Interest rates are applied to borrowed items. Common borrowed items with Interest rates applied are cash, accounts, vehicles, and buildings. Another term for interest rate is lease rate. (Investopedia.com)
The I.R. is supposed to cover the risk. It is the charge for the use of the item borrowed. I.R. is described as compensation of a loss of opportunity.
The rate is divided into a period of time. The unit rate is set according to the lender. The time is usually annually, or yearly. There are formulas.
Simple Interest - Principal x Rate x Time
Compound Interest - Principal (1 + Interest)^Time
Let's look at some examples.
1) Aunt Sally has $100 in her bank. After one year, she has withdrawn a total of $20 and she still has $85 in the bank. What is the yearly interest rate of her bank account?
Answer: 6.25%
Explanation: Since Sally has withdrawn $20, that means she only has $80 in her account.
80 + 80x = 85
80x = 5
x = 5 / 80
x = 0.0625
6.25%
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2) If an entrepreneur borrows $200,000 at an interest rate of 6% compounded annually, when she profits in 4 years, how much money will she owe? Round to the nearest dollar.
Answer: $252,495
Explanation: A = P(1+r)^t
A is the amount of money owed,
P is the sum borrowed,
r is the yearly interest rate,
n is the amount of times the interest is compounded per year, and
t is the number of years.
A = $200,000 (1+0.061)^4
A = $252,495
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3) Dillon borrows $200,000 at an interest rate of 6% compounded quarterly, when she graduates in 4 years how much money will she owe? Round to the nearest dollar.
3) Dillon borrows $200,000 at an interest rate of 6% compounded quarterly, when she graduates in 4 years how much money will she owe? Round to the nearest dollar.
Answer: $253,797
Explanation: A = P(1+r)^t
P = $200,000
r = 6% =0.06
t = 4
A = $200,000 (1+0.064)^4
A = $253,797
I.R. (interest rate) is the amount charged by a lender toward a debt in a percentage.
