The principal, often referred to as the "principal amount" or "principal sum," is the initial amount of money that is either invested, borrowed, or used as the basis for various financial calculations. It is the original sum of money that is involved in a financial transaction, and it is the amount upon which interest is calculated.
In investment scenarios, the principal is the initial amount of money that is invested. When you earn interest or returns on your investment, it is typically calculated based on this principal amount. In the case of loans, the principal is the original amount borrowed. Borrowers are typically required to repay the lender both the principal and interest over a specified period. Payments made by the borrower go toward reducing the principal balance and covering interest charges.
There are different types of principal depending on the nature of the transaction.
This is the initial amount of money borrowed or lent in a loan or debt arrangement. It represents the original sum of money that needs to be repaid, excluding any interest or other charges. As loan payments are made, they typically cover both interest and a portion of the principal, gradually reducing the outstanding balance.
In the context of investments, principal refers to the original amount of money invested. It represents the initial capital invested in assets such as stocks, bonds, real estate, or other investment vehicles.
Principal in a Bond
When referring to a bond, the principal, also known as the face value or par value, is the amount that the bondholder will receive back when the bond matures. Bonds pay periodic interest (coupon payments) to the bondholder based on a fixed interest rate applied to the principal amount.
Principal in Amortisation
In amortisation schedules, principal refers to the portion of each loan payment that goes toward reducing the loan balance. Over time, as more principal is paid, the interest portion of the payment decreases.
This is a payment made to reduce the loan balance or the outstanding principal amount. Principal payments are separate from interest payments and help to gradually pay down a debt.
The formula to calculate the principal (the initial amount of money invested or borrowed) depends on the context. Here are the primary formulas for calculating principal in various financial contexts:
If you want to calculate the principal amount for an investment:
Principal = Future Value / (1 + Rate)^n
Future Value: The amount the investment will grow to
Rate: The annual interest rate or return on the investment (expressed as a decimal)
n: The number of compounding periods
If you want to calculate the loan principal for a loan or mortgage:
Principal = Loan Amount / (1 + Rate)^n
Loan Amount: The total amount borrowed
Rate: The annual interest rate (expressed as a decimal)
n: The number of loan payments
Principal Balance (Remaining Principal):
To calculate the remaining principal balance on a loan or mortgage after a certain number of payments:
Remaining Principal = P * [(1 - (1 + r)^(-n)) / r]
P: Monthly payment amount.
r: Monthly interest rate (annual interest rate divided by 12).
n: Number of payments made.
Let's consider an example relevant to India for calculating the principal amount in a company's financial context. In this scenario, we'll calculate the principal amount for a corporate bond issued by an Indian company.
Company XYZ is an Indian corporation that has issued a 5-year corporate bond with a face value (par value) of Rs 10,000. The bond offers a fixed annual interest rate of 8%. Let's calculate the principal amount of this bond:
- Bond Face Value (Par Value): Rs 10,000
- Annual Interest Rate (Coupon Rate): 8%
- Number of Years to Maturity: 5 years
The principal amount (the initial investment made by bondholders) is equal to the face value of the bond. In this case, the face value is Rs 10,000.
So, in this example, the principal amount of the bond issued by Company XYZ is Rs 10,000. This represents the initial investment made by bondholders when they purchase the bond. Over the bond's life, bondholders will receive periodic interest payments based on this principal amount, and at the bond's maturity, they will receive the principal amount back.