Unit 7
Principles of Simple Interest

Interest is a fee paid for the use of money over time. Borrowing and lending are opposite sides of the same transaction, like getting financing and investing. The amount of the fee depends on the amount borrowed (the principal), the annual rate of interest charged, and the length of time the money is borrowed. Bank discount, which is sometimes referred to as interest in advance, also represents a fee paid for the use of money over time; however, whereas in simple interest the fee paid is a percentage of the original amount borrowed, in bank discount the fee is a percentage of the final amount owing.

The concepts of simple interest and bank discount provide the framework for more advanced topics, such as compound interest, annuities, perpetuities, and investment decision making, which we discuss in Units 8 to 12.

Note: Ensure that in this unit and the following you understand the concepts and what tools to apply to solve problems. It is not just plugging numbers into formulas. You must understand what the formulas do from a conceptual point of view to be successful in mastering and being able to apply them.

Objectives

After completing this unit, you should be able to perform the following tasks.

  1. Define “simple interest,” and solve problems involving this concept.
  2. Calculate any single variable—principal, interest rate, amount of interest, or time—given the other three.
  3. Define “amount,” “present value,” “maturity value,” and “equivalent value,” and solve problems involving these concepts.
  4. Explain the terminology used in the type of contract known as a “promissory note.”
  5. Distinguish between an interest bearing note and a non-interest bearing note, and calculate present and maturity values for such notes.
  6. Explain the process of discounting a promissory note, and calculate the proceeds of a discounted promissory note.
  7. Define “bank discount,” calculate the discount rate and proceeds for interest bearing and non-interest bearing notes, and calculate the maturity value of a loan, given the proceeds, the discount rate, and the period of discount.
  8. Explain the difference between simple interest and bank discount, and calculate one, given the other.