DR. FILEMON C.

AGUILAR MEMORIAL COLLEGE

College of Business Administration
Golden Gate Subdivision, Talon 3, Las Piñas City

Course code and Title: FINE 2 / PERSONAL FINANCE

LESSON NUMBER: Module 5

Topic: INTEREST RATE

Introduction:
Interest is a term that you hear when working with money. It is the cost of
borrowing money. Most of the time you will hear about interest is when banking. When
you put money into a savings account, then the higher you save the money in the bank,
the more interest accumulates.
Simple interest is normally expressed as a percentage and is normally used to
show what either has to be paid to borrow money or lend money. By borrowing / lending
the principal amount (the loan amount) you would normally expect to receive something
in return or pay something because of this loan. This is normally expressed as a
percentage and is called the simple interest rate.

Understanding simple interest is one of the most important and fundamental

concepts for mastering your finances. It involves some simple math, but calculators can
do the work for you if you prefer. With an understanding of how interest works, you
become empowered to make better financial decisions that save your money.

Learning Objectives :

After this lesson, the student should be able to:

1. Learn about Loans and Interest

2. Calculate the simple interest

3. Define the terms interest rate, deposits and withdrawal

Pre-Assessment:

 Instruction: Write your answer in ½ sheet of paper or in a document file.

 1. Give 3 advantages and disadvantages of short and long term interest rate.

Lesson Presentation:

What do you know about Interest Rates?

 An Interest rates is defined as the proportion of an amount loaned which the

lender is charge as interest to the borrower, normally expressed as an amount
percentage. It is the amount of money that is paid or earned based on using
money whether it's loaned, borrowed, or invested.

 Interest rate is a percentage charged on the total amount you borrow or save. If
you’re a borrower, the interest rate is the amount you are charged for
borrowing money – a percentage of the total amount of the loan.

 It is the rate a bank or other lender charges to borrow its money or the rate a
bank pay its savers for keeping money in an account.

When Interest Rates are applied?

1. On Savings: When you put money into a savings account, then the bank
calculates how much money interest you earn. You earn interest based on the
time that the bank has the money.
2. On Borrowings or Loans: Interest rate apply to most borrowing transactions.
Individuals borrow money to purchase home fund projects.
3. On Lending: to let out (money) for temporary use on condition of repayment with
interest

 Simple interest represents a fee paid on savings, a loan or lending.

Types of Interest:

When depositing money: 

 savings accounts pay interest income because you are making money
available to the bank to lend to others.

When borrowing money: 

 You must repay the amount you borrowed and make extra payments
for interest, which represents the cost of borrowing.

When lending money:

 You typically set a rate and earn interest income in exchange for
making your money available to other people.

Methods of Calculating Future Value

 Compounding - it is the process of finding the future values of cash flows by

applying the concept of compound interest
  Compound interest - it is the interest that is received on the original amount
(principal) as well as on any interest earned but not withdrawn during earlier
periods.

 Simple interest - it is the interest that is calculated only on the original amount
(principal), and thus, no compounding of interest takes place.

Summary:
 The interest rate is the amount charged on top of the principal by a lender to a
borrower for the use of assets.
 An interest rate also applies to the amount earned at a bank or credit union from
a deposit account.
 Most mortgages use simple interest. However, some loans use compound
interest, which is applied to the principal but also to the accumulated interest of
previous periods.
 A borrower that is considered low risk by the lender will have a lower interest
rate. A loan that is considered high risk will have a higher interest rate.
 Consumer loans typically use an APR, which does not use compound interest.
 The APY is the interest rate that is earned at a bank or credit union from a
savings account or CD. Savings accounts and CDs use compounded interest.

Understanding Simple Interest?

- Simple Interest is a quick and easy method of calculating the interest charge
on a loan. Simple interest is determined by multiplying the daily interest rate by the
principal by the number of days that elapse between payments.

This type of interest usually applies to automobile loans or short-term loans, although
some mortgages use this calculation method.

When you make a payment on a simple interest loan, the payment first goes toward that
month’s interest, and the remainder goes toward the principal. 

The Formula for Simple Interest is:

I=Px R x T
P = principal amount
r = daily interest rate
t = number of days between payment

Example:
For example, a student obtains a simple-interest loan to pay one year of college
tuition, which costs 18,000, and the annual interest rate on the loan is 6%. The
student repays the loan over three years. The amount of simple interest paid is:
Given:
P = 18,000
r = 6 % = .06
t = 3 yrs
I = 18,000 x .06 x 3
I = 3,240
  and the total amount paid is
P 21,240 = 18,000 + 3240

Compound Interest Rate

 Some lenders prefer the compound interest method, which means that the
borrower pays even more in interest. Compound interest, also called interest on
interest, is applied to the principal but also on the accumulated interest of
previous periods.
 The bank assumes that at the end of the first year the borrower owes the
principal plus interest for that year.
 The bank also assumes that at the end of the second year, the borrower
owes the principal plus the interest for the first year plus the interest on
interest for the first year.
 The interest owed when compounding is higher than the interest owed using the
simple interest method. The interest is charged monthly on the principal including
accrued interest from the previous months.
 For shorter time frames, the calculation of interest will be similar for both
methods. As the lending time increases, however, the disparity between the two
types of interest calculations grows.

Sample problem:
Using the example above, at the end of 30 years, the total owed in interest is almost
$700,000 on a $300,000 loan with a 4% interest rate.

The following formula can be used to calculate compound interest:

Compound interest = p X [(1 + interest rate)n − 1] where:
p = principal
n = number of compounding periods

Compound Interest and Savings Accounts

 When you save money using a savings account, compound interest is favorable.
The interest earned on these accounts is compounded and is compensation to
the account holder for allowing the bank to use the deposited funds.
 If, for example, you deposit $500,000 into a high-yield savings account, the bank
can take $300,000 of these funds to use as a mortgage loan. To compensate
you, the bank pays 1% interest into the account annually. So, while the bank is
taking 4% from the borrower, it is giving 1% to the account holder, netting it 3% in
interest. In effect, savers lend the bank money which, in turn, provides funds to
borrowers in return for interest.

Borrower's Cost of Debt

 While interest rates represent interest income to the lender, they constitute a cost
of debt to the borrower. Companies weigh the cost of borrowing against the cost
of equity, such as dividend payments, to determine which source of funding will
be the least expensive. Since most companies fund their capital by either taking
on debt and/or issuing equity, the cost of the capital is evaluated to achieve an
optimal capital structure.

APR vs. APY

  Interest rates on consumer loans are typically quoted as the annual percentage
rate (APR). This is the rate of return that lenders demand for the ability to borrow
their money.
 For example, the interest rate on credit cards is quoted as an APR. In our
example above, 4% is the APR for the mortgage or borrower. The APR
does not consider compounded interest for the year.
 The annual percentage yield (APY) is the interest rate that is earned at a bank or
credit union from a savings account or CD. This interest rate takes compounding
into account.

How Are Interest Rates Determined?

 The interest rate charged by banks is determined by a number of factors, such as
the state of the economy. A country's central bank (the Federal Reserve in the
U.S. / Bangko Sentral ng Pilipinas BSP) sets the interest rate, which each bank
use to determine the APR range they offer.
 When the central bank sets interest rates at a high level, the cost of debt rises.
 When the cost of debt is high, it discourages people from borrowing and slows
consumer demand. Also, interest rates tend to rise with inflation. 1

Inflation, Stocks and Interest rate

 To combat inflation, banks may set higher reserve requirements, tight money

supply ensues, or there is greater demand for credit. In a high-interest rate
economy, people resort to saving their money since they receive more from the
savings rate.
 The stock market suffers since investors would rather take advantage of the
higher rate from savings than invest in the stock market with lower returns.
 Businesses also have limited access to capital funding through debt, which leads
to economic contraction.
 Economies are often stimulated during periods of low-interest rates because
borrowers have access to loans at inexpensive rates. Since interest rates on
savings are low, businesses and individuals are more likely to spend and
purchase riskier investment vehicles such as stocks.
 This spending fuels the economy and provides an injection to capital
markets leading to economic expansion.
 While governments prefer lower interest rates, they eventually lead to market
disequilibrium where demand exceeds supply causing inflation. When inflation
occurs, interest rates increase, which may relate to Walras' law.

Generalization:

When it comes to basics of finance you have to learn about simple

interest! Simple interest will affect your loans and investments and understanding this
concept will make your money or lose your money.

 Simple interest is calculated by multiplying the daily interest rate by the principal,
by the number of days that elapse between payments.
 Simple interest benefits consumers who pay their loans on time or early each
month.
 Auto loans and short-term personal loans are usually simple interest loans.
Application:

Reinforcement:

Instruction:

Online resource:
https://bench.co/blog/accounting/cash-flow-statements/
Personal Finance 2nd edition, Jeff Madura, 2017 Pearson Education
Investment Management with Personal Finance, 2014-2016 edition, Lawrence J. Gitman

Interest Rate
https://www.investopedia.com/terms/s/simple_interest.asp