Which type of interest is calculated using only the principal amount?

Which type of interest is calculated using only the principal amount?

• A. Simple Interest
• B. Compound Interest
• C. Interest
• D. Time Value of Money

Answer: (A)

The main idea here is how interest is calculated: whether it’s based only on the original amount or on the original amount plus previously earned interest. Simple interest uses only the principal for each period, so the interest doesn’t build on itself. Its formula is I = P × r × t, which means the interest grows linearly with time. This is why it’s the type calculated using just the principal amount. For example, $1,000 at 5% for three years earns $150 in interest (1,000 × 0.05 × 3) and the total is $1,150. In contrast, compound interest adds interest to the balance after each period, so future interest is earned on the new, larger amount, leading to faster growth because interest compounds. The other terms aren’t a calculation method: “Interest” is a broad term, and “Time Value of Money” is a concept about value today versus in the future, not a specific way to compute interest.

The main idea here is how interest is calculated: whether it’s based only on the original amount or on the original amount plus previously earned interest. Simple interest uses only the principal for each period, so the interest doesn’t build on itself. Its formula is I = P × r × t, which means the interest grows linearly with time. This is why it’s the type calculated using just the principal amount. For example, $1,000 at 5% for three years earns $150 in interest (1,000 × 0.05 × 3) and the total is $1,150. In contrast, compound interest adds interest to the balance after each period, so future interest is earned on the new, larger amount, leading to faster growth because interest compounds. The other terms aren’t a calculation method: “Interest” is a broad term, and “Time Value of Money” is a concept about value today versus in the future, not a specific way to compute interest.