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

## Presentation on theme: "Understanding Interest Business Economics. Why Interest? Nothing in this world is free. Banks wouldn’t make money People wouldn’t make money Businesses."— Presentation transcript:

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

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

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

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

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

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

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

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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