Interest

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Interest

The amount the borrower pays the lender regularly at a particular rate for the use of money lent, or for delaying the repayment of a debt.

15c from, what one has a legal concern in, compensation for loss, interest damage, it is of importance it makes a difference. Financial sense of "money paid for the use of money lent" (1520s) earlier was distinguished from usury by being in reference to "compensation due from a defaulting debtor. Interest rate by 1959. [1]


Interest is calculated on the principal amount that a person borrows as a loan based on an interest rate. Interest can be calculated on the principal as a straight forward simple interest, or a little more complex compound interest.

Simple Interest

This is something like a flat rate that you pay on the balance amount of the loan. The monthly payments are distributed appropriately and go towards the principal and interest every month at a constant ratio. Interest for the next month is calculated solely based on the principal balance at that point of time and usually goes down gradually while the loan is being paid off.


Formula to calculate simple interest

Principal = P
Annual Rate of Interest = R (expressed as %, annual rate)
Time period = T (in number of years)
Interest per year = I

I = (P*T*R)

Compound Interest

This on the other hand is calculated on the sum of principal and also the interest amount accrued over a period of time until the next payment.

Example, a loan of $10,000 compounded annually at a rate of 10% interest for a term of 2 years would be

Year Balance
Now $10000
1 $10000 + (10*10000)/100 (total = $11000)
2 ($10000 + (10*10000)/100) + 10($10000 + (10*10000)/100) (total = $12100)

So the total interest that the borrower would have paid would be $2100 apart from the principal amount.

Formula for compound interest

Principal = P
Annual Rate of Interest = R (expressed as %, annual rate)
Time period = N (in number of years)
Interest per year = I

I = P*(1+R)^N

Purchase yield

An original investment in bonds, compounds automatically at the purchase yield only until the funds are paid back in the form of coupons and finally principal. If future investment rates during the life of the bond are less than the purchase yield, then the realized compound yield for the whole life of the bond will be less than the purchase yield. [1]

References

  1. Inside the Yield Book: The Classic That Created the Science of Bond Analysis, New Edition by Sidney Homer and Martin L. Leibowitz ISBN-10: 1576601595 pg21
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