2 Interest - For STUDENTS

Interest: Simple and Compound
When money is deposited in a bank or building society account, it commonly attracts

interest; in a similar way, a borrower must normally pay interest on money
borrowed. The rate of interest is usually (but not always) quoted as a rate per
cent per year. At the time of writing a typical rate is 1.5% per annum for money
deposited and 1%-2% per annum for money borrowed. Up-to-date rates are
available from finance organizations.
There are two basic ways of calculating the amount of interest paid on money deposited:
simple interest and compound interest.
If simple interest is paid, interest is calculated only on the principal £P, the amount
deposited (the original capital sum). The interest £I payable after one year years at rate
r% per annum is given by the formula
r
Interest = *P
100
and the total amount owing can then be calculated by adding I to P.
Example 1
Ahmed invests £250 in a building society account. At the end of the year his account is
credited with 2% interest. How much interest had his £250 earned in the year?
Solution
Interest = 2 % of £250
2
Interest = * 250 = 5
100
That is the interest is £5
Example 2
Alaa invests £140 in an account that pays r% interest. After the first year he receives
£4.20 interest. What is the value of r, the rate of interest?
Solution
After one year, the amount of interest is given by
r
× £140 = £4.20
100
140 r = 420
r = 420 /140 = 3
So the interest rate is 3%.
Page 1 of 4
Compound Interest
Simple interest is very rarely used in real life: almost all banks and other financial. This is when
interest is added (or compounded) to the principal sum so that interest is paid on the whole amount. Under
this method, if the interest for the first year is left in the account, the interest for the second year is calculated
on the whole amount so far accumulated.
Example 1
I deposit £250 in a high-earning account paying 9% compound interest and leave it for
Solution
Balance after 0 years
Interest: 9% of £250.00 
Balance after 1 year:
Interest: 9% of 272.50 
Balance after 2 years
Interest: 9% of £297.02 =
Balance after 3 years =
(Note that, for simplicity, all results here are rounded to the nearest penny; computer calculations
are often made to several decimal places.)
Example 2
Jodie invests £1200 in a bank account which pays interest at the rate of 4% per annum.
Calculate the value of her investment after 4 years.
Solution
At an interest rate of 4% per annum, the value of her investment after one year is
V = £1200 + ( 4 / 100 ) x £1200

= 1.04 × £1200
= £1248
After two years, the investment is worth
1.04 × £1248 = £1297.92
and after three years,
1.04 × £1297.92 = £1349.84

At the end of four years, the value of Jodie's investment will be
1.04 × £1349.84 = £1403.83
Page 2 of 4
Compound Interest Formula
Compound interest is somewhat cumbersome, but fortunately there is a formula.
As 100%, and adding 9% to 100% gives 109%. So adding 9% to any amount of money is
equivalent to multiplying that amount by 1.09. Check that
$ 250.00 * 1.09 = $ 272.50

$ 272.50 * 1.09 = $ 297.02, and
$ 297.20 * 1.09 = $ 323.70
r % to a sum of money corresponds to multiplying by ( 1 + r / 100 ) will be multiplied by ( 1 + r/100 ).
The total amount , by the end of time T will be
A = P ( 1 + r / 100 ) T .
What amount will you have to pay back?
Example 2
Given the amount is 500 and interest rate of 6.5 % . What will the total amount be after 4
years at a compound interest ?
Solution
Using the formula,
A = 500 × 1.0654
= 500 × 1.28646...
= 643.233
The same formula can be used to calculate the principal sum, the interest rate, or the 500.
Example 3
How much must Samir deposit in a 6% savings account if he wants it to amount to
£120 after two years?
Solution
Using the formula
120 = P × 1.062
Giving P = 120 ÷ 1.062
= 106.799
He must deposit £106.80.
Example 3
The value of a computer depreciates at a rate of 20% per annum. A new computer costs
£1200. What will be its value after
Page 3 of 4
(a) 2 years (b) 6 years (c) 10 years?
Solution
(a) Value = £1200 × ( 1 – 20 / 100 )2

= £1200 × ( 4 / 5 )2
= £768
(b) Value = £1200 × ( 1 – 20 / 100 )6
= ( 4 / 5 )6
= £314.57
10
(c) Value = £1200 × ( 4 / 5 )
= £128.85
Example 4
What rate of interest will allow £350 to grow to £500 in five years?
Solution
From the formula,
5
500 = 350 x ( 1 + r / 100 )
5
 ( 1 + r / 100 ) = 500 / 350 = 1.42857
 ( 1 + r / 100 ) = 5 1.42857 = 1.0739
 r = 7.39
 The interest rate is approximately 7.4%
Example 5
For how long must a sum be deposited in an account paying 14% compound
interest in order to double in value?
Solution
2P = P × 1.14T
⇒ 1.14T = 2
⇒ T log1.14 = log 2
⇒ T = log 2 ÷ log1.14
0.3010... ÷ 0.0569...
= 5.29
The deposit must be left for 5.3 years but as interest is paid yearly, it would have to be left
for 6 years. (Note that after 5 years, the multiplier would be 1.14  5 ≈ 1 .925 but after 6
years
1.14  6 ≈ 2.195.
Page 4 of 4

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Interest: Simple and Compound

When money is deposited in a bank or building society account, it commonly attracts

That is the interest is £5

So the interest rate is 3%.

V = £1200 + ( 4 / 100 ) x £1200

1.04 × £1297.92 = £1349.84

$ 250.00 * 1.09 = $ 272.50

r % to a sum of money corresponds to multiplying by ( 1 + r / 100 ) will be multiplied by ( 1 + r/100 ).

The total amount , by the end of time T will be

What amount will you have to pay back?

(a) Value = £1200 × ( 1 – 20 / 100 )2

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