WallStreetMojo

WallStreetMojo

WallStreetMojo

MENUMENU
  • Blog
  • Free Video Tutorials
  • Courses
  • All In One Bundle
  • Login
Home » Accounting Tutorials » Income Statement Tutorials » Interest on Investments

Interest on Investments

By Madhuri ThakurMadhuri Thakur | Reviewed By Dheeraj VaidyaDheeraj Vaidya, CFA, FRM

What is Interest on Investments?

Interest in investments is the periodic receipt of inflows on financial instruments, which may be like the bond, government securities, or bank account. It is income earned from the specified form of assets, which may be liquid. The pay-out can be monthly, quarterly, or annually. It is of utmost importance to keep track of the receipt of interest income. Over time, new models of money lending are getting evolved, along with that receipt of interest income is also getting modified accordingly.

Types of Interest on Investments

Following are the various type of interest on an investment that can be earned from different modes:

#1 – Interest from Bonds like Corporate Bonds, Secured Debentures, etc

Under this, the investor will get interested in bonds like debentures, corporate bonds, certificates of deposits, etc. for the tenure of holding of respective financial instruments.

#2 – Bank Account like Saving Account, Current Account, etc

Under this, the account holder will get simple and compounding interest on the balance in the accounts based on the days for which balance is available in the account.

#3 – Government Securities

Under this, an investor will invest in securities issued by various government departments and in the gilt bonds. Same as a corporate bond, here also investors will get interested based on the tenure of holding the financial instrument.

Interest on Investments

Formula

Interest Income = P * R * N

Where,

  • P= Principal
  • R= Rate of interest
  • N= Period

It is the formula for simple interest. Normally in the market for bonds and deposits with periodic payout are using the above formula. However, in deposits where the periodic payout is not available, their concept of compounding is used. In simple interest, interest will be paid periodically, and then at the end principal will be repaid.

Popular Course in this category
Sale
All in One Financial Analyst Bundle (250+ Courses, 40+ Projects)
4.9 (1,067 ratings)
250+ Courses | 40+ Projects | 1000+ Hours | Full Lifetime Access | Certificate of Completion
View Course

However, in compounding, periodic interest will be reinvested, and at the end of tenure, cumulative interest will be repaid along with the principal. Compounding is generally seen also in the mutual funds as well, where systematic investment plans are kept on getting invested and return on the same is getting accrued and reinvested.

Interest on Investments Examples

Below are the examples:

You can download this Interest on Investments Excel Template here – Interest on Investments Excel Template

Example #1

ABC Limited invested $ 10,000 in the bonds of the Fed. The duration of the bond is 5 years. The rate of interest in the bond is 5 years.

You are requested to calculate:

  1. Interest income earned by ABC Limited
  2. The total amount that ABC Ltd will get back post maturity of the bond

Solution

  • P= $ 10,000
  • R= 5%
  • N= 5 years

Interest on Investment - Example 1-3

Calculation of interest earnings

Interest on Investment - Example 1

= $ 10,000 * 5% rate of interest * 5 years

Interest earning will be –

Interest on Investment - Example 1-1

  • Interest-Earning = $ 2500

Amount = Principal + Interest

Interest on Investment - Example 1-2

  • Total Amount = $ 12,500

Thus, ABC limited will earn an interest of $ 2500 with investment in bond and will get back the total amount of $ 12,500 post maturity of the bond.

Example #2

Mr. Jackman invested $ 8,000 in bank deposits for 40 days with Deutsch Bank. The rate of interest on the deposit is 10 %. You are requested to calculate the interest income for Mr. Jackman.

Solution

  • P= $ 8,000
  • R = 10%
  • N = 40 days

Example 2

Calculation of interest earning

Example 2-1

= $ 8,000 * 10% * 40 days / 365 days

Interest Earning will be –

Example 2-2

  • Interest Earning = $ 87.67

Thus, Mr. Jackman will earn $ 87.67 as interest from the investment in deposit

Advantages

  • Fixed-Rate of Interest – One of the best advantages of interest income is that it gives steady earnings with a fixed rate for the specified period.
  • Tax Saving Benefit – Interest income over government departmental bonds is tax exempted. Hence one can enjoy the benefit of earning the income and getting tax exemption as well.
  • Safe Mode of Earning – Earning interest income is one of the safest modes of earning in comparison to other investment options because of the risk profile of the investment.

Disadvantages

  • Low Rate of Interest – As compared to other investment alternatives, interest-bearing securities give the least return because the rate is fixed and does not get increased with the passage of time and inflation effect.
  • Charges and Fees – Many times, charges and fees are getting auto deducted from the account, and this levies financial charges. It gives a negative return to investors.

IFRS Requirement to Recognize Interest Income

As per IFRS 9, interest income will be recognized based on general or simplified approaches and Credit adjusted approach,

The detailed description is given below:

Recognize Interest Income

The effective interest rate is the rate that discounts the all expected future cash outflows/inflows from the financial instrument at asset’s Amortized Cost preceding to any allowance for expected credit losses.

Conclusion

  • Thus, interest income is a safe way of earning income from the financial instrument. It has the power to give perennial income at a fixed rate without any stoppage. Also, with time, many innovative models of investment have come. These also give the support of income with the effect of inflation as well.
  • Interest income is one of a good source of income for income and corporates for safe income. In simple words, interest income is a good and safe source of income, even though the rate of interest is not so high.

Recommended Articles

This article has been a guide to What is Interest on Investments & its Definition. Here we discuss the formula to calculate interest on investment examples and types along with advantages and disadvantages. You can learn more about from the following articles –

  • Daily Compound Interest
  • Interest Rate Effect
  • PIK Interest Types
0 Shares
Share
Tweet
Share
Primary Sidebar
Footer
COMPANY
About
Reviews
Contact
Privacy
Terms of Service
RESOURCES
Blog
Free Courses
Free Tutorials
Investment Banking Tutorials
Financial Modeling Tutorials
Excel Tutorials
Accounting Tutorials
Financial Statement Analysis
COURSES
All Courses
Financial Analyst All in One Course
Investment Banking Course
Financial Modeling Course
Private Equity Course
Venture Capital Course
Excel All in One Course

Copyright © 2021. CFA Institute Does Not Endorse, Promote, Or Warrant The Accuracy Or Quality Of WallStreetMojo. CFA® And Chartered Financial Analyst® Are Registered Trademarks Owned By CFA Institute.
Return to top

WallStreetMojo

Free Investment Banking Course

IB Excel Templates, Accounting, Valuation, Financial Modeling, Video Tutorials

* Please provide your correct email id. Login details for this Free course will be emailed to you

Book Your One Instructor : One Learner Free Class
Let’s Get Started
Please select the batch
Saturday - Sunday 9 am IST to 5 pm IST
Saturday - Sunday 9 am IST to 5 pm IST

This website or its third-party tools use cookies, which are necessary to its functioning and required to achieve the purposes illustrated in the cookie policy. By closing this banner, scrolling this page, clicking a link or continuing to browse otherwise, you agree to our Privacy Policy

Login

Forgot Password?

WallStreetMojo

Free Accounting Course

You will Learn Basics of Accounting in Just 1 Hour, Guaranteed!

* Please provide your correct email id. Login details for this Free course will be emailed to you

WallStreetMojo

Download Interest on Investments Excel Template

Special Offer - All in One Financial Analyst Bundle (250+ Courses, 40+ Projects) View More