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If you have extra money you can invest it in a bank, building
society or government bonds, for example, and this investment will earn
money for you.
The sum of money invested is called the principal. We often
denote the principal by P. The money earned by the principal is
called the interest and it is earned at a rate known as the interest
rate. Interest is often represented by I and the interest
rate by r.
There are many ways in which interest is calculated and paid. The
simplest of the methods used is called simple interest.
Let us consider an example of an investment on simple interest terms of
$100 invested for 3 years at 10% per annum (p.a.).
The investor also gets the principal of $100 back at the end of the
third year.
Note that we could have calculated the interest, I, as follows:
In general:
If $P is invested at the rate of r per annum for t
years, then the total (simple) interest, $I, earned is given by
I = Prt
Example 15
Solution:
Note:
Both r and t need to be expressed in the same units. So,
if the rate is measured in per cent per annum (i.e. annually), then the
time needs to be measured in years.
Key Terms
principal, interest, interest
rate, simple interest, simple
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