Interest rate in financial system

The interest rate is the amount a lender

charges a borrower and is a percentage
of the principal—the amount loaned.
.The interest rate on a loan is typically
noted on an annual basis known as the
annual percentage rate (APR).
 An interest rate refers to the amount charged by a
lender to a borrower for any form of debt given,
generally expressed as a percentage of the principal.
 The asset borrowed can be in the form of cash,
large assets such as vehicle or building, or just
consumer goods. In the case of larger assets, the
interest rate is commonly referred to as the “lease
rate.”
• An interest rate can also apply to the amount
earned at a bank or credit union from a
savings account or certificate of deposit (CD).
Annual percentage yield (APY) refers to the
interest earned on these deposit accounts.
• The interest rate is the amount charged on
top of the principal by a lender to a borrower
for the use of assets.
• An interest rate also applies to the amount
earned at a bank or credit union from a
deposit account.
• Most mortgages use simple interest.
However, some loans use compound
interest, which is applied to the
principal but also to the accumulated
interest of previous periods.
• A borrower that is considered low risk
by the lender will have a lower
interest rate. A loan that is considered
high risk will have a higher interest
rate.

Consumer loans typically use an APR, which does
not use compound interest.


The APY is the interest rate that is earned at a
bank or credit union from a savings account or CD.
Savings accounts and CDs use compounded
interest.

The interest rate is the amount charged on top of
the principal by a lender to a borrower for the use
of assets.


An interest rate also applies to the amount earned
at a bank or credit union from a deposit account.

Most mortgages use simple interest.
However, some loans use compound interest,
which is applied to the principal but also to
the accumulated interest of previous periods.


A borrower that is considered low risk by the
lender will have a lower interest rate. A loan
that is considered high risk will have a higher
interest rate.


Consumer loans typically use an APR, which
does not use compound interest.

The APY is the interest rate that is earned
at a bank or credit union from a savings
account or CD. Savings accounts and CDs
use compounded interest.
Compound interest (or compounding
interest) is the interest on a loan or deposit


calculated based on both the initial

principal and the accumulated interest
from previous periods. Thought to have
originated in 17th-century Italy, compound
interest can be thought of as "interest on
interest," and will make a sum grow at a
faster rate than simple interest, which is
calculated only on the principal amount.

The rate at which compound interest accrues depends on
the frequency of compounding, such that the higher the
number of compounding periods, the greater the compound
interest. Thus, the amount of compound interest accrued on
$100 compounded at 10% annually will be lower than that
on $100 compounded at 5% semi-annually over the same
time period.

Because the interest-on-interest effect can generate
increasingly positive returns based on the initial principal
amount, compounding has sometimes been referred to as
the "miracle of compound interest."

Simple interest accumulates only on
the principal balance, while compound
interest accrues to both the principal
balance and the accumulated interest.
Simple interest works in your favor
when you borrow money, while
compound interest is better for you as
an investor.
• Interest formulas mainly refer to the
formulas of simple and compound interests.
The simple interest (SI) is a type of interest that
is applied to the amount borrowed or invested
for the entire duration of the loan, without
taking any other factors into account, such as
past interest (paid or charged) or any other
financial considerations. Simple interest is
generally applied to short-term loans, usually
one year or less, that are administered by
financial companies. The same applies to
money invested for a similarly short period of
time. The simple interest rate is a ratio and is
typically expressed as a percentage.
• On the other hand, the compound interest
is the interest which is calculated on the
principal and the interest that is
accumulated over the previous tenure.
Thus, the compound interest (CI) is also
called “interest on interest”. It plays an
important role in determining the amount
of interest on a loan or investment. The
formulas for both the compound and
simple interest are given below.
• Interest Formulas for SI and CI
• The Interest formulas are given as,
Formulas for Interests (Simple and
Compound)

SI Formula S.I. = Principal × Rate × Time

C.I. = Principal (1 + Rate)Time −

CI Formula
Principal
• Question 1: A sum of Birr 4000 is borrowed and the rate is
7%. What is the simple and compound interest for 2 years?
• Solution:
Simple Interest = Principle × Rate × Time = PTR/100
⇒ Simple Interest = 4000 × (7 ⁄ 100) × 2
⇒ Simple Interest = 560
∴ The simple Interest for 2 years is birr 560
• Compound Interest = Principal × (1 + Rate)Time − Principal

So, Compound Interest = 4000 × (1 + 7 ⁄ 100)2

− 4000
• ⇒ Compound Interest = (4000 × 1.1449) −
4000
• ⇒ Compound Interest = 580
• ∴ The compound interest for 2 years is birr
580
• Question 2: A sum of birr. 25000 becomes birr.
30000 at the end of 4 years when calculated at
simple interest. Find the rate of interest.
• Solution:
Given,
Principal = P = birr. 25000
Time = T = 4 years
Amount at the end of 4 years = birr. 30000
SI = birr. 30000 – birr. 25000 = birr. 5000
SI = PTR / 100
⇒ R = SI × 100 / PT
⇒ R = 5000 × 100 /( 25000 × 4)
⇒ R = 5%
Hence, the rate of interest = 5%
• Question 3: Find the compound interest on birr.
13000 at 10% for 2 years, compounded annually.
• Solution:

Given,

Principal = P = birr.13000

Rate of interest = r = 10%

Time = t = 2 years

Amount on CI = P(1 + r/100)

2

= 13000(1 + 10/100)
2

= 13000 (1 + 0.1)

2

= 13000(1.1)

2

= 13000 × 1.21

= 15730

CI = Amount on CI – Principal

= birr. 15730 – birr. 13000

= birr. 2730

Therefore, the compound interest = birr. 2730
 The Time Value of Money
• the time value of money, money
that you have right now will be
worth more over time. So one
dollar now will be worth more
than a dollar in a year from now.
• The present value formula consists of the
present value and future value related to
compound interest. The present value or PV is
the initial amount (the amount invested, the
amount lent, the amount borrowed, etc). The
future value or FV is the final amount.
• i.e., FV = PV + interest.
• The present value formula is PV = FV/(1 + i) n

where PV = present value,

FV = future value,
i = decimalized interest rate, and
n = number of periods. ...
• The future value formula is FV = PV× (1 + i) .
n
Future Value
• how much money put in the bank today
will turn into at some point in the future with
the interest. You needs to know three things:
1. How much you has now
2. What the interest rate is
3. How many years you wants to put the
money away for
• Then you can use a formula to figure out
how much syou'll have at the end.
The formula is: FV = PV (1 + r)n
• In this formula,


PV is how much she has now, or the present
value


r equals the interest rate she will earn on the
money


n equals the number of periods she will put the
money away, and


FV equals how much she will have at the end, or
future value.
• Let's imagine that you puts $100 in the
bank for five years at five percent interest,
and plug that into the equation.
• FV = 100 (1 + 0.05)5
• FV = 100 * 1.2762
• FV = $127.62