Introduction
Generally, interest is the cost of borrowing money, for instance, the interest charged on a loan balance by the bank or the lenders, depending on the loan circumstances. In contrast, interest can be defined as the rate charged for the deposited money. However, the mathematics of interest is correct; the custom of charging, computing, and disclosing is full of discrepancies and hence often controversial on ethical concerns. This paper examines some general use of interest, which must be corrected as unfair and illogical on the ethical ground. In addition, the paper will examine the use of interest using some theories, such as practical and formalist schools of ethical theories, that recognize them as inappropriate in public life. It also seeks to provide a detailed analysis of the similarities and differences between simple and compound interests from a broader way of ethics.
Simple Interest (SI)
Simple interest (SI) is the mathematical method used to compute the interest amount charged on a loan for the principal amount.SI is calculated by multiplying the outstanding principal by the daily interest rate by the number of days between payments. It means that simple interest is a fixed proportion of the principal figure of a loan. The formula for the calculation of simple interest is :( Principal (P)* Daily interest rate(r)*Number of days between payments (T) subjected to the outstanding interest so that the interest is paid off and the remaining amount goes to the remaining loan balance(Ambuehl et al., 2022). The approach benefits the borrowers who pay early since the interest paid is less, and the remaining amount is left to cater to a more significant proportion of the outstanding principal amount balance.
Contrary, suppose the payment of the loan is paid late. In that case, more of the loan payment goes towards paying off the interest, leaving an outstanding residual loan balance. Simple interest is oftenly applied for short-term loans that require an early offset. For instance, Makau took on a simple interest rate of $21,000, which attracts an annual interest rate of 3%. Makau decides to repay the loan in 5 years. The amount payable in 5 years would be calculated as follows: SI=p*r*n=$21,000*0.03*5=$3,150. Therefore the total amount of loan payable by Makau would be; principal + interest earned on laon=$21,000+$3,150=$24,150.
Compound Interest
Compound interest(CI) is a mathematical method used for interest on saving computed based on the initial principal and the accumulated interest from previous periods. Compound interest is calculated based on the outstanding principal and any interest accumulated in the previous periods. It is calculated based frequently on the year, such as on a monthly or half of the year or quarterly basis of the year. A greater degree of calculation based on higher periods results in a more rapid interest growth rate. It implies that the current interest is compounding interest.
In compound interest, the amount obtained after calculation exceeds the amount of money calculated by the simple interest because, in simple interest, the amount of money is obtained only from the amount of principal. The computation of interest using compound interest increases the interest on a personal loan since the next principal is obtained by adding the previous interest, which implies a greater degree of subsequent interest in the personal loan(Busch et al., 2022). The formula for the compound interest calculation is CI=[P(1+i)^n-P]; Where P=outstanding principal,i=annual interest rate; n=number of compounding periods. For instance, Makau took a 2-year loan of $10,000 at an interest rate of 5%, compounding annually. Compute the amount of compound interest earned. In this case, the amount of interest payable would be; CI=[P(1+i)^n-1]; $10,000(1+0.05)^2-1]=$10,000(1.1025-1)=$1,025; Amount payable in 2 years=$10,000+$$1,025=$11,025.
Simple and Compound Interest Similarities and Differences
Both simple and compound interest is computed based on the principal amount outstanding on the personal loan. On the other hand, principal refers to the amount of money initially borrowed(loan) from the bank or invested. Also, both compound and simple interest are used to compute interest on the amount of money saved or borrowed. The difference between simple and compound interest occurs when simple interest is computed based on the principal amount of the loan. In contrast, compound interest is computed based on the principal amount and the accumulated interest of the prior periods, such as half-yearly, quarterly, or even daily.
The formula for the simple interest computation is SI=p*r*n, whereas the formula for the compound interest calculation is computed as CI=[p(1+i)^n-p]. For instance, Makau took a loan with a simple interest of $10,000, attracting an annual interest of 5%. He repaid the loan in 2 years. therefore,the amount repayable would be SI=p*r*n=$10,000*0.05*2=$1,000, amount repayable =$10,000+$1,000=$11,000. On the other hand, Makau took a 2-year loan of $10,000 at an interest rate of 5%, compounding annually. Compute the amount of compound interest earned. In this case, CI=[p(1+i)^n-1]=10,000(1+0.05)^2-1=$1,025; the amount repayable=$10,000+$1,025=$11,025. This implies that interest obtained in the compound interest calculation is larger than simple interest because of accumulated previous interest on the principal.
Ethical Issues of Simple and Compound Interest
However, the mathematics of the interest is the same price but questionable on ethical grounds, .for instance, estimation of intrayear rates and deceptive advertising. The interest rate paid based on the annual percentage rate(APR) is invariable. Intryear rates show ethical issues if computed based on the APR. For instance, APR computed annually will not show a discrepancy, while APR calculation based on a nonannual basis will show ethical issues(Manthiram et al., 2022). Other ethical issues arise when practice lenders use deceptive advertising to profit themselves on the certificate of deposit deception method rather than employing a more elaborate method of simple interest plus principle.
Conclusion
Interest is defined as the amount charged on a loan. Mathematics of interest is correct since the methods such as simple and compound interests employ a precise mechanism that minimizes errors. For instance, simple interest refers to interest charged annually on the principal amount. In contrast, compound interest refers to interest charged on the principal amount plus accumulated interest based on the greater degree of periods. The amount paid using compound interest is greater than the amount payable on simple interest because of the previously accumulated interest added to the principal amount. Although, there are some ethical issues, such as computation of the effective APR and deceptive advertising, need to be rectified.
References
Ambuehl, S., Bernheim, B. D., & Lusardi, A. (2022). Evaluating deliberative competence: A simple method with an application to financial choice. American Economic Review, 112(11), 3584-3626.
https://www.aeaweb.org/doi/10.1257/aer.20210290
Busch, M., Ahlberg, E., Ahlberg, E., & Laasonen, K. (2022). How to Predict the p K an of Any Compound in Any Solvent. ACS omega, 7(20), 17369-17383.
https://scholar.google.com/citations?user=oT0dXuYAAAAJ&hl=en&oi=sra
Manthiram, A., Lutkenhaus, J. L., Fu, Y., Bai, P., Kim, B. G., Lee, S. W., … & Penner, R. M. (2022). Technological pathways toward sustainable batteries. One Earth, 5(3), 203-206.
https://www.sciencedirect.com/science/article/pii/S2590332222000951
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