Compound Interest Arises when interest is added to the principal Interest also earns interest Interest added to the principal is called compounding

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Example of Compound Interest Formula A=P(1+r/n) nt P = principal amount (initial amount) R = annual rate of interest T = number of years that amount is deposited A = amount of money accumulated after n years, including interest N = number of times the interest is compounded per year Initial investment $1,000 3% interest Compounded 4 times per year (quarterly) After 4 years =$1,000 x (1+0.0075) 16 $1,126.99

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2 More Examples Initial investment $5,000 Rate 8% Compounded monthly For 5 years =$5,000 (1+0.00666667) 60 $7,449.23 Initial investment $300 Rate 5% Compounded daily For 3 years =$300 (1+0.000136986) 1095 $348.55

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You Decide…. Regards of the principal, interest rate, or time, which would you rather have if you were investing money and expecting a return? – Interest compounded quarterly – Interest compounded monthly – Interest compounded daily

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