What is Interest?
Interest is the income you receive from deposits or fees you pay on loans. Interest is of two types: Simple Interest and Compound Interest.
Simple Interest is a measure of interest that does not account for interest or accruals over multiple periods. The interest rate applies only to the principal of the loan or investment and is not affected by interest accrued.
Compound Interest is the interest on the principal and the interest accrued in the previous period. This is different from simple interest, which does not add interest to the principal when compounding interest over the next period.
Putting Money in Bank to Earn Interest
Terms Related to Interest
Some terms like Principal, rate and time used to find Interest. Let’s discuss each:
Principal: The amount borrowed from the bank by a person is called the Principal. The head is designated by the letter P.
Rate: The interest rate is the interest rate at which the principal is paid to someone over a period of time, which could be 5% or 15% etc. The interest rate is denoted by R.
Time: Time is a period given to someone on the principal amount. Time is indicated by the letter T.
Amount: When you get a loan from a bank, you must repay the principal plus interest, and this repayment is called the amount. Amount is denoted by A.
What is Compound Interest?
A modern method of calculating interest called compound interest is now used in all financial and commercial transactions all over the world. A modern method of calculating interest called compound interest is now used in all financial and commercial transactions all over the world.
Let's say we look at our bank transactions and see that interest is deposited into our account each year. This percentage changes each year by the same principal. We see increased interest in the coming years. The interest charged by the bank is compound interest or interest known as compound interest.
Compound interest is the interest applied on the amount of a loan or deposit. This is the most commonly used concept in our daily life. Compounding the amount depends on the principal and the interest received during the period. Compound interest is calculated after calculating the total amount throughout time based on the interest rate and the principal amount.
How to Calculate Compound Interest?
What is the Compound Interest formula? Compound Interest is calculated by using the formula:
\[CI = P{\left( {1 + \frac{r}{n}} \right)^{nt}} - P\]
Where,
P = Principal
r=Percentage rate of Interest in year
t=time taken annually
n =the compounding frequency or the number of times interest is compounded in a year.
Formula for Compound Interest
Compound Interest Formula Example
Since the compound interest is calculated annually so the time (t) taken will be 1 year so the formula for compound annual interest is:
\[CI = P{\left( {1 + \frac{r}{n}} \right)^nt} - P\]
Conclusion
Now we got our answer to the question: What is compound interest formula? Your wealth increases more quickly due to compound interest. Due to the fact that you will receive returns on both the money you invest and returns at the conclusion of each compounding period, it causes a sum of money to increase more quickly than with simple interest.
Compound Interest Formula Examples
1. If the principal is Rs. 2500 for 1 year at the rate of 15% compounded annually .Calculate compound interest.
Ans: Using the compounded annually interest formula
\[CI = P{\left( {1 + \frac{r}{n}} \right)^{nt}} - P\]
Putting value in the formula we will get:
\[\begin{array}{l}CI = 2500\left( {1 + \frac{{15}}{{100}}} \right) - 2500\\CI = 2875 - 2500\\CI = 375\end{array}\]
FAQs on Compounded Annually Formula
1. Write the formula to calculate compound interest.
Compound Interest is calculated by using the formula:
\[CI = P{\left( {1 + \frac{r}{n}} \right)^{nt}} - P\]
Where,
P = Principal
r=Percentage rate of Interest per annum (year)
t=time taken in the year
n =compounding frequency or the number of times interest is compounded in a year.
2. Define the term amount.
The compensation a lender or financial organisation receives for giving out money is called interest. The percentage of a stockholder's ownership in a corporation that is also referred to as interest.
3. What does compounded annually mean?
When the time to calculate the compound interest is annually i.e. for 1 year then the compound interest is called compounded annually . It is calculated using formula
\[CI = P{\left( {1 + \frac{r}{n}} \right)^{nt}} - P\]
4. How compound interest is different from simple interest?
Interest that is obtained on both the principal and the interest from the prior period is known as compound interest. This differs from simple interest, which does not increase the principal when interest is compounded over the following period.
