1.

Definition: Compound interest is a method of calculating interest where interest is

not only earned on the initial principal (the original amount of money) but also on any
interest that has been added to it in previous periods.
2. Formula: The compound interest formula is often expressed as:
A = P(1 + r/n)^(nt)
• A is the future value of the investment/loan, including interest.
• P is the principal amount (initial amount of money).
• r is the annual interest rate (expressed as a decimal).
• n is the number of times that interest is compounded per year.
• t is the number of years the money is invested or borrowed for.
3. Compounding Frequency: The "n" in the formula represents how often the
interest is compounded in a year. Common compounding frequencies include annually (n
= 1), semi-annually (n = 2), quarterly (n = 4), and monthly (n = 12). The more frequently
interest is compounded, the higher the effective interest rate.
4. Impact of Compounding: Compound interest leads to the exponential growth of
an investment over time. As interest is earned on both the principal and previously earned
interest, the total amount grows faster than with simple interest.
5. Comparison with Simple Interest: Compound interest differs from simple
interest, where interest is only calculated on the initial principal. Compound interest
results in higher returns on investments and higher costs for loans over time.
6. Applications: Compound interest is used in various financial contexts, including
savings accounts, investments, loans, mortgages, and credit cards. It determines how
much money you'll earn on a savings account, how much you owe on a loan, and how
much you'll pay on a credit card balance.
7. Time and Rate Factors: The key variables affecting compound interest are time
(the longer the money is invested, the more it grows) and the interest rate (higher interest
rates lead to faster growth).
8. Rule of 72: The Rule of 72 is a quick way to estimate how long it will take for an
investment to double at a fixed annual rate of return. Simply divide 72 by the annual
interest rate to get an approximate doubling time.
9. Financial Planning: Understanding compound interest is crucial for financial
planning, as it allows individuals and businesses to make informed decisions about
investments, savings goals, and loan repayments.
10. Risk and Return: Investors should be aware of the risk-return trade-off. Higher
returns often come with higher risks, so it's essential to balance investment choices based
on one's financial goals and risk tolerance.