. Compound interest: calculations and examples.
What is compounding of interest explain with examples? Compound interest is when the interest you earn on an investment is added to your principal, so that the next time interest is paid, it's paid on a larger sum of money.
For example, let's say you invest $1,000 at a 10% annual interest rate. After one year, you would have earned $100 in interest, which would be added to your principal, so you would now have $1,100. The next year, you would earn 10% on $1,100, which would come to $110. So, your total investment would now be worth $1,210.
As you can see, each year your interest earnings increase, because you're earning interest on both your original investment and on the interest you earned in previous years. This is what's known as compounding.
Compounding can have a major impact on your investment over time. For example, if you invest $1,000 at a 10% annual interest rate, after 10 years your investment will be worth $2,593. But if you wait just one additional year to start investing, and then invest the same $1,000 at the same 10% annual interest rate, after 20 years your investment will be worth $6,727.
The lesson here is that the sooner you start investing, the more time your money has to grow through compounding. What is called power of compounding? The power of compounding is the ability of an investment to generate returns that are greater than the original investment. This occurs when the investment generates earnings that are reinvested, and those earnings in turn generate their own earnings. The power of compounding can have a dramatic effect on the growth of an investment over time.
For example, let's say you invest $1,000 at an annual rate of return of 10%. After one year, you would have $1,100. The $100 in earnings would be reinvested at the same 10% rate, so you would have $1,210 at the end of the second year. In the third year, you would have $1,331, and so on. As you can see, the power of compounding can cause your investment to grow very quickly over time. How do you find the power of compound interest? To calculate the power of compound interest, you need to know the interest rate, the number of compounding periods, and the principal amount. The interest rate is the percentage of the principal that will be paid in interest each period. The number of compounding periods is the number of times per year that the interest will be compounded. The principal is the amount of money that will be invested.
The formula for calculating the power of compound interest is:
A = P(1 + r/n)^nt
Where:
A is the future value of the investment
P is the principal
r is the interest rate
n is the number of compounding periods
t is the number of years
For example, let's say you have an investment with a principal of $10,000, an interest rate of 5%, and it is compounded monthly. This means that the interest rate is 0.42% per month (5%/12). The number of compounding periods is 12 (1 per month), and the number of years is 10.
To calculate the future value of this investment, we would use the following formula:
A = $10,000(1 + 0.42%/12)^(12*10)
A = $10,000(1.0042)^120
A = $10,000(2.14)
A = $21,400
So, in this example, the future value of the investment would be $21,400. What are the two types of compounding? The two types of compounding are simple interest and compound interest.
With simple interest, the interest earned is not reinvested and is not added to the principal, so the interest earned each period is fixed. With compound interest, the interest earned is reinvested and added to the principal, so the interest earned each period is higher than with simple interest.
Do banks use compound or simple interest? Banks typically use compound interest when calculating the interest owed on a loan. This means that the interest is calculated based on the original loan amount, as well as any accrued interest. This can result in a higher interest rate than if the interest was calculated using simple interest.