ORIE 3150 class 11 (Oct 1st)

ORIE 3150 class 11 (Oct 1st) - ORIE 3150 October 1 2009...

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ORIE 3150 October 1, 2009 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 percentage rates. If you borrow \$100 from the bank at 6% per annum (per year), you must pay the bank \$100 + \$6 (with the \$6 coming from the calculation \$6 = 0.06 × \$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 Simple interest is not used too often in business. It is used for short term notes and for some bank loans. Most of the time, compound interest is used. 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. Ex. You borrow \$500 on January 1, 2000 at 10% interest, compounded annually. You pay the loan on Dec. 31, 2004. What will your total payment be? Year Principal Interest Total Payoff at End of Year 2000 \$500.00 \$50.00 \$550.00 2001 550.00 55.00 605.00 2002 605.00 60.50 665.50 2003 665.50 66.55 732.05 2004 732.05 73.21 805.26 Answer: You must pay \$805.26

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Interest can be compounded continuously, daily, monthly, quarterly, or semi-annually, or annually. We will focus on the latter four. Present and Future Value of Single Amounts
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ORIE 3150 class 11 (Oct 1st) - ORIE 3150 October 1 2009...

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