Simple Interest - Basics For Finance Math

By Manjit Singh Atwal
Simple Interest

In this presentation, I am going to explore the concept of the simple interest. Students in finance courses need good understanding about the interest. So, let's explore interest.

What is interest?

In simplest language, interest is the time value of money. For example, if I borrow $10 from my friend today and I spend this $10 bill to buy a fruit cake. If I return the same $10 to my friend after 5 years, would my friend be able to buy the same fruit cake with $10 after five years? Probably, not.

Things get expensive and money loses value over time. The fruit cake I bought for $10 today would probably cost $12 or more after five years.

Therefore, is this reasonable to return the same amount of money we borrowed couple years ago?

No, we have to add some extra money with the original amount; we borrowed, to match the value of money with the inflation (inflation is the degree by which the things we use get expensive). The extra money we add with the original amount (Principle) is called the interest.

Formula to calculate simple interest:

If the original money borrowed is "P" and "R" is the rate of interest and the money is borrowed for "T" years then the interest "I" can be calculated as follows:

I = PRT

Some students don't understand the rate of interest. The rate of interest is just how much money will be added to $100 if it is borrowed for one year. For example, if the rate of interest is 8%, it means if I borrow $100 today then I have to payback $108 after one complete year. Hence, I added $8 for using $100 for a full year and which is interest.

For $200 the interest for the whole year at same rate is $16.

When the money borrowed is not $100 or it's multiple and some other weird number such as $733.58 then we have math formula to deal with this. To find interest in this case the interest rate is converted into decimal and then multiplied with this weird amount and with number of years too.

Consider a person borrowed $733.58 at a rate of 12%. Calculate the simple interest for 2 years.

In the given problem, Money borrowed P = $733.58

Rate of interest R = 12% = 0.12

Divide the %age rate by 100 to convert it into a decimal.

Number of years T = 2 years

Simple interest "I = PRT".

Substitute the values for "P", "R" and "T" in the above formula to calculate the simple interest "I" as shown below:

I = 733.58 * 0.12 * 2

I = 176.06

Hence the simple interest is $176.06 (rounded to nearest cent)

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