Banks like having money deposited with them because they can use the money to do their business.
To encourage people to invest money with them they pay out interest to the people who deposit money with them. There are two types of interest, simple interest and compound interest. This year we will look at simple interest and next year we will look at compound interest.
Banks are also happy to loan out money to people (if they trust that they will get it back). But they charge interest to the borrowers. In order for the bank to make money, the interest they charge will always be higher than the interest they pay on money that is deposited. This interest can also be simple or compound.
For any question involving loans or savings, we use the following variables:
P – principal. This is the amount invested or borrowed;
R – rate of interest. So if the rate of interest is 8%, then R=8;
T – number of years (a measure of time). So if the money is invested from 2 years, T=2.
Based on the above variables we can use the following formula to calculate the amount of interest that a deposit will receive or the amount of interest that will need to be paid on a loan.
Always take care when reading a question to see if you are being asked about the interest earned or the final total amount (which would be P+I)
Let’s complete the following exercise, 16H, from pages 273 and 274 of the textbook:
The answers are below: