Compound interest
Definition
Compound interest is the interest on a loan or deposit calculated based on both the initial principal and the accumulated interest from previous periods. It allows money to grow at a faster rate compared to simple interest.
5 Must Know Facts For Your Next Test
- The formula for compound interest is A = P(1 + r/n)^(nt), where A is the amount of money accumulated after n years, including interest.
- The frequency of compounding (annually, semi-annually, quarterly, monthly, daily) affects the amount of compound interest earned or paid.
- Compound interest can significantly increase savings over long periods due to the effect of 'interest on interest.'
- Investments with higher compounding frequencies will yield more total returns than those with lower frequencies given the same nominal rate.
- Understanding compound interest is crucial for evaluating loans, mortgages, and investment growth.
Review Questions
- What is the main difference between compound and simple interest?
- How does the frequency of compounding affect the total amount of interest earned or paid?
- What variables are needed to calculate compound interest using its formula?
"Compound interest" appears in:
Related terms
Principal: The initial sum of money invested or loaned.
Interest Rate: The percentage at which interest is charged or paid.
Simple Interest: Interest calculated only on the initial principal without compounding.
