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Chapter 8: Problem 59

Describe the difference between simple and compound interest.

Short Answer

Expert verified
The main difference between simple and compound interest is that simple interest is calculated only on the initial amount of money (principal), while compound interest is calculated on the principal as well as on the accumulated interest of prior periods.

Step by step solution

01

Understanding Simple Interest

The concept of Simple Interest is straightforward. It is basically the interest calculated on the original principal amount (or the initial amount of money) throughout the term of the loan or deposit, regardless of the amount of interest that has already been added. Interest is added only on the original amount that was deposited or borrowed.
02

Understanding Compound Interest

Compound Interest, on the other hand, is calculated on the initial principal and also on the accumulated interest of previous periods of a deposit or loan. It means that the interest gets added to the original amount of money, and that new addition becomes part of the new principal on which the interest for the next period is calculated. In short, with Compound Interest, you earn or owe interest on not just the original amount but also on the interest that has already been added.
03

Highlighting the Difference

To summarise, the main difference between Simple Interest and Compound Interest lies in the fact that with Simple Interest, interest is only gained or paid on the original principal; whereas with Compound Interest, interest is gained or owed on the original principal as well as on the interest that has been added over time.

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Most popular questions from this chapter

In Exercises 1-10, a. Find the value of each annuity. Round to the nearest dollar b. Find the interest.$$ \begin{array}{|l|l|l|} \hline \begin{array}{l} \$ 1000 \text { at the end of } \\ \text { every three months } \end{array} & \begin{array}{l} 6.25 \% \text { compounded } \\ \text { quarterly } \end{array} & 6 \text { years } \\ \hline \end{array} $$

In terms of paying less in interest, which is more economical for a $$ 150,000\( mortgage: a 30 -year fixed-rate at \)8 \%\( or a 20 -year fixed-rate at \)7.5 \%$ ? How much is saved in interest?

In Exercises 11-18, a. Determine the periodic deposit. Round up to the nearest dollar. b. How much of the financial goal comes from deposits and how much comes from interest? $$ \begin{array}{|l|l|l|l|} \hline \$ \text { ? at the end of each month } & 7.25 \% \text { compounded monthly } & 40 \text { years } & \$ 1,000,000 \\ \hline \end{array} $$

In Exercises 1-10, a. Find the value of each annuity. Round to the nearest dollar b. Find the interest. $$ \begin{array}{|l|l|l|} \hline \begin{array}{l} \$ 150 \text { at the end of } \\ \text { every six months } \end{array} & \begin{array}{l} 6.5 \% \text { compounded } \\ \text { semiannually } \end{array} & 25 \text { years } \\ \hline \end{array} $$

How much should you deposit at the end of each month into an IRA that pays \(6.5 \%\) compounded monthly to have \(\$ 2\) million when you retire in 45 years? How much of the \(\$ 2\) million comes from interest?
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