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Definition of Terms: What Comes in Your Mind When You See A Bank?

Lovely invested PHP 1,000 at a 5% simple interest rate for 5 years, earning PHP 250 in interest for a total of PHP 1,250. Lorraine invested PHP 1,000 at a 5% compound interest rate annually for 5 years, earning PHP 276.29 in interest for a total of PHP 1,276.29. Compound interest results in higher earnings than simple interest because with compound interest, interest is added to the principal each period so interest is earned on both the principal and previous interest amounts.

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Cindy Bonono
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205 views

Definition of Terms: What Comes in Your Mind When You See A Bank?

Lovely invested PHP 1,000 at a 5% simple interest rate for 5 years, earning PHP 250 in interest for a total of PHP 1,250. Lorraine invested PHP 1,000 at a 5% compound interest rate annually for 5 years, earning PHP 276.29 in interest for a total of PHP 1,276.29. Compound interest results in higher earnings than simple interest because with compound interest, interest is added to the principal each period so interest is earned on both the principal and previous interest amounts.

Uploaded by

Cindy Bonono
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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ILLUSTRATING SIMPLE AND COMPOUND INTEREST

What comes in your mind when you see a bank?

_________________________________

Basic Concepts
Almost everyday money is borrowed and loaned in thousands of transactions
amounting, in total, to hundreds of millions of pesos. A bank is a financial
institution which is involved in borrowing and lending money. Banks take
customer deposits in return for paying customers an annual interest payment. The
bank then uses the majority of these deposits to lend to other customers for a
variety of loans.
Borrowing and lending are two sides of the same transaction. To the lender
loan represents an investment in a debt obligation. The interest charged provides
income form the investment. The rate of return on the investment is equal to the
rate of interest charged to the customer.
In view of the fact that borrowing and lending are so central to our daily
lives and in the economic system, it is essential to familiarize with the definition of
terms and learn the computation of interest in borrowing/lending transactions.

Definition of Terms
 Debtor or Maker – an individual or institution that borrows money for any
purpose
 Lender –an individual or financial institution which loans the money
 Interest (I) – the payment for the use of borrowed money or the amount
earned on invested money
 Principal (P) – the capital or sum of money borrowed or invested
 Rate of Interest (r) – this is a fractional part of the principal that is paid on
the loan or investment which is usually expressed as percent
 Time (t) – the number of years for which money is borrowed or invested
 Maturity Value or Future Value (F) – the sum of the principal and the
interest accumulated over a certain period
To illustrate the difference between simple and compound interest, and better
understand the concept of compound interest, consider the following example.
Lovely and Lorainne have Php 1, 000.00 each. Lovely lent her money to a
friend who agreed to pay her back after 5 years with 5% simple interest. Lorraine,
on the other hand, deposited her money to a savings account and left it there for 5
years to earn 5% compounded annually.

Guide Questions:
1. Who do you think will earn higher after 5 years?

2. How much is their money’s worth after 5 years?

The chart below shows how the simple and compound interests are computed.
Lovely’s investment at 5% simple interest Lorainne’s investment at 5% compounded annually
Time Simple Time Compound
Maturity Value Interest (Is) Maturity Value Interest (Ic)
(t) (t)
0 =Php 1,000.00 0 0 =Php 1,000.00 0
=1,000 + 1,000 (0.05) (1) =1,000 + 1,000 (0.05) (1)
1 =1,000 + 50 1 =1,000 + 50
=1,050.00 Php 50.00 =1,050.00 Php 50.00
=1,000 + 1,000 (0.05) (2)
=1,050 + 1,050 (0.05) (1)
=1,000 + 1,000 (0.1)
2 2 =1,050 + 52.50
=1,000 + 100
Php 100.00 =1,102.50 Php 102.50
=1,100.00
=1,000 + 1,000 (0.05) (3)
=1,102.50 + 1,102.50 (0.05) (1)
=1,000 + 1,000 (0.15)
3 3 =1,102.50 + 55.13
=1,000 + 150
Php 150.00 =1,157.63 Php 157.63
=1,150.00
=1,000 + 1,000 (0.05) (4)
=1,157.63 + 1,157.63 (0.05) (1)
=1,000 + 1,000(0.2)
4 4 =1,157.63 + 57.88
=1,000 + 200
=1,200.00 Php 200.00 =1,215.51 Php 215.51
=1,000 + 1,000 (.005) (5)
=1,215.51 + 1,215.51 (0.05) (1)
=1,000 + 1,000 (0.25)
5 5 =1,215.51 + 60.78
=1,000 + 250 Php 276.29
Php 250.00 =1,276.29
=1,250.00
Questions:
1. How much money will Lovely have after 5 years? How much interest she
gained?

2. How much money will Lorainne have after 5 years? How much interest
she gained?

3. What have you noticed with the computation?

Think of It
With simple interest, interest stays the same as time passes. With compound
interest, interest grows as time passes because previous interest is compounded or
added to the principal to earn interest. The principal continuously changes during
the time period.

Bear in Mind
Compound interest is higher than simple interest when principal, rate and time
are the same. However, when the interest is only compounded for one period,
say 1 year, the compound interest and the simple interest are the same.

We have seen the difference between simple and compound interest using
computation. This time, let us study the comparison of facts underlying between
simple and compound interests.
How do you find the comparison? Can you distinguish now between simple
and compound interests?

Enhancement Exercise 1.1

A. Illustrate the given situation below:


1. Gazini is planning to invest her separation fee from her working company after
she resigned as Payroll Supervisor. She received Php 230,000.00 and plan to
invest it for 5 years. Which investment is better? A bank offers 7.5% simple
interest a year or a lending company offers 7.5% compounded annually?
2. Bea Patricia wants her Php 35,700.00 to gain more when she used to invest it for
3 years. She is looking for a bank with best offers and services. Will she go for
ABC Bank offering 4.25% simple interest rate per year or XYZ Bank offering
4.35% compounded annually? Justify your answer.
B. Write SI if the statement below refers to simple interest and CI if compound
interest.
1. The product of principal, rate and time.
2. It is useful for investing since it allows the fund to grow at a faster rate.
3. Most of the car loans calculated based on it.
4. Computation is very easy and easy to understand.
5. Interest is charged on the principal and the interest amount.
6. Principal and interest growth is rapid and increases at a fast pace.
7. The principal keeps on changing due to the addition of accrued interest in
the entire period.
8. The principal is constant.
9. It offers a comparatively high return to the lenders.
10. It is the interest which is a percentage of both principal and accrued
interest.

The Philippines isn’t the only country that uses peso as a


currency.
In 16th century, the Spanish peso had a value of eight pieces of real, the Spanish
Empire’s currency. Because of this, most of the colonies of the Spanish empire
adapted the currency, despite some countries discarding it. As of the moment,
Argentina, Chile, Colombia, Cuba, Dominican Republic, Mexico, the Philippines, and
Uruguay still use the peso.

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