Simple interest is paid only on the _.
A. Principal Borrowed
B. Outstanding Balance
C. Projected Balance
The Correct Answer and Explanation is:
The correct answer is A. Principal Borrowed.
Explanation:
Simple interest is a method of calculating interest where the interest is paid only on the principal borrowed throughout the term of the loan or investment. In simple interest, the interest does not compound, meaning it is calculated only on the initial amount (the principal) that was borrowed or invested, and it remains the same for the duration of the agreement.
How Simple Interest Works:
Simple interest is calculated using the following formula:
[
I = P \times r \times t
]
Where:
- (I) is the interest.
- (P) is the principal (the original amount of money borrowed or invested).
- (r) is the annual interest rate (expressed as a decimal).
- (t) is the time for which the money is borrowed or invested, typically in years.
For example, if a borrower takes out a loan of $1,000 at an interest rate of 5% per year for 3 years, the interest will be calculated as follows:
[
I = 1000 \times 0.05 \times 3 = 150
]
Thus, over the 3 years, the borrower will pay $150 in interest, and the total amount to be repaid will be $1,150 ($1,000 principal + $150 interest). This calculation assumes that the interest is not added to the principal and does not change over time, as it would in compound interest.
Why It’s Not the Outstanding or Projected Balance:
- Outstanding Balance (B) refers to the amount that the borrower still owes at any point in time. In compound interest, the interest is calculated on the outstanding balance, but in simple interest, it is calculated only on the initial principal, regardless of any payments made or changes in the balance.
- Projected Balance (C) refers to the estimated amount at a future date, including potential interest or changes in principal. However, in the context of simple interest, the interest does not depend on future projections but remains based solely on the original principal.
Thus, A. Principal Borrowed is the correct answer because simple interest is applied only to the initial amount of money borrowed.