SIMPLE INTEREST

Introduction

Interest can be defined as :

a. extra money earned when certain amount of money is invested / deposited.

b. extra money paid when certain amount of money is borrowed.

Islamic banking system vs. secular banking system;

The major difference:

Islamic banking system is based on the profit sharing method (which is calculated
based on the actual performance of the bank), whereas
the secular banking system is based on the fixed interest rate (which is calculated
based on the prediction performance).

Basically there are two types of interest :

a. simple interest

b. compound interest

Formula

Simple interest

At simple interest, the interest is computed on the original principal during the whole
time, or term of the loan, at the stated annual rate of interest.

The simple interest, I on principal P for t years at annual rate r is given by

I = Prt

where :
I : simple interest
P : principal / original amount of money borrowed or invested
r : interest rate per year
t : term or period in years

Simple interest is used primarily for short term loans and investments.

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Example 1 :

a) Ali invested RM5,000 in a bank for three years, earning a simple interest rate of
7.5 % a year. Find the simple interest earned. (RM1,125)

Solutions :

b) Fiona borrowed some money for 18 months at 12 % simple interest per year. If
she paid RM1,530 in interest, how much did she borrow ? (RM8,500)

Solutions :

c) At what rate of simple interest will RM1,200 accumulate interest of RM72

in 6 months? (12 %)

Solutions :

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Maturity value / Simple amount (S)

When a loan is repaid, the borrower pays the principal plus interest. This sum is called
the amount or maturity value, S.

S= Original principal + Interest

S= P + I
S= P + Prt
S= P ( 1 + rt )

Example 2 :

a) A sum of RM20,000 is invested for 6 years 9 months in a bank earning a simple

interest rate of 4 % per annum. Find the simple amount and the interest earned at
the end of the investment period. (RM25,400, RM5,400)

Solutions :

b) A sum of RM10,800 is deposited in a bank earnings simple interest of 3.5 % per

year. Find the amount in the account after 9 months. (RM11,083.50)

Solutions :

c) Ms. Lynn deposited RM7,500 in a bank. After 10 years, her deposit became
RM11,250. Find the rate of interest given. (5 %)

Solutions :

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d) Adam deposited RM4,500 in a bank earnings simple interest of 6.5 %. After 2
years, he deposited another amount of RM3,300 in the same account. Find the
accumulated amount and the total interest after 5 years. (RM9,906,RM2,106)

Solutions :

e) Mariana needed some money to start up her bakery. She borrowed RM12,000
for 30 months and paid back RM14,250 at the end of the loan period. What was
the interest rate ? (7.5 %)

Solutions :

f) Samsul took out a RM30,000 construction loan to renovate a house. The loan
rate is 8.3 % simple interest per year and will be repaid back in six months.
How much is paid back ? (RM31,245)

Solutions :

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Present value

When an unknown principal is computed, this computation is often referred to as finding

the present value or present worth.

From S = P ( 1 + rt )

S
Present value, P = or P = S (1 + rt) -1
1 + rt

Example 3 :

a) Find the present value at 9 % simple interest of a debt RM5,000 due in four months.
(RM4,854.37)

Solutions :

b) The amount in an account which was opened 180 days ago is RM205. If the account
was offered a simple interest of 5 % per annum, find the original principal.
(RM200)

Solutions :

c) Compute the present value of RM1,000 due in three months with interest at 6 %
annually. (RM985.22)

Solutions :

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Four Basic Concepts of Daily Interest

Some times the time period of a loan is indicated by the beginning date and the due
date. In the calculation of number of days between the two given dates, we have two
concepts :

1. Exact time - it is the exact number of days between two given dates.

2. Approximate time - it assumes a month has 30 days.

If the time period of the loan is in term of days, then using simple interest formula
requires that the rate ALSO be expressed as a rate per day. From the interest formula
I = Prt ,

1. Ordinary simple interest uses

given number of days
t =
360

2. Exact simple interest uses

given number of days
t =
365 or 366 days

There are four methods for computing simple interest between dates

a. exact time and ordinary simple interest - also called ‘ BANKER’S RULE ‘

b. exact time and exact simple interest

c. approximate time and ordinary simple interest

d. approximate time and exact simple interest

Example 4 :

Find the exact time and the approximate time for the following periods :

a) 12/ 1 / 2000 to 21/ 5 / 2000 b) 22/ 2 / 2001 to 3/ 9 / 2001

Solutions : Solutions :

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Example 5 :

a) On 4/1/02, Hakim deposited RM650 at 6 % interest. By Banker’s Rule, find the

amount in his account on 8/5/02. (RM663.43)

Solutions :

b) On 25/1/00, Halim deposited RM12,450 at 7 % interest. Find the amount in his

account on 20/7/00 if exact interest and approximate time was used to calculate
interest. (RM12,866.70)

Solutions :

c) RM720 was deposited in a bank. After 165 days, that was on 14/9/2003 the
account became RM733.66. By Banker’s rule, find the interest rate and the date
of deposit. (4.14 %, 2/4/2003)

Solutions :

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d) Madam Lau borrows RM1,000 for 220 days at 11.25 %. What amount must she
repay ? (RM1,068.75)
Solutions :

e) Find the ordinary interest on a RM100 loan at a 10 % simple interest rate from
July 4 to August 9. (RM1)

Solutions :

f) Eighty days after borrowing money, a person pays back exactly RM850. How
much was borrowed if the simple interest is 9 ¾ % ? (RM831.97)

Solutions :

g) How long will it take for RM500 to accumulate to at least RM560 at 13 ¼ %

ordinary simple interest? (327 days)

Solutions :