Financial Mathematics → Interest → Simple Interest → Compound Interest
In practice, interest is allowed to earn interest itself. When interest earns interest itself, it is called “compound interest”. So, we always use compound interest formula in financial calculations.
The simple interest formula is
The total amount after 1 year (n=1) is
Now, in compound interest, the interest is allowed to earn interest itself. So, the total amount after 2 years is
Similarly, the total amount after 3 years is
And, the total amount after n years is
So, we have the compound interest formula for n years
Where,
C = Cash amount (original amount)
i = Annual interest rate
n = Time in years
A = Amount after n years (final amount)
Example 1. Suppose $1,000 is deposited in a bank that earns compounded interest of 12% per annum. How much will be in the account after:
(a) 1 year
(b) 2 years and 4 months
Solution:
As we know that the compound interest formula is
(a) After 1 year (Put n = 1, i = 0.12)
Answer
(b) After 2 years and 4 months (Put )
Answer
Next: Varying Interest Rate