Home > Student Questions > A.1.83 student question re “simple interest”

A.1.83 student question re “simple interest”

November 18th, 2010

I received the following question:

When we are trying to find the value at time 4 for a $1000 cash flow at time 2, don’t we need to discount back to time 0 by dividing by 1.10, and then multiply by 1.2 since we are dealing with simple interest? Maybe I am not looking at it right, but I didn’t think that we could go directly from time 2 to time 4?

Here is my response:

There is a difference between saying

(1) interest is credited using a simple interest rate of 20% per year for t >= 4


(2) interest is credited at a force of interest

I know that is confusing since it appears that (2) implies simple interest of 20%, but really if it says “interest is credited using simple interest” in words then you treat every payment as if that happens at time 0. Really we should just say that simple interest doesn’t have an accumulation function. Instead you just take the amount multiply by the simple interest rate and that is the interest for every period.

James Student Questions

  1. No comments yet.
  1. No trackbacks yet.