Interest and Compound Interest? Why Is Knowing

¶ … interest and compound interest? Why is knowing the difference important? What is the formula for determining the future value of an amount? Why is a dollar today worth more than a dollar received in the future? First Student Response: Interest in financial terms is when your initial investment yields benefits. You invest an amount and a percentage of that basic investment turns into financial surplus. You gain funds through your investment. There are two types of interest: simple interest and complex interest (Buckelew).

Simple interest is when the amount gained does not change. There is a formula which goes I (interest) = P (principle) multiplied by r (rate of interest) and multiplied again by t (time). So the interest you get is based on the amount you put in, the rate of interest, and the time you leave your interest to grow. Compound interest is more complicated than this. In this form, interest is accrued not just on the principal but also on all the interest that has already been gathered.

Essentially, at the end of the period of the compound, the interest is added to the principal and sort of reinvested. Due to this, the interest from a compound interest investment will be far greater than one of simple interest. Knowing this difference is very important because it can impact your financial situation. For example, in investing your money in a bank account, you will receive simple interest. However, in other business transactions, such as in a loan or a credit account, the interest will be of the compound variety.

You will not only be paying interest on the principle you borrowed, but also on any interest that balance has accrued since the beginning of your loan. By using the formula already listed here, you can estimate the amount you will either receive or owe depending upon which side of the investment or loan you are on. The value of the things continually changes which is why a dollar today will be worth more than one in the future.

Second Student Response: There is something called the time value of money (Lane 2013). What this means is that a dollar you get today is more valuable than one you get another time because you can invest that dollar today which will then get interest from that investment. It might be worth one hundred times what it was when initially invested. However, if you get a dollar in the future, that dollar is only worth a single dollar.

Money increases in value over time, so long as it is invested in a reputable manner which provides genuine income. The amount you invest is very important, but so is the type of interest you are dealing with. Compound interest will provide a far higher financial yield than an investment with simple interest.

The reason for this is that while simple interest only pays out based upon the principle, the rate of interest, and the time you keep your money invested, compound interest also takes into account the amount of interest you have already earned. In this scenario, a dollar today invested with simple interest is less valuable than a dollar invested with compound interest. Understanding these terms allows you to make the most out of your money. Third Student Response: There is a big difference between simple interest and compound interest.

The difference is the way the interest is determined. The difference can be seen in the different formulas for determining the two types of interest. The formula for simple interest is I=Prt. This means your interest is found my multiplying principle, rate, and time (Simple 2013). The formula for compound interest is I=P (1+r) n. This means that interest is found by multiplying principle, the set of one more than the rate, and using time as the exponent.

The interest is added to the amount of the investment as opposed to simple interest where that is not a factor. Money invested in a compound interest formula will be more valuable after the same amount of time as money invested in a simple interest formula. This is where the idea that a dollar is worth more today than it will be in the future. If you invest something today, then you will be earning interest on it.

Only in this way is a dollar now different from a dollar sometime in the future. The longer you have something invested, the more it will be worth later on when you go to cash in on your investment. Part B: Reflect on what you have learned from this question. I have learned the difference between complex and simple interest.

Although I was already aware of the difference due both to mathematics and business classes, not to mention real-world experience with banks, credit cards, and loan agreements, this exercise allowed me to think more deeply about the ways in which such interest can seriously affect my life. This has, admittedly, not been something I have thought much about in the years that have gone by and I understand what a negative impact.