"Therefore, I believe that the interest and the understatement penalty should be reduced from what they assessed."

They did not assess anything with a CP-2000.  They proposed an assessment, to which you should have responded "not quite."  If they proposed $5,000 and $1,200 penalty and interest, it would have included the 20% "substantial understatement" Section 6662 penalty that doesn't apply if the assessment is less than $5,000.  If you agreed that the actual tax owed was $1,000, then you should have sent that amount, plus interest on that amount.  Section 6662 would not have applied.  Or you could have waited for a revised CP-2000, and paid a little more interest that would have accrued while they shuffled the paperwork.