The lending and borrowing of money involves the concept of simple interest and compound interest. If you borrow money for certain period of time, you would have to return the this sum of money (Principal) with some extra money. this extra money is called Interest.
The money borrowed is called principal. The sum of interest and principal is called the amount. The time for which money is borrowed is called period.
The rate of interest is as per annum (unless indicated).
Simple Interest
Simple interest is simply calculated on principal amount using the following formula:
where, P = principal, R = rate per annum, T = time in years
Amount can be calculated by adding interest to principal.
Compound Interest
When the borrower and the lender agree to fix up a certain unit of time (say yearly or half-yearly or quarterly) to settle the previous account. In such cases ,the amount after the first unit of time becomes the principal for the 2nd unit. The amount after second unit becomes the principal for the 3rd unit and so on. After a specified period, the difference between the amount and the money borrowed is called Compound Interest for that period.
Suppose you lend Rs.10000 (principal) for 3 years at 10% per annum. So, you will get Rs.1000 as interest per annum (simple interest) For three years, interest will be Rs.3000 and thus you will get total amount of Rs.13000.
Compound interest involves interest on interest too, thus will give you better amount after 3 years. While calculating the compound interest, the principal amount keeps changing year after year (if the interest is compounded annually).
After 1 year: Interest = Rs.1000; New Principal = Rs.11000After 2 years: Interest = Rs.1100; New Principal = 12100
After 3 years: Interest = Rs.1210; You get Rs.13310. So, there is gain of Rs.310 if you lend at compound interest!
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