Interest

Definition

Interest is the cost of borrowing money, typically expressed as a percentage of the principal amount. It can also be seen as the return on investment for money that is lent or invested over time.

5 Must Know Facts For Your Next Test

1. Simple interest is calculated using the formula I = PRT, where P is principal, R is the rate, and T is time.
2. Compound interest involves calculating interest on both the initial principal and any accumulated interest from previous periods.
3. The future value of an investment or loan with compound interest can be found using FV = PV(1 + r/n)^(nt), where PV is present value, r is annual interest rate, n is number of compounding periods per year, and t is time in years.
4. The concept of discounting future cash flows to present value relies heavily on understanding how interest impacts the time value of money.
5. Higher interest rates generally lead to a higher future value for savings but increase the cost of borrowing.

Review Questions

• What formula would you use to calculate simple interest?
• How does compound interest differ from simple interest?
• Why are higher interest rates significant in finance?

Related terms

Principal: The original sum of money borrowed or invested before any interest.

Compound Interest: Interest calculated on both the initial principal and also on the accumulated interest from previous periods.

Present Value (PV): The current worth of a future sum of money given a specified rate of return.