8.0: Introduction
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If you have a lot of surplus cash, it would hardly make sense to hide it under your mattress or bury it in the backyard of your townhouse. As any investment specialist will tell you, you want your money to work for you instead of just sitting idle. So you can invest and be rewarded by earning interest.
Do you know if your account at the Royal Bank of Canada (RBC) has paid you the right amount of interest? You might assume that because everything at a bank is fully automated it is guaranteed to be correct. However, ultimately all automation at the Royal Bank relies on input by an employee. What if your interest rate is keyed in wrong? Maybe the computer programmer erred in a line of computer code and the amount of interest is miscalculated. What if RBC had a computer glitch? These pitfalls highlight the importance of always checking your account statements.
In business, it would be rare for an organization to borrow or lend money for free. That is not to say that businesses are ruthless with each other; in the previous chapter, you saw that most business transactions are completed through interest free credit transactions involving invoicing. However, this generosity does not extend indefinitely. After the credit period elapses, the business essentially treats an unpaid invoice as a loan and starts charging an interest penalty.
When businesses need to borrow money, promissory notes, demand loans, and commercial papers are just three of the possibilities discussed later in this chapter.
Even governments need to borrow money. Have you ever thought about how the government of Canada or your provincial government goes about doing that? While a government has many methods at its disposal, a common method is to use treasury bills—in essence, borrowing the money from investors.
On a personal level, almost all people invest and borrow money at some time. This chapter examines consumer lines of credit and student loans, both of which carry simple interest rates. On the earnings side, it is common for people to have savings accounts that earn low rates of interest. Other short-term investments include treasury bills, commercial papers, and short-term guaranteed investment certificates (GICs).
The bottom line is that money does not come free. In this chapter, you will explore the concept of simple interest, learn how to calculate it, and then apply simple interest to various financial tools.