INTEREST-A REWARD FOR ONE BUT AN OBLIGATION FOR ANOTHER

As per the heading ,the concept of 'interest' can be explained under two different aspects:

The first aspect can be considered favourable as it will represent 'interest' as a Reward.

The second aspect can be considered unfavourable as it will represent 'interest' as a compulsory obligation*

*Compulsory obligation represents a liability.

The concept of interest plays its role when the money is used as Medium of loan or a grant.

Here two parties are involved -Lender,who gives his money as a loan and receiver who acquires the  money.

Interest represents the percentage of principal amount of money taken as loan.
In today's business environment there is nothing free of cost i.e there is always a consideration for a benefit.

Here it must be noted that a lender or receiver may be an institution also.

Let's understand this concept with an illustration:

You as a business owner (receiver) took a loan of INR 2500000 from a financial institution (lender) at 1% rate of interest per month.

Therefore, according to it monthly interest will be INR 25000(2500000*1/100)
 Here it must be noted that interest amount does not include any part of principle amount i.e the amount of borrowing (or loan)will be the same.

But with the mutual concent of both the parties there may be a provision under which interest may include some part of principle amount so that the burden of loan get reduced to some extent.For example interest amount may be INR 30000(25000+5000) so next interest will be calculated on INR 2495000(2500000-5000).
Here INR 5000 is part of principle amount.

There is one more point that we should consider is that in case of arrears (i.e non payment of interest)
the interest will be calculated on loan amount + interest due.
If in above mentioned illustration there is non payment of interest for one month then on next month interest will be calculated as:

1% of 2525000(2500000+25000)=INR 25250

In this illustration 'interest' is considered as an obligation from your side.

Now let's understand it as a reward:

For example you as an investor invested your money on various marketable securities like bonds.
Here you are giving your idle money which can be utilised for other purposes.
Suppose you invested INR 50000 on fixed income securities like 10% government bonds
Therefore interest=INR 5000
Hence interest becomes a reward for you.

ASCERTAINING THE FUTURE VALUE

In the modern scenario where there is always uncertainty in the environment, it's very important for the people to save some part of their income i.e to facilitate savings.But savings will only be useful when it maintains the value of money.


Now the question arises what's the value of money??

Money value for a person refers to his purchasing power i.e. how much purchase he can make with his given income.

For example:If there is inflation in the economy i.e prices of commodities increases but the income remains same so the purchasing power of people decreases as the value of money decreases and in case of deflation the prices of commodities decreases and as a result purchasing power increases.


In order to combat such situations a new concept called 'investments' was developed in which a person uses his idle money in various securities or funds so that a reasonable interest can be gained.


As an investor every person wants to know the future value of his investment in a particular time period which influences his decision of investing.

Let's take an example:Assume a common consumer wants to use his savings of INR 10000 in a fixed interest securities so that he doesn't have to bear the market risks.It is known as conservative investment i.e fixed return with zero risk. For ascertaining the future value(FV) we must have 3 important information:

(1) amount of investment i.e present value(PV)

(2) rate of interest on investment(i)

(3) Time period for which the amount is invested(n)


It can be represented by following formula:

Lets understand it with an illustration:

Suppose the person invested INR 10000 in a 12% government securities for a period of 2 years

Now the future value will be:


FV=PV *(1+i)^n


=10000*(1+0.12)^2

=INR 12544


Therefore, future value will be INR 12544


Here it must be noted that a person invests it's amount only when he gets the benefit of 'compounding'.


Compounding means earning interest on interest earned.

In the above illustration if interest is calculated separately then for the first year interest will be INR 1200(10000*12%)

and for the second year interest will be INR 1344[(10000+1200)*12%].

Total interest:INR 2544(1200+1344)

VALUE AFTER 2 YEARS=INR 12544(10000+2544)