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Interest is the reward for use of capital. In other words, it is the charge paid for the use of borrowed money. It is paid to the lender by the borrower.

When money is borrowed, the borrower is called the debtor and the lender is called the creditor. The sum of money borrowed is called the principal. The time for which it is borrowed is called the time period and the sum returned by the borrower with interest is called the amount.

Symbolically, Α = P + I, where A = Amount, P = Principal, I = Interest


A rate of interest is paid for use of a certain sum of money for a certain time. The interest paid per hundred rupees per unit time period is called the rate of interest. It is generally given as rate of interest per year or per annum.


Example 5.1: If ₹8 is paid as interest on ₹100 for a year, then the rate of interest is said to be 8% per annum.


Interest has to be paid due to the following reasons:

  • To compensate for the decrease in value of money with time
  • To compensate the opportunity cost incurred by the lender
  • To compensate for rise in prices of goods and services due to inflation
  • To compensate for the risk involved if the lender is not getting his money back

Types of interest

If an amount of money is lent, interest accumulates at regular time intervals. Each time interval constitutes an interest period (also called “conversion period”). The interest earned on the original amount is calculated according to a specified rate of interest at the end of each interest period.

Two different types of interest can be calculated: Simple Interest (S.I.) and Compound Interest (C.I.).

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