Give five examples showing how different factors affect interest rate calculations

What will be an ideal response?

To determine the interest rate, one compares the interest paid with the amount borrowed: (1) The payback period is important. If you borrow $10,000 and repay that amount plus $1000 at the end of the year, the interest rate is 10% (i = $1000/$10,000 = 10%). (2) In some cases a lender will discount the interest payment at the time the loan is made, so the borrower would pay the $1000 interest in advance and receive the remaining $9000 for an 11% rate of interest (i = $1000/$9000 = 11%). (3) In other cases the financial institution uses a 360-day year instead of 365 days to calculate the interest rate, because it is simpler to calculate monthly rates (twelve 30-day months), but this does reduce interest paid. (4) If the loan is paid back in installments, the process becomes more complicated because on average the borrower had only half the loan for the full year (i = $1000/$5000 = 20%). (5) The compounding of interest also affects the calculation. If the interest payment is added on to the deposit as it is earned, then the new amount plus the interest payment earns interest. Compound interest on deposits is effectively more than simple interest. The more often the interest payment is made and compounded, the higher effective rate of interest will be.