The interest banks pay on deposits is calculated in a fairly complicated manner, so we will start by considering a personal loan to a friend or relative. When you make such a loan, you agree on an amount of the loan (called the principal) and an interest rate. The interest rate is a percentage of the loan amount your friend agrees to pay you for every year she keeps your money. This is called simple interest.
Example. If you loan a friend $1000 and she agrees to pay you simple interest of 5% per year, then for each year she keeps your money you should receive receive an interest payment of
5 | ||
5% $1000 = | $1000 = $50. | |
100 |
If you agree to let her keep the money for 3 years and she agrees to pay back your loan plus all of the interest at that time, then you expect to receive
$1000 + 3 .05 $1000 = $1000 + $150 = $1150
after 3 years elapse.
Problem: Jane loans John $250 for 5 years. At the end of 5 years, John pays Jane $287.50. Assuming this represents the total principal and simple interest on her $250 loan, what rate did he pay?
Solution: To see the solution, open up this pop-up window.
© 1997,1998 Robby Robson, Oregon State University.
Last Modified: 11/27/2024 23:32:21