Overview

Interest rate is the rate at which borrowers need to pay back to the lender of debt. It is usually expressed as a percentage of the principal. Interest rate is directly related to the amount of risk associated with the borrower because the lender could have invested the amount instead of lending it to the borrower. Interest rates can be applied over different time periods, for example monthly, quarterly, or bi-annually. Generally speaking, most interest rates are annualized (i.e. applied over one year of time). There are two types of interest rates for borrowing money:

Simple Interest: calculated based on the principal amount of loan. Simple Interest = Principal x Interest Rate x Term of the Loan

Compound Interest: calculated based on the accumulated interest over the compounding period. Compound Interest = P(1+i)^n - P

Where:

P = Principal amount

i = Annual interest rate

n = Number of compounding periods in a year

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