MBATricks

Tips and Tricks about my MBA experience

Finance :: Compound Interest Rate

 

‘Compound interest’ calculations apply to investments where the amount of interest is calculated on the present balance of the account. The amount you invest is called the ‘Principal‘.

Example…

If you invest a principal of $1000 at 10% compound interest paid monthly, then after the first month, the interest payment will be:

interest (first month) = 10% of $1000 = $100

If the interest is added to the principal, you now have: $1000 + $100 = $1100, so the next months interest will be 10% of the new total:

interest (second month) = 10% of $1100 = $110

So the principal increases to $1210 after the second month. Notice that the increase is $10 greater after the second month than after the first. This trend will continue during the life of the investment so that it will continue to grow faster and faster as time goes on.

The compound interest formula calculates the value of a compound interest investment after ‘n’ interest periods.

A = P(1+i)^n

where:

‘A’ = Amount after ‘n’ interest periods.
‘P’ = Principal, the amount invested at the start.
‘i’ = the interest rate applying to each period.
‘n’ = the number of interest periods

Source: http://www.teacherschoice.com.au/Maths_Library/Money/compound_interest.htm

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