PFL Study Guide 8
Use this guide to take notes as you work through the activity. Taking good notes can help you remember important ideas. Your notes on this guide will help you prepare for quizzes and tests.
1. What are the two opposing forces that affect savings?
Interest and inflation. Interest increases the value of your money over time, and inflation decreases the value of your money over time.
Understanding Interest
2. Explain the difference between interest earned in a bank account and interest owed on a credit card.
Interest earned in a bank account is money a bank pays you for holding your money. Interest owed on a credit card is what you are charged when you don't fully pay off your card balance.
3. Explain how money you deposit earns interest from a bank.
The bank secures my deposit. Then it lends part of that deposit to other borrowers, charging interest. When those borrowers pay back their loans with interest, the bank shares part of that interest with me. That portion of interest goes into my account, adding to my original deposit over time.
4. When you are a borrower, the higher the interest rate on your credit card, the more you _____. When you are a lender, the higher the interest rate on your savings account, the more you _____. owe, earn
5. Fill in the table to compare simple and compound interest.
Simple Interest | Compound Interest |
|---|---|
Money paid only on the principal (what you put into the account) | Money paid on the principal plus any interest you've already earned |
Nominal Interest Rates
6. What is the nominal interest rate?
An interest rate that does not adjust for inflation.
7. Using the nominal interest rate of 4 percent, find the annual percentage yield (APY) on a $2,500 deposit. Explain how the APY is calculated.
$100; To calculate APY, multiply 0.04 by $2,500.
Inflation
8. In your own words, describe inflation.
Inflation is when prices go up over time, which leads the value of money to go down.
9. List some of the impacts of inflation on society.
Can make it harder for people to buy basic needs, decreases the value of your savings, means you have to earn more to keep up with cost of living. Can hurt salaries and especially people earning minimum wage.
10. Suppose a pair of jeans costs $20 today. If they increase in price based on the rate of inflation of 3 percent, how much will the jeans cost next year?
The jeans will cost $20.60 next year.
Real Interest Rate
11. Interest and inflation have _______ effects on savings. opposite
12. Explain how the real interest rate differs from the nominal interest rate.
The nominal interest rate is not adjusted for inflation. The real interest rate is the rate of return after the inflation rate is subtracted.
13. How do you calculate real interest rate?
Subtract the rate of inflation from the nominal interest rate.
Compound Interest
14. Describe the effect of compound interest on savings.
When interest compounds, you earn interest on top of interest, so it grows at a faster rate over time.
15. Briefly describe the Rule of 72.
To find out about how long it takes you to double your savings, you divide 72 by the rate of return.
Key Terms
Use this table to write definitions for the key terms from this activity in your own words. If you're confident you know a term, put a check mark next to it and move on.
Key Term | Definition |
|---|---|
annual percentage yield (APY) | The amount of interest earned in a year. |
compound interest | The amount of interest earned when compounding all interest. |
inflation | An increase in prices combined with a fall in the value of money. |
inflation rate | The rate at which prices are rising over a period of time. |
interest | The charge applied to borrowing money, most often in the form of a percentage of a loan amount. |
nominal interest rate | Interest rate that has not been adjusted for inflation. |
personal financial planning | Planning that involves setting long-term and short-term financial goals. |
real interest rate | Interest rate that reflects the rate of growth of purchasing power. |
Rule of 72 | A way to quickly determine the number of years required to double a sum of money at a given annual rate of return. |
simple interest | The amount of interest earned when interest is not compounded. |
If you noticed other unfamiliar terms in this activity, use the blank rows to list them and their definitions.