Interest on Investments

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 interestCompounding InterestCompound Interest is the interest earned from the initial Principal & the previously accumulated Interest amount. This is also known as “Interest on Interest” & it is always higher than the Simple Interest. read more 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

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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.

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

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:

General or Simplified Approach

DescriptionsNo Evidence of Impairment ExistsEvidence of Impairment ExistsCredit Adjusted Approach
Interest income will be calculate on the basis ofCarrying value of the assets at the beginning of periodCarrying value of the assets at the beginning of period adjusted with credit riskCarrying value of the assets at the beginning of period adjusted with credit risk
Rate of Interest that will be apply on the basis of Effective Rate of InterestEffective Rate of InterestEffective Rate of Interest adjusted with credit risk

The effective interest rateEffective Interest RateEffective Interest Rate, also called Annual Equivalent Rate, is the actual rate of interest that a person pays or earns on a financial instrument by considering the compounding interest over a given period.read more 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.

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 –

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