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Simple and Compound Interest: CAT Preparation Admission CAT Concepts Courses IIM MBA Uncategorized 

Simple and Compound Interest: CAT Preparation

Simple and Compound Interest in daily life :

Simple and Compound Interest is a very challenging topic but we somehow use it in our daily life. If you have a savings account with a bank and deposit some money, the bank will pay you extra money for saving with them. Similarly, if you need to borrow money from a bank the bank will expect you to pay back more than you borrowed from them in the first place! How much extra depends on the interest rate set by the bank. Banks make their money by charging more for their loans than they give for their savings accounts.
Simple interest is where the amount of interest earned is fixed over time. For example, if you saved £1000 at 4% simple interest you would earn £40 per year, every year. The amount of interest earned stays the same when dealing with simple interest.
Compound interest is where interest is paid on the amount already earned leading to greater and greater amounts of interest. For example, £1000  at  4%  compound interest would earn you £40 in the first year but in the second year, you would earn 4% on the new amount of £1040  which would be £41.60.
Compound interest is by far the most common type of interest used in real life. It is the reason why small amounts saved can turn into retirement nest eggs and why small loans taken out can spiral into a spiral into huge debts very quickly.

Simple Interest :

As the name implies, the calculation of simple interest is pretty simple. Multiply the principal amount with the number of years and the rate of interest.

Formula:  Simple Interest = Principal *Time *Rate of interest / 100

Abbreviated as SI=P*T*R/100

1. Principal: The money borrowed or lent out for a certain period is called the principal or the sum.
2. Interest: This is the extra money paid for taking the money as loan. This is often expressed as a percentage. Say, the interest is 10% on a loan of Rs.100. Then the interest in amount is Rs.10 and at the end of the year, the amount to be paid is Rs.110. “Extra money paid for using other’s money is called interest”.
3. Time: This is the time period for which the money is lent or the time period in which the money has to be returned with interest.
4. Simple Interest(S.I.): If the interest on a sum borrowed for certain period is reckoned uniformly, then it is called simple interest.

Compound Interest:

In compound interest, the principal amount with interest after the first unit of time becomes the principal for the next unit. Say, when compounded annually for 2years, the principal amount with interest accrued at the end of first year becomes the principal for the second year.

Formula:  Amount =Principal * [1+Rate of Interest/100]Time period (Time period being being hypertexted)

Abbreviated as Amount =P*[1+R/100]t , when compounded annually. Sometimes, the interest is also calculated half-yearly or quarterly. When compounded semi-annually or half-yearly,

Amount= P[1+(R/2)/100]2t (2t being hypertexted)

When compounded quarterly,

Amount = P[1+(R/4)/100]4t  ( 4t being hypertexted)

Present worth of Principal P due t years hence is given by : P/[1+R/100]t ( t being hypertexted)


Hear it from the of Topper Chhavi Gupta.

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