Question

All other factors being equal, both the simple interest and the compound interest methods will generate the same amount of earned interest by the end of the first year, if annual compounding is used for the compound interest method

true or false

Answer 1

The given statement is true.

The interest for the first year will be same in case of simple interest and compound interest methods when annual compounding is used.

Let us see through the following example :

Simple Interest method :

Let, Principal(P) = $1000, rate of interest per year(R) = 10%, time period(T) is 1 year

Interest = PTR => 1000 * 10% * 1 => $100

Compound Interest method :

Interest for the above data with compounding on annual basis = P * [(1+r)ⁿ - 1]

=> 1000 * [(1+0.10)¹ - 1]

=> 1000 * [1.10 - 1]

=> 1000 * 0.10

=> $100

As seen from the above, the interest for the first year will be the same in both the methods when compounding is on annual basis.