Question

What is interest? Define simple interest Define compound interest What are the differences between simple & compound Interest? What does the term equivalence mean in Engineering economic analysis? Be able to give examples that are NOT economic. . What are the similarities and differences between nominal and effective interest? What is continuous compounding, and how does it work? What is a compounding period? What is the usual (by convention)compounding period? What is frequency of compounding? How does it differ from compounding period? When compounding period and payment period differ, how do you proceed? Functional notation e.g. economic function notation [define it]

Answer 1

1. Finance: A fee paid for the use of another party's money. To the borrower it is the cost of renting money, to the lender the income from lending it.
Interest on all debt is normally deductible before taxes are assessed on a company's income. Corporate legislation requires disclosure of interest payable on loans, and companies often show a single interest figure in the income statement while providing details in a note that may also include netting out of interest received or some other adjustments. In cost accounting, interest is normally excluded from cost computations on the grounds that (being a payment for capital) it is equivalent to dividend, and hence is a finance item and not a cost item.
The rate of interest is usually expressed as an annual percentage of the principal, and is influenced by the money supply, fiscal policy, amount being borrowed, creditworthiness of the borrower, and rate of inflation. the two types of interest are simple interest and compound interest.

2. Definition of simple interest

: interest paid or computed on the original principal only of a loan or on the amount of an account

3. Define compound interest?

Here's an explanation that should make everything crystal clear:

When you take out a loan, interest is calculated for the first period (be it a month or a year). This interest is then added to the original total. Following on from that, the interest for the next period is calculated but is based on the gross figure from the first period. From there, well, you get the idea.

It does sound complicated. So, as it's often said a picture paints a thousand words, here's an illustration:

Compound interest example 1

Let's say you borrow $2,000 over a 3 year period, pay 10% annual interest on your debt and are not making regular repayments. In this case, the amount you will have to repay will look like this:

Year 1: $2,000 x 10% = $200.
Year 2: $2,200 x 10% = $220.
Year 3: $2,420 x 10% = $242.

The total repayment figure after 3 years is $2,662 (the $662 interest is the sum of each year's interest).

It should be noted that if you make regular repayments on your loan, the total compound interest will be lower because the remaining principal on the loan will be decreasing at each compound interval. We have a loan calculator if you want to try out some figures.

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