INDEX

     

Basic concepts Simple interest Compound interest Nominal and effective rate of interest Present value Future value

BASIC CONCEPTS
    

Principal (P) :Time (t) :Interest (I) :Amount (A) :Rate of interest (r) :-

SIMPLE INTEREST
Interest computed on the principal for the entire period of borrowing.  Calculate on outstanding principal balance. formula :I = P*R*N Where, I = Interest in rupees P = Principal in rupees R = Rate of interest N = Number of years


Here, Amount = P+ I Where, p = principal amount I = interest

ILLUSTRATION - 1
Find simple interest on Rs.2500 at 6% p.a for 5 years? Solution Given: P = Rs.2500 R = 6% = 6/100 = 0.06 N = 5 years Therefore, I = P*N*R = 2500 * 0.06 * 5 I = Rs.750 A=P+I = 2500 + 750 A = Rs.3250

ILLUSTRATION - 2
An investor has option of investing in two investment schemes, scheme A and scheme B.Scheme B gives 2% more simple interest than scheme A. For a 3 year period interest earned on a sum in scheme B would be Rs.600 more than that earned in scheme A. Find interest rates offered in schemes A and B.

SOLUTION :Let, interest on A = r% Therefore, interest on scheme B = (r + 2)% Let Principal (P) = x t = 3 years Therefore interest earned in scheme A = xr3/100 = 3*r/100 Interest earned in scheme B = x(r+2)3/100 = 3*r + 6x/100 Difference between two interests : interest in scheme A interest in scheme B = 600

3*r + 6x/100 3*r/100 = 600 Therefore 3*r + 6x 3*r/100 = 600 Therefore 6x = 600000 Therefore x = 10000 Therefore P = principal = Rs. 10000

COMPOUND INTEREST
Interest earned on the principal amount.  Interest which is reinvested along with the principal amount.  Principal amount increases for the next time.  Most investments operate on principle of compound interest.


ILLUSTRATION - 1
Suppose Rs. 1000 are invested at compound interest of 5% p.a, for a period of two years. Find the amount of interest.  At the end of 1st year: I=P*r*n = 1000 * 5/100 * 1 = Rs 50.


For the 2nd year : The interest earned in the 1st year will be added to the principal. New P = P + I = 1000 + 50 New P = Rs 1050. Now interest earned in the 2nd year =P*r*n = 1050 * 5/100 * 1 = Rs 52.50


Therefore at the end of the 2nd year: Amount = A = 1050 + 52.5 Therefore A = 1102.5 Rs.
 1.

Various terms :

Compounded sum = Rs 1102.5 2. Compound interest = A P = 1102.5 1000 = 102.5rs 3. Conversion period = in the above Illustration, the conversion period is 1 year.

FORMULAE OF COMPOUND INTEREST



At the end of 1st year, I = P*r*t, Where t = 1 Therefore, I = Pr Therefore, A= P+ I A = P + Pr Therefore A = P(1 + r)

For the 2nd year Principal = P(1 + r) Interest = (P(1 + r))r.t = (P(1 + r))r, t=1 At the end of 2nd year, Amount = principal + interest = (P(1 + r)) + (P(1 + r)) = P(1 + r)^2 Similarly, at the end of 3rd year, Amount = P(1 + r)^3

At the end of n years, A = P(1 + r)^n  For multiple conversion periods in a single year A = P(1 + r/m)^m.n, where m = number of conversion periods


Illustrations 2 :
Compute the compound interest on Rs.4000 for one and a half years at 10% p.a compounded half yearly. Solution: here P = 4000 n = 1 1/2 years i.e 3 years r = 10% p.a i.e 5% (compounded half yearly) Now A = P(1 + r)^n = 4000(1 + 5%)^3


Therefore A = 4000(1+0.05)^3 A = 4630.50 The compound interest is therefore Rs.4630.50 4000 = Rs.630.50

Nominal and effective rate of interest

Nominal rate of interest : The normal rate of interest that is calculated on the principal amount annually. e.g r = 10%, P = 100rs then interest should be Rs.10 Hence nominal rate of interest is the normal interest taken on the principal amount once in a year.


Effective rate of interest : Effective rate of interest is the interest rate that is compounded more than once a year. The effective rate of interest exceeds the per annum interest rate, Eg : if u invest rs.100000 for a year at the rate of 6%p.a compounded semi-annually Effective rate of interest for a year will be more then 6%p.a since interest is being compounded more then once a year.


Interest for 1st 6 months = 100000 *6%*6/12 = Rs.3000 So principal for next 6 months = 100000 + 3000 = Rs.103000 Interest for next 6 months = 103000*6%*6/12 = Rs.3090 Therefore total interest earned = 3000 + 3090 = Rs.6090

Present value
Today's value of tomorrows money discounted at the interest rate.  Present value is a reciprocal of future value.  For e.g.:- you have invested rs1000 at 7%,you get rs1070 at the end of the year. Therefore rs1000 is your present value of tomorrows rs 1070 at 7%


We can also compute effective rate of interest by following formula I = PEn 6090=100000 x E x 1 Therefore, E = 6090/100000 i.e, E = 0.0609 or 6.09% Thus, effective interest rate will be more then actual interest rate if compounded more then once a year Actual interest rate = effective interest rate if compounded annually. Effective interest rate = (1 + r)^n 1 Where, r = rate of interest n = number of conversion period.

Future value
Future value is a cash value of an investment at some time in the future.  It is tomorrows value of today's money compounded at a certain rate of interest.  For e.g.:-you have invested rs1000 at 10%


Presented by :
       

Vicky Bhansali - 02 Sameer Jain 09 Sumit Jain 11 Aagam Shah 37 Jay Shah 41 Shahil Shah 49 Shashank Shah - 50 Nikhil Shand - 51

Thank You