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Sept 30

# Sept 30 - ORIE 3150 Time Value of Money Interest is the...

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ORIE 3150 Time Value of Money Interest is the cost of borrowing money or the return from lending money. If you lend someone \$5 today and you receive \$6 one year from now, the difference of \$1 represents the interest paid on the account borrowed. Interest rates are usually stated as annual rates. If you borrow \$100 from the bank at 6% per annum (per year), you must pay the bank \$100 + \$6 (0.06 x \$100) or a total of \$106 at the end of the year. The interest rate applicable in an economic transaction is affected by the perceived risk or probability of non-payment in the transaction. A bank may lend money to a low risk customer at 7.5%, but a high risk person may have to borrow money at the pawn shop at 36% or more. Simple Interest . Simple interest is interest earned only on the original principal. The formula for calculating simple interest is n i P I × × = Where I = simple interest P = principal (amount borrowed or lent) i = interest rate per year n = number of years or fraction thereof Compound Interest Compound interest is interest that is earned on both principal and interest. When interest is compounded, interest is earned on the original principal and on the interest accumulated for the preceding periods.

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