Compound Interest
Compound interest means earning interest on both the principal and previously earned interest. It is used in savings accounts, loans, and investments and grows faster than simple interest.
What You Need to Know
Key Concept Diagram
Simple interest: I = PRT/100, interest is always calculated on the original principal
Compound interest: A = P(1 + r/100)^n, where interest is added to the principal each period
Compound interest grows exponentially; simple interest grows linearly
The more frequently interest is compounded, the greater the final amount
Key Vocabulary
Principal
The original amount of money invested or borrowed
Interest rate
The percentage charged or earned per period
Compound interest
Interest calculated on the principal plus accumulated interest
Principal plus interest
The total amount including the original investment and all interest earned
Knowledge Check
Select the correct answer for each question. Click "Check Answer" to see if you are right.
Question 1
$2,000 is invested at 5% per annum compound interest for 3 years. What is the amount after 3 years?
Question 2
How much more does compound interest earn compared to simple interest on $1,000 at 10% for 2 years?
Question 3
In compound interest, what does the n in the formula A = P(1 + r/100)^n represent?
Key Concepts Summary
- ●Simple interest: I = PRT/100, interest is always calculated on the original principal
- ●Compound interest: A = P(1 + r/100)^n, where interest is added to the principal each period
- ●Compound interest grows exponentially; simple interest grows linearly
- ●The more frequently interest is compounded, the greater the final amount