Question

If someone deposits $1,000 into a savings account that pays 1% interest. At the end of the first year, he's earned $10 in interest and there is $1,010 in the account. If the account has simple interest, the 1% interest for year two would be based off:

A) The original deposit ($1,000)
B) The year one account balance ($1,010)
C) The year one interest ($10)
D) The year one account balance ($1,010)

Answer 1

The 1% simple interest for year two of the savings account with $1,000 original deposit would be based on the original deposit amount, which is $1,000. This is because simple interest is calculated only on the original principal, unlike compound interest which would involve the accrued interest.

Step-by-step explanation:

If someone deposits $1,000 into a savings account that pays 1% interest and after the first year they have earned $10 in interest, for the second year the 1% interest will be calculated based on the same principle amount since the interest is simple interest. Simple interest is calculated only on the original principal for each period. Therefore, the correct answer is A) The original deposit ($1,000).

The formula for simple interest is principal times the interest rate times the number of time periods. So, if we apply this to the given question:

Year 1 Interest: $1,000 × 0.01 × 1 = $10

Year 2 Interest: $1,000 × 0.01 × 1 = $10 (again, because with simple interest the amount does not change)

This differs from compound interest, where the interest for each period is added to the principal before calculating the next period's interest.