Given below are two statements: Statement I: Compound interest involves the…
2020
Given below are two statements:
Statement I: Compound interest involves the reinvestment of the earned interest, which in future years also earns interest Statement II: Simple interest is the amount earned or paid on a sum of compound interest and principal amount
In light of the above statements, choose the most appropriate answer from the options given below:
- A.
Both Statement I and Statement II are true
- B.
Both Statement I and Statement II are false
- C.
Statement I is correct but Statement II is false
- D.
Statement I is incorrect but Statement II is true
Show answer & explanation
Correct answer: C
Concept
Simple interest (SI) is computed only on the original principal for the whole period, so the interest is the same every period: SI = (P x R x T) / 100. Compound interest (CI) is computed on the principal plus all previously accumulated interest, so each period's interest is itself reinvested and goes on to earn further interest.
Applying it to the two statements
Statement I says compound interest involves reinvesting the earned interest, which then earns more interest in later years. That is exactly the defining feature of compounding, so Statement I is a true description of compound interest.
Statement II says simple interest is the amount earned or paid on a sum of compound interest and principal. Simple interest is charged only on the original principal, never on any accumulated or compound interest, so this definition is wrong. Statement II is false.
Contrasting the wording
The trap is that Statement II borrows the language of compounding (adding interest to the base) and attaches it to simple interest. Under simple interest the base never grows; only the fixed principal earns interest each period.
Result
Statement I is correct and Statement II is false, so the appropriate choice is the one stating Statement I is correct but Statement II is false.