Key Terms

There are a variety of terms that you need to be familiar with when dealing with investments.

It is important to be able to identify these key terms when calculating simple and compound interest.

Complete these interactive problems.

Simple Interest

Simple interest is interest that is paid on only the principal of your investment for the number of years that you are investing.

Let’s take a look at an example.

Example

You have $4000.00 and are investing it in a Guaranteed Investment Certificate (GIC) that pays you a guaranteed return on your investment.

It pays 4% simple interest for 5 years.

How much interest will you earn and what is the amount of the investment at the end of the term?

Solution

To determine the amount of interest that your investment will earn we need to complete the following calculation:

The following video shows the solution to the example.

Question

What is the simple interest earned on $1000.00 that earns 6% interest for 10 years.

Question

What is the simple interest earned on $2500.00 that earns 3.5% interest for 24 months.

Question

What is the simple interest earned on $10 000.00 that earns 4% interest for 3.5 years.

Question

Determine the amount of the investment on $1000.00 that earns 6% simple interest for 10 years.

Question

Determine the amount of the investment on $2500 that earns 3.5% simple interest for 24 months.

Question

Determine the amount of the investment on $10 000.00 that earns 4% simple interest for 3.5 years.

Investigating Compound Interest

Let's look at the $4000.00 you invested in the GIC for simple interest but this time we will investigate how much interest will be earned if we are paid 4% interest per year compounded annually, for 5 years. Annually is the compounding period. The compounding period tells us when the interest is added to our investment.

In this case, the interest is added at the end of each year.

Note that the interest rate and term is exactly the same as the simple interest example.

Question

Determine the amount of interest and the total amount of the investment for the FIRST year only.

Question

Determine the amount of interest and the total amount of the investment for the SECOND year only.

The amount of the investment at the end of the second year is now the principal for the third year of the investment.

Working with Compound Interest

There are a variety of ways that we can calculate the amount of an investment and the interest earned when we are working with compound interest.

One of the easiest ways is to use a Time Value of Money Solver (TVM Solver) program that performs financial calculations.

This TVM Solver will be a good one for you to use.

The following video will help you learn how to use the TVM solver tool.

The compounding period will not always be annual. The compounded period can occur more frequently in one year which means that interest will be paid more frequently on the investment.

The following chart summarizes the most common compounding periods.

Using the TVM Solver Tool, determine the amount of the $4000.00 investment if the compounding period is changed to each of the following (assume the interest rate remains as 4%):

Semi-annually:
Answer

Quarterly:
Answer

Monthly:
Answer

Weekly:
Answer

Daily:
Answer

Using a tool like the TVM Solver Tool allows us to quickly determine the effect on the future value or amount if we change some conditions.

Try the following problems using the TVM Solver Tool.

Question

You invest $4000.00 at 4% compounded annually for 6 years. What is the future value of the investment and the total amount of interest earned?

Question

You invest $4000.00 at 5% compounded semi-annually for 5 years. What is the future value of the investment and the total amount of interest earned?

Question

You would like to have $6000.00 in 5 years. You can invest your money at 4% compounded quarterly. How much do you need to invest today (present value) to achieve this savings goal?

You can watch a video of the solutions for the problems above.

The Relationship Between Simple and Compound Interest

To see a graphical representation of the way the $4000.00 grows using simple interest and compound interest, use the interactive graphing tool provided below.

Fill in the principal, interest rate and time then click on the Calculate button.

Once you start earning money and saving your money, you may want to invest it to reach some short term or long term goals. Being knowledgeable about the ways that your investment earns interest can help you to make better financial decisions.