PRINCIPAL

&
INTEREST
 Table of Contents

1 2 3

PRINCIPAL & INTEREST SIMPLE INTEREST COMPOUND INTEREST

4 5 6

COMPOUND INTEREST NOMINAL & EFFECTIVE EXAMPLE

AT VARIOUS INTEREST RATES
INTERVALS
1
Principal & Interest
 Principal & Interest

PRINCIPAL
● The original amount of
investment made or initial capital
● Initial sum committed to purchase
assets
● Initial size of loan or a bond
INTEREST
● The money received over the
principal amount after a
certain period of time
● The time value of money
Simple Interest
 • Interest accumulated is proportional to the total
time of the investment.

• The proportionality constant is termed as the “rate

The of interest”.

Basic • Partial years are treated in proportional manner.

Principles
• Principal remains fixed throughout the term period.

Simple interest exhibits linear growth

 Simple Interest = (Principal)*(Time)*(Rate of Interest)
(Here rate of interest is expressed in decimal form)

Amount = Principal + Interest

= P + P*n*r
Mathematica A = (1 + rn)P
l where A = amount after n years
Formulae P = Principal amount
n = time in years
r = rate of interest

If the proportional rule holds for fractional years, then after

time t,
A = (1 + rt)P
 Applications of simple interest in real life
Car loan = $20,000 ( = Principal)

1 Car loans Rate of interest = 4% = 0.04

Term period = 5 years

2 Consumer Loans Simple Interest = $20000*5*0.04 = $4000

So, total amount to be paid = $20,000 + $4,000 = $24,000

3 Certificates of Deposit
Amount to be paid per month = $24,000/60 = $400

Interest paid per month = $4000/60 = $66.67

4 Discounts on Early Payments
Amount going towards principal repayment per month =
$400 - $66.67 = $333.33
Source : Investopedia
3
Compound
Interest
 • Compound interest is interest on interest.

The • This cycle leads to increasing interest and account

balances at an increasing rate.
Basic
Principles • Principal changes after every compounding.

Compound interest exhibits geometric growth

 (Here it is assumed that compounding is done yearly)

A = (1 + r)nP

where,
Mathematica A = amount after n years
l P = Principal amount
n = time in years
Formulae r = rate of interest expressed in decimal form

The compound interest after n years is given by:

Compound Interest = A - P
 THE
SEVEN - TEN
RULE
● Money invested at 10% rate of compound interest doubles in approximately
7 years.

● Money invested at 7% rate of compound interest doubles in approximately

10 years.

● For interest rates<20%, the doubling time is approximately given by:

t = 72/i

where i is the rate of interest.

 Interest can be compounded on any given schedule, from
instantaneous to annually.

There are standard compounding frequency schedules

such as:

Compound ● Daily

Interest at ● Monthly
Various ● Quarterly
Intervals ● Semi- Annually

● Annually

These schedules are usually applied to financial

instruments.
 A = P(1 + r/m)tm

where,

Mathematica A = amount after t years

P = Principal amount
l t = time in years
Formulae r = rate of interest expressed in decimal form
m= the number of compoundings in a year

The compound interest after n years is given by:

Compound Interest = A - P
 Quarterly Compounding

1st quarterly compounding 3rd quarterly compounding

Amount after compounding = Rs.102.5 Amount after compounding = Rs.107.6891

1st April 1st October

1st January 1st July

Invested Rs.100 2nd quarterly compounding
At rate of interest 10% Amount after compounding = Rs.105.0625

Amount at the end of 1 year = Rs.110.3813

5 Nominal &
Effective
Interest Rates
Nominal Interest Rate
● The basic yearly interest rate

● The interest rate before adjustment for inflation

● The interest rate without adjustment for full

effect of compounding

Effective Interest Rate

● The interest rate which is equivalent to the yearly
interest rate that would produce same result after
one year without compounding

● In the previous example, the effective interest rate is

10.3813%
 THE POWER OF COMPOUNDING

Source : https://medium.com/@akhil20187/power-of-compounding-8th-wonder-of-the-world-c3b7c395ae0
Example
 Example
Compounding frequency (#compoundings/1year) ↓
Time (years)↓ Simple Interest↓
1 2 3 4 6 12
1 110 110 110.25 110.337 110.381 110.426 110.471
2 120 121 121.551 121.743 121.840 121.939 122.039
3 130 133.1 134.010 134.327 134.489 134.653 134.818
Principal → 100 4 140 146.41 147.746 148.213 148.451 148.691 148.935
5 150 161.051 162.889 163.533 163.862 164.194 164.531
Nominal 6 160 177.156 179.586 180.438 180.873 181.313 181.759
0.1
Interest →
7 170 194.872 197.993 199.090 199.650 200.217 200.792
8 180 214.359 218.287 219.670 220.376 221.092 221.818
9 190 235.795 240.662 242.377 243.254 244.143 245.045
10 200 259.374 265.330 267.432 268.506 269.597 270.704
11 210 285.312 292.526 295.076 296.381 297.705 299.050
12 220 313.843 322.510 325.579 327.149 328.744 330.365
13 230 345.227 355.567 359.234 361.111 363.019 364.958
14 240 379.750 392.013 396.368 398.599 400.868 403.174
15 250 417.725 432.194 437.341 439.979 442.662 445.392
Effective rate
0.1 0.1 0.1025 0.10337 0.10381 0.10426 0.10471
of interest →
 Simple Interest vs. Compound Interest
Simple Interest vs. Compound Interest at 10% rate of interest with compounding frequency
one/year

450
400
350
300
Amount →

250
200
150
100
50
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Time (years) →

Amount interested simply Amount interested by compounding

Thank you Presented by:

Divyanshi – 358
Rhiteek Agarwal – 335
Goda Venkata Adithya Tarun – 257
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