1. Simple Interest
Let's start by exploring the concept of simple interest. Now, we don't see
simple interest very often in finance. But it's a great place to start
to introduce some terminology and start building some really important concepts.
Interest is the fee that a borrower pays a lender to borrow an
amount of money. The amount borrowed is called the principle. Now,
with simple interest, there is an initial principle amount, and the interest
payments are based on this amount. To calculate the interest payments,
take their simple interest rate, expressed as a percentage and multiply
this by the principle. With simple interest, the principle does not change
and so the interest payment remain constant. Say you borrow $100 today from
a bank which is charging you 5% simple interest per year,
the $100 is the principal, and the bank wants you to repay the
principal in the total simple interest after three years. The simple interest
each year is $100 multiplied by 5%, which of course is $5. So
at the end of the art, you need to repay the bank,
the principle of $100 plus the accumulated simple interest of 15
for a total of 115. I'm going to do this in Excel as a
bit of a warm up, and I'd really like it if you follow
along. So pause the video now, if you need to and download the
Excel workbook called Simple and Compound interest template, which you can
find in the download section for this course. And press play when you're
ready to continue. I've opened up the workbook called Simple and compound
interest template, and I've moved to the second sheet called Demo.
Now, I'm going to walk through the example that we just saw,
I'd really like it, if you tried this yourself as well,
and then you can do that in a number of different ways.
You can watch me walk through the example first, then try to replicate
it. You can have a go first and then watch me do it.
So maybe you want to pause, have a go and press play to
see how I would go about this, or you might just want to
work along with me by watching a snippet of video, pressing pause and
working along at the same speed. However you decide to do,
it is up to you, but I really encourage you to have a
go yourselves at this. So the example that we just saw,
we were borrowing 100 from the bank, so that principle is 100.
The simple interest rate was 5% per year, and the term was three
years. And remember in this example, which is a little bit unusual,
the bank wants us to repay the principle and all the interest,
the total interest after three years in one go.
So this is how I would complete the table, first of all,
I'm just going to reference the principle and sell G11. I'm just going
to bring it down there. Now then, the principal each year is going
to remain the same, it's still 100. So I'm going to reference the
principle again here, and I'm just going to this time press F4 to
absolutely reference that cell, so that they may not hold... The column
by holding down the shift and arrow down, Ctrl+D to fill down and
here is my principal at the start of each period or each year.
The simple interest or I can calculate by again, absolute referencing the
interest at 5% and then just multiply it by that principle.
Remember, the interest under the simple interest approach doesn't change,
it's the same each year. It's 5% of the principle of 100.
Now the total in just... Well, in E1, the title interest is simply
the year one interest, but in year two the total interest is the
interest from year one plus the interest from year too. All right. So,
there is the formula there. And then, because I've got the formula,
I can just again, select the column by holding down the shift and arrow
down, Ctrl+D to fill down. And you can see there that my total
interest under the simple interest approach at the end of the three is
15. So what's the total value? How much do I owe the bank
at the end of each year? Well, at the end year one,
I owe the bank the principle, and again, I'm just going to absolutely reference
there, 'cause I always have to repay the principal and then the total
interest at the end of year one which is five. So at the
end of year one, I owe the bank 105. And now,
that I've got that formula in, if I just slip the column and
Ctrl+D, you can see how much I owe at the end of year two, which
is 110. And at the end of year three, I owe the bank
115, the principal plus three years of simple interest, which is the same
numbers that we saw in the example before we open up our Excel
workbook.
2. Let's practice!