Banking

What is Simple Interest ?

Simple interest is calculated on the principal amount, or on that portion of the principal amount which
remains unpaid. Simple Interest is straightforward and does not take into account the effect of interest
on interest. It is typically easier to calculate.

Simple interest is an easy and quick method to calculate interest on money. With simple interest, the
interest is always applied to the original principal amount, using a fixed interest rate for each time
period of the loan. A loan is an agreement between a bank or financial institution and an individual who
borrows money to meet their needs, typically in exchange for a mortgage.

What is Compound interest ?

Compound interest is calculated on the initial principal, which also includes all the accumulated interest
from previous periods on a deposit or loan.
Compound interest, also known as compounding interest, is the interest on a loan or deposit calculated
based on both the initial principal amount and the accumulated interest from previous periods. It can
be thought of as "interest on interest," causing the sum to grow at a much faster rate.
Principal (P): The initial amount of money invested or loaned.

Rate of Interest (R): The percentage at which interest is charged or earned per time period, usually per
year.

Time (T): The duration for which the money is invested or borrowed, typically in years.

Amount (A): The total amount of money accumulated after interest is applied.

Formula:
Simple interest:

Formula for Simple Interest:

𝑃𝑃×𝑅𝑅×𝑇𝑇
𝑆𝑆𝑆𝑆 = 100

For eg. Suppose you invest $1000 at an annual interest rate of 5% for 3 years.
1000×5×3
Sol. 𝑆𝑆𝑆𝑆 = 100
= 150
So, the simple interest earned would be $150.

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Formula for Amount:

Amount = Principal + Simple interest
𝑃𝑃×𝑅𝑅×𝑇𝑇
Amount= 𝑃𝑃 + 100

For eg. John invests $5000 in a savings account that pays an annual interest rate of 4%. How much
money will he have after 3 years?

Sol. To find the amount John will have after 3 years, we need to calculate the simple interest first and
then add it to the principal amount.
Given:
• Principal amount (P) = $5000
• Rate of interest (R) = 4% per annum
• Time period (T) = 3 years
𝑃𝑃×𝑅𝑅×𝑇𝑇
𝑆𝑆𝑆𝑆 =100
5000×4×3
𝑆𝑆𝑆𝑆 = 100
= 240
Amount= 5000 + 240 = 5240

Compound Interest:

Formula for Compound Interest:

𝑅𝑅 𝑇𝑇
𝐶𝐶𝐶𝐶 = 𝑃𝑃(1 + ) − 𝑃𝑃
100

For eg. Suppose you invest $1000 at an annual interest rate of 5% compounded annually for 3 years.
5 3
Sol. 𝐴𝐴 = 1000 �1 + 100� = 1157.63
𝐶𝐶𝐶𝐶 = 1157.63 − 1000 = 157.63

Formula for Amount:

Amount = Principal + Compound interest
𝑅𝑅 𝑇𝑇
Amount= 𝑃𝑃 �1 + 100�

For eg. Sarah invests $8000 in a fixed deposit account that pays an annual interest rate of 6%,
compounded annually. How much money will she have after 5 years?

Sol. To find the amount Sarah will have after 5 years, we need to calculate the compound interest and
then add it to the principal amount.
Given:
• Principal amount (P) = $8000
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• Rate of interest (R) = 6% per annum

• Time period (T) = 5 years
6
Amount = 8000(1 + 100)5 = 10705.80
After 5 years, Sarah will have approximately $10,705.80 in her fixed deposit account.

NOTE:
1. First Year Interest Rate:
• In both compound interest and simple interest calculations, the interest rate for the first year is
the same.
• This is because both formulas use the initial rate PR/100 to calculate interest for the first year.
2. Subsequent Years - Compound Interest vs. Simple Interest:
• Compound Interest: After the first year, compound interest starts to accumulate on the initial
principal plus any interest that has already been earned.
o This means that each subsequent year, the interest is calculated on an increasing amount,
resulting in a larger interest amount compared to simple interest.
• Simple Interest: In contrast, simple interest only applies to the original principal amount (P)
throughout the entire period.
o The interest amount remains constant each year because it's calculated solely based on the
initial principal.

2 years CI/SI difference formula:

The formula for calculating the difference between Compound Interest (CI) and Simple Interest (SI) over
a period of 2 years is derived from the basic principles of interest calculations.
𝑅𝑅 2
𝐷𝐷 = 𝑃𝑃 �100�
Where:
• P is the Principal amount (initial investment or loan amount)
• R is the Rate of interest per annum

3-year CI SI difference formula:

The formula for calculating the difference between Compound Interest (CI) and Simple Interest (SI) over
a period of 3 years involves the principles of interest calculations, where compound interest
incorporates interest on interest over time.
Formula:
The difference between Compound Interest (CI) and Simple Interest (SI) for 3 years can be expressed
as:
𝑅𝑅 3 𝑅𝑅
Difference= 𝑃𝑃 ��100� × �100 + 3��
OR

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𝑅𝑅 3 3𝑅𝑅
Difference= 𝑃𝑃 ��1 + 100� − 1 − 100�

Compound interest Formula for Periodic Compounding Rate:

For periodic compounding, where the interest is compounded n times per year, the compound interest
formula adjusts accordingly to account for the more frequent compounding periods. Here's how you can
express the compound interest formula with periodic compounding:

Formula:
𝑟𝑟 𝑛𝑛𝑛𝑛
𝐴𝐴 = 𝑃𝑃 �1 + 𝑛𝑛�
Where:
• A is the amount of money accumulated after t years, including interest.
• P is the principal amount (the initial amount of money before interest).
• r is the annual nominal interest rate (decimal).
• n is the number of compounding periods per year.
• t is the time the money is invested for, in years.
Explanation:
• Annual Nominal Interest Rate (r): This is the stated annual interest rate.
• Number of Compounding Periods per Year (n): Indicates how many times the interest is
compounded within one year (e.g., quarterly compounding means n=, monthly compounding
means n=12).
• Time (t): The duration for which the money is invested or borrowed, typically in years.

Solved Examples:
1) If the principal is Rs.10000 and the rate of interest is 5% per annum for 2 years at simple interest,
then find the simple interest on this principal.
a) 1000
b) 1200
c) 1100
d) 1250
e) None of these
Answer:(a)
(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 × 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 × 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇)
Simple Interest = 100
where:
Principal = 𝑅𝑅𝑅𝑅. 10,000
Rate = 5% 𝑝𝑝𝑝𝑝𝑝𝑝 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎
Time = 2 𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦
(10,000 ×5 ×2)
Simple Interest = 100
= 𝑅𝑅𝑅𝑅. 1,000

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2) If the rate of interest is 6% per annum and the total simple interest after 5 years is Rs.9000, then
find the principal.
(a) 25000
(b) 24000
(c) 30000
(d) 28000
(e) None of these
Answer:(C)
(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 × 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 × 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇)
Simple Interest = 100
where:
Principal = 𝑅𝑅𝑅𝑅 𝑃𝑃
Rate = 6% 𝑝𝑝𝑝𝑝𝑝𝑝 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎
Time = 5 𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦
(𝑃𝑃× 6 ×5)
Simple Interest = 100
= 0.3𝑃𝑃
⇒ 9000=0.3P
⇒ P=30000

3) If the principal is Rs.10000 and the time for which this principal is invested is 3 years. If he gets
simple interest of Rs.1800 after 3 years, then find the rate of interest.
a) 6%
b) 5%
c) 4%
d) 7%
e) None of these
Answer:(a)
(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 × 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 × 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇)
Simple Interest = 100
where:
Principal = 𝑅𝑅𝑅𝑅. 10,000
Rate = 𝑅𝑅% 𝑝𝑝𝑝𝑝𝑝𝑝 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎
Time = 3 𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦
(10,000 × 𝑅𝑅 ×3)
Simple Interest = 100
⇒ 1800=300R
⇒ R= 6%

4) If the principal is Rs.20000 and the rate of interest is 10%. If the simple interest on this principal is
Rs.4000 on a certain period of time, then find the time period.
(a) 4 yrs
(b) 5 yrs
(c) 6 yrs

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(d) 2 yrs
(e) None of these
Answer: (d)
(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 × 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 × 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇)
Simple Interest = 100
where:
Principal = 𝑅𝑅𝑅𝑅. 20,000
Rate = 10% 𝑝𝑝𝑝𝑝𝑝𝑝 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎
Time = 𝑇𝑇 𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦
(20,000 × 𝑅𝑅 × 10)
Simple Interest = 100
⇒ 4000=2000T
⇒ T= 2 years

5) If the principal is Rs.20000 and the rate of interest is 10% per annum for 3 years at compound
interest, then find the compound interest on this principal.
(a) Rs. 6620
(b) Rs. 6500
(c) Rs. 5500
(d) Rs. 6200
(e) None of these
Answer:(a)
𝑟𝑟
A = 𝑃𝑃(1 + 100)𝑡𝑡
So;
P = 𝑅𝑅𝑅𝑅. 20,000, 𝑟𝑟 = 10% per annum, t = 3 𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦.
10 3
A = 20,000(1 + 100
)
A = 20,000(1.1)3
A = 26620
Compound interest = A - P
Compound interest = 26620 − 20000
Compound interest = 6620

6) The compound interest on Rs. 64000 invested at 12.5% per annum for a certain time is Rs. 8000.
The time is.
(a) 1 year
(b) 2 year
(c) 3 year
(d) 5 year
(e) None of these
Answer:(a)
Let the time be t

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Compound interest = amount - principal

12.5
8000 = [64000(1 + 100 )𝑡𝑡 - 64000]
9 9 𝑡𝑡
8
= �8�
t = 1 year

7) If the principal is Rs.30000 and the time for which this principal invested is 2 years. If he gets
compound interest of Rs.6300 after 2 years, then find the rate of interest.
(a) 7%
(b) 18%
(c) 15%
(d) 10%
(e) None of these
Answer:(d)
Compound interest
𝑅𝑅 2
= 30000 ��1 + 100� − 1�
𝑅𝑅 2
⇒ 6300 = 30000 ��1 + 100� − 1�
6300 𝑅𝑅 2
⇒ 30000 = �1 + 100� − 1
21 𝑅𝑅 2
⇒ �100� + 1 = �1 + 100�
11 2 𝑅𝑅 2
⇒ �10� = �1 + 100�
11 𝑅𝑅
⇒ 10 = 1 + 100
1 𝑅𝑅
⇒ 10 = 100
⇒ 𝑅𝑅 = 10%

8) Find the compound interest on Rs. 8000 at 50% per annum, for 2 years compounded half
yearly.(approx)
(a) Rs. 11531
(b) Rs. 10000
(c) Rs. 11500
(d) Rs. 11200
(e) None of these
Answer:(a)
According to question
50%
P = Rs. 8000, r = 2
half yearly = 25% half yearly
And n = 2×2 half years = 4 half years
𝑟𝑟 𝑛𝑛
C.I. = P��1 + 100� − 1�
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125 4
⇒ 8000��100� − 1�
5 4 625
⇒ 8000��4� − 1� = 8000�256 − 1�
369
⇒ 8000×256 ≈ Rs. 11531(approx)

Weightage of Simple and Compound interest:

The weightage of "SI/CI" questions can vary depending on the specific exam and the overall structure
of the test. Here's a general overview:

Importance and Weightage:

1. Quantitative Aptitude Section:
★ Frequency: "SI/CI” questions frequently appear in this section.
★ Weightage: Typically, you can expect 2-5 questions out of 35-50 in exams like IBPS PO, SBI PO,
RBI Grade B, and clerical exams.
2. Exam-Specific Insights:
★ IBPS PO: Often includes 2-3 "SI/CI" questions.
★ SBI PO: Similar pattern with 2-3 questions.
★ RBI Grade B: Can vary but usually includes a couple of questions.
★ Clerical Exams: Slightly fewer questions, around 1-2, but still important.

Previous year Simple and Compound Interest based Questions:

Q1. A sum of $5000 is invested at a simple interest rate of 8% per annum for 3 years. Calculate
the total amount accumulated after 3 years.

Q2. An amount of $10,000 is invested at a compound interest rate of 6% per annum,

compounded annually. Calculate the total amount accumulated after 2 years.

Q3. Mark took a loan of $12,000 at a compound interest rate of 10% per annum, compounded
annually. He repaid the loan after 2 years. Calculate the total amount Mark repaid and the
difference between compound interest and simple interest for the same period.

Q4. Jane deposits $8000 in a savings account that pays a simple interest rate of 5% per annum.
How much interest will Jane earn after 4 years?

Q5. Robert invests $10,000 in a fixed deposit at a compound interest rate of 8% per annum,
compounded annually. Calculate the amount Robert will have after 3 years.

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Q6. Sarah borrows $15,000 at a compound interest rate of 12% per annum, compounded semi-
annually. She repays the loan after 2 years. Calculate the total amount Sarah repays and the
difference between compound interest and simple interest for the same period

FAQS:

Q1. What is Simple Interest?

Ans. Simple Interest is a method of calculating interest where interest is only applied to the original
principal amount (P) over the entire period of the loan or investment.

Q2. In which scenarios is Simple Interest commonly used?

Ans. Simple Interest is typically used for short-term loans, like personal loans or short-term deposits,
where interest does not compound over time.

Q3. How does Simple Interest differ from Compound Interest?

Ans. Simple Interest only applies to the initial principal amount throughout the loan or investment
period, whereas Compound Interest includes interest on both the principal and the accumulated
interest from previous periods.

Q4. What is Compound Interest?

Ans. Compound Interest is a method of calculating interest where interest is calculated on the initial
principal amount as well as on the accumulated interest from previous periods.

Q5. What are some examples of Compound Interest in real-life applications?

Ans. Compound Interest is commonly used in investments such as savings accounts, fixed deposits,
mortgages, and long-term loans where interest is compounded regularly.

Q6. What are effective interest rates, and how are they calculated?
Ans. Effective interest rates take into account the effects of compounding and are calculated using the
formula:
𝑟𝑟 𝑛𝑛
Effective interest rate = �1 + 𝑛𝑛� − 1
Where RRR is the nominal annual interest rate and n is the number of compounding periods per
year.

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