F3 - Interest Rates

Question 1

Simple interest

Answer 1

Is the amount paid only on the original amount invested or borrowed

Question 2

Compound interest

Answer 2

The amount paid on the total amount when the interest is calculated

Question 3

What is the amount of interest payment based on?

Answer 3

The original amount you pay
The interest rate
The period of time on which the interest is calculated, known as the term

Question 4

What is the formula for calculating simple interest?

Answer 4

I = Prt

Where, 
I = is the interest 
P = is the principal (original amount)
r = is the interest rate [DECIMAL NOT %]
t = is the time, usually measured in years

Question 5

What is the simple interest when £1200 is invested for 5 years at 6%?

Answer 5

P = 1200
r = 0.06
t = 5

I = 1200 x 0.06 x 5 = £360

Question 6

An amount is invested for 3 years at 2%. An interest of £78 is earned.
Work out the principal amount.

Answer 6

I = 78
r = 0.02
t = 3

78 = P x 0.02 x 3 
P = 78/(0.02x3) = £1300

Question 7

What is the formula for calculating the amount accumulated using compound interest?

Answer 7

A = P(1+r)^t

Where;
A = the amount accumulated 
P = the principal 
r = the interest rate [DECIMAL NOT %]
t = the time, usually measured in years

Question 8

What is the final amount when compound interest is paid on £1200 for 5 years with an annual interest rate of 6%?

Answer 8

P = £1200 
r = 0.06
t = 5

A = 1200(1+0.06)^5 = 1200 x 1.06^5 = 1605.8706...
A = £1605.87

Total interest paid is £1605.87 - £1200 = £405.87

Question 9

What is ‘The rule of 72’?

Answer 9

The Rule of 72 gives an estimate of how long it will take (T) in years to double an investment that pays r% compound interest per annum.

T = 72/r

It is used in financial situations to give people an idea of how long it will take to double their money if they invest in a lump sum.

Question 10

Use the Rule of 72 to find approx how long it would take to double an investment of £100 with a compound interest of 3%

Answer 10

72 / 3 = 24

After 24 years an investment of £100 at 3%,
Compound interest = 100(1+0.03)^24 = £203.2794…

(23 years = £197.3586 ~ not quite double)

Question 11

What does AER stand for?

Answer 11

Annual Equivalent Rate

Question 12

What is the AER used for?

Answer 12

To compare the annual interest rates between savings where the interest is calculated over different periods.

Question 13

What is the formula for AER?

*YOU DO NOT NEED TO REMEMBER THIS, IT WILL BE GIVEN IN THE EXAM FORMULA BOOKLET

Answer 13

r = (1 + i )^n - 1
–
n

i = nominal interest as a decimal
n = number of compounding periods 

YOU DO NOT NEED TO REMEMBER THIS, IT WILL BE GIVEN IN THE EXAM FORMULA BOOKLET

Question 14

AER

Nominal rate of 7% paid monthly

Answer 14

7% x 12 = 84% annually

r = ( 1 + [0.84/12] ) ^12 - 1 = 1.07^12 - 1 = 2.252191… - 1 = 1.252191… = 125.22%