Compound Interest
Compound interest is an interest accumulated on the principal and interest together over a given time period. The interest accumulated on a principal over a period of time is also accounted under the principal. Further, the interest calculation for the next time period is on the accumulated principal value. Compound interest is the new method of calculation of interest used for all financial and business transactions across the world. The power of compounding can easily be understood, when we observe the compound interest values accumulated across successive time periods.
A sum of money of $100 invested over a period of time for a 10% rate would give a simple interest of $10, $10, $10... over successive time periods of 1 year, but would give a compound interest of $10, $11, $12.1, $13.31... Let us understand more about this, and the calculations of compound interest in the below content.
1.  What is meant by Compound Interest? 
2.  Compound Interest Formula 
3.  Derivation of Compound Interest Formula 
4.  Compound Interest Formula for Different Time Periods 
5.  FAQs on Compound Interest 
What is meant by Compound Interest?
Compound interest is the interest paid on both principal and interest, compounded at regular intervals. At regular intervals, the interest so far accumulated is clubbed with the existing principal amount and then the interest is calculated for the new principal. The new principal is equal to the sum of the Initial principal, and the interest accumulated so far.
Compound Interest = Interest on Principal + Compounded Interest at Regular Intervals
The compound interest is calculated at regular intervals like annually(yearly), semiannually, quarterly, monthly, etc; It is like, reinvesting the interest income from an investment makes the money grow faster over time! It is exactly what the compound interest does to the money. Banks or any financial organization calculate the amount based on compound interest only.
Compound Interest Formula
The compound interest is calculated, after calculating the total amount over a period of time, based on the rate of interest, and the initial principal. For an initial principal of P, rate of interest per annum of r, time period t in years, frequency of the number of times the interest is compounded annually n, the formula for calculation of amount is as follows.
The above formula represents the total amount at the end of the time period and includes the compounded interest and the principal. Further, we can calculate the compound interest by subtracting the principal from this amount. The formula for calculating the compound interest is as follows
In the above expression,
 P is the principal amount
 r is the rate of interest(decimal)
 n is frequency or no. of times the interest is compounded annually
 t is the overall tenure.
It is to be noted that the abovegiven formula is the general formula when the principal is compounded n number of times in a year. If the given principal is compounded annually, the amount after the time period at percent rate of interest, r, is given as:
A = P(1 + r/100)^{t}, and C.I. would be: P(1 + r/100)^{t } P .
Derivation of Compound Interest Formula
The formula for compound interest can be derived from the formula for simple interest. The formula for simple interest is the product of the principal, time period, and rate of interest (SI = ptr/100). Before looking into to derivation of the formula for compound interest, let us understand the basic difference between simple interest, compound interest computation. The principal remains constant over a period of time, for simple internet computation, but for compound interest computation the interest is added to the principal, for compound interest computation.
Derivation:
The derivation of the compound interest formula is given in the following steps:
 Let the principal be P and the rate of interest be R% per annum. Since the interest is compounded annually, so the compounding period is 1 year. It is to be noted that the principal (P) will change after every 1 year. So, let us calculate the interest for the first year. The interest for the first year will be as follows:
 Let the interest for the first year be I_{1}
 I_{1}_{ }= R% of P = R/100 × P
 Now, the amount at the end of the first year will be:
 A_{1} = P + I_{1} = P + (R/100 × P). This will give A_{1} = P (1 + R/100)
 Now, let us calculate the interest for the second year. It is to be noted that the amount of the first year will become the Principal of the second year. Let this Principal be P_{2}
 Now, P_{2} = A_{1} = P (1 + R/100)
 Now, let us take the interest for the second year to be I_{2} = R% of P_{2}, which is R/100 × P_{2} = R/100 × P(1 + R/100)
 Now, the amount at the end of the second year will be A_{2 }= P_{2 }+_{ }I_{2 }which is P (1 + R/100) + R/100 × P(1 + R/100)
 This expression can be written as A_{2 }=_{ }P (1 + R/100) (1 + R/100) = P (1 + R/100)^{2}
 Continuing in this manner for n compounding periods, the amount at the end of the n^{th }compounding period can be expressed as A = P(1 + R/100)^{n}.
 From the above formulas and computations, you can observe that the compound interest is the same as simple interest for the first interval. But, over a period of time, there is a remarkable difference in returns.
The simple interest value for each of the years is the same, as the principal on which it is calculated is constant. But the compound interest is varying and increasing across the years. Because the principal on which the compound interest is calculated is increasing. The principal for a particular year is equal to the sum of the initial principal value, and the accumulated interest of the past years.
For example, a sum of $10,000 is deposited at a rate of 10%. The below table explains the difference between simple interest and compound interest computation on this principal:
Simple Interest Calculation (r = 10%)  Compound Interest Calculation(r = 10%) 
For 1^{st} year: P = 10,000 Time = 1 year Interest = 1000 
For 1^{st} year: P = 10,000 Time = 1 year Interest = 1000 
For 2^{nd} year: P = 10,000 Time = 1 year Interest = 1000 
For 2^{nd} year: P = 11000 Time = 1 year Interest = 1100 
For 3^{rd} year: P = 10,000 Time = 1 year Interest = 1000 
For 3^{rd} year: P = 12100 Time = 1 year Interest = 1210 
For 4^{th} year: P = 10,000 Time = 1 year Interest = 1000 
For 4^{th} year: P = 13310 Time = 1 year Interest = 1331 
For 5^{th} year: P = 10,000 Time = 1 year Interest = 1000 
For 5^{th} year: P = 14641 Time = 1 year Interest = 1464.1 
Total Simple Interest = 5000  Total Compount Interest = 6105.1 
Total Amount = 1000 + 5000 = 6000  Total Amount = 1000 + 6105.1 = 7105.1 
Compound Interest Formula for Different Time Periods
Compound interest for a given principal can be calculated for different time periods using different formulas.
Compound Interest Formula  Half Yearly
The interest in the case of compound interest varies based on the period of computation. If the time period for the calculation of interest is halfyearly, the interest is calculated every six months, and the amount is compounded twice a year.
The formula to calculate the compound interest when the principal is compounded semiannually or halfyearly is given as:
Here the compound interest is calculated for the halfyearly period, and hence the rate of interest r, is divided by 2 and the time period is doubled. The formula to calculate the amount when the principal is compounded semiannually or halfyearly is given by:
In the above expression,
 A is the amount at the end of the time period
 P is the initial principal value, r is the rate of interest per annum
 t is the time period
 C.I. is the compound interest.
Compound Interest Formula  Quarterly
If the time period for the calculation of interest is quarterly, the interest is calculated for every three months, and the amount is compounded 4 times a year. The formula to calculate the compound interest when the principal is compounded quarterly is given as:
Here the compound interest is calculated for the quarterly time period, and hence the rate of interest r, is divided by 4 and the time period is quadrupled. The formula to calculate the amount when the principal is compounded quarterly is given by:
In the above expression,
 A is the amount at the end of the time period
 P is the initial principal value, r is the rate of interest per annum
 t is the time period
 C.I. is the compound interest.
Monthly Compound Interest Formula
The monthly compound interest formula is also known as the interest calculated per month i.e., n = 12. Total compound interest is the final amount excluding the principal amount. The monthly compound interest formula is expressed as:
CI = P (1 + r/12)^{12t}  P
Daily Compound Interest Formula
When the amount compounds daily, it means that the amount compounds 365 times in a year. i.e., n = 365. The daily compound interest formula is expressed as:
CI = P (1 + r/365)^{365t}  P
Important Notes
 Compound interest depends on the amount accumulated at the end of the previous tenure but not on the original principal.
 Banks, insurance companies, etc. generally levy compound interest.
 If the interest is compounded quarterly, the formula of amount is given by:\begin{equation}A=P\left(1+\frac{r / 4}{100}\right)^{4 n}\end{equation}
 While calculating the compound interest, the rate of interest, and each time period must be of the same duration.
Tips & Tricks
 The rule of 72: It is a quick method to know how long it will take for your money to double. Doubling Time = 72/Interest Rate
Using the rule of 72, we can find the number of years to double your money by simply dividing 72 by the rate of interest. For example, at an 8% compounded interest rate your money will double in 72 ÷ 8 = 9  The time duration over which an interest rate is applicable is referred to in many different terms. Sometimes it is called “per annum” or “annual” or “per year”. All of these mean you’ll get the given rate of interest over a period of 1 year. Semiannual is 6 months. While quarterly is 3 months duration.
Solved Examples on Compound Interest

Example 1: Noah lends $4000 to Emma at an interest rate of 10% per annum, compounded halfyearly for a period of 2 years. Can you help him find out how much amount he gets after a period of 2 years from Emma?
Solution:
Let us identify the data given to us: The principal amount 'P' is $4000. The rate of interest, r' is 10% per annum. Conversion period = Halfyear, Rate of interest per halfyear = 10/2 % = 5%. The time period 't' is 2 years.
Time Period Amount Calculation 1^{st} half year Principal = $4000
Interest = 5% × $4000 = (5/100) × 4000 = $200
Amount = $4000 + $200 = $4200
2^{nd} half year Principal = $4200
Interest = 5% × $4200 = 5/100 × 4200 = $210
Amount = $4200 + $210 = $4410
3^{rd} half year Principal = $4410
Interest = 5% × $4410 = $220.5
Amount = $4410 + $220.5 = $4630.5
4^{th} half year Principal = $4630.5
Interest = 5% × $4630.5 = $231.53
Amount = $4630.5 + $231.53 = $4862.03
The total interest to be paid over 2 years 200 + $210 + $220.5 + $231.53 = $862.03. Total Amount = P + I=$4000 + $862.03 = $4862.03. Therefore the total amount is $4862.03.

Example 2: Solve the abovegiven problem using the compound interest formula.
Solution:
The principal amount 'P' is $4000. The rate of interest 'r' is 10% per annum. Conversion period = Halfyear, Rate of interest per halfyear = 10/2% = 5%. The time period 't' is 2 years. The compounding frequency 'n' is 2.
Let us substitute the given data in the compound interest formula: A = P(1+{r / 2}/100)^{2n}= 4000(1+{10 / 2}/100)^{2(2)}= $4862.03
Therefore the final amount is $4862.03, and the compound interest formula makes the solution simple.
FAQs on Compound Interest
How to Calculate Compound Interest?
The formula used to calculate compound interest is CI = P( 1 + r/100)^{n}  P. Here in this formula the amount is calculated and then the principal is subtracted from it, to obtain the compound interest value.
What Is the Difference Between Simple and Compound Interest?
Simple interest is the interest paid only on the principal, whereas, compound interest is the interest paid on both principal and interest compounded at regular intervals.
How to Calculate Amount Using Compound Interest?
There is a direct formula for the calculation of compound interest. A = P(1 + r/100)^{n}. Here we need to define the rate of interest and the time interval at which the compound interest is calculated.
How To Calculate Amount Using Compound Interest Formula?
There is a general compound interest formula for the calculation of compound interest i.e.,
CI = Amount  Principal
where, Amount = P(1 + r/100)^{t}. By substituting the given parameters such as P (principal amount), r (rate of interest), and t (time) amount can be easily calculated.
What Is the Monthly Compound Interest Formula?
The monthly compound interest formula is given as
CI = P(1 + (r/12) )^{12t } P. Where, P is the principal amount, r is the interest rate in decimal form, n = 12 (it means that the amount compounded 12 times in a year), and t is the time.
What Is the Daily Compound Interest Formula?
The daily compound interest formula is given as
A = P (1 + r / 365)^{365 t}, where P is the principal amount, r is the interest rate of interest in decimal form, n = 365 (it means that the amount compounded 365 times in a year), and t is the time.
What Is the Future Value Compound Interest Formula?
The future value compound interest formula is expressed as FV = PV (1 + r / n)^{n t}. Here, PV = Present Value (Initial investment), r = rate of interest, n = number of times the amount is compounding, and t = time in years.
Is Interest Compounded Daily Better than Monthly?
The interest compounded daily has 365 compounding cycles a year. It will generate more money compared to interest compounded monthly, which has only 12 compounding cycles per year.
What Are the Main Disadvantages of Compound Interest?
If we miss a payment by a day also, towards the end of tenure it may incur a huge loss. The interest calculation is for the next cycle and for a higher value. Compound interest is actually designed to help the lenders but not the borrowers.
How Does Compound Interest Depend on Time Period?
The compound interest depends on the time interval of calculation of interest. The time interval for the calculation of interest can be a day, a week, month, quarterly, halfyearly. For the shorter time period of calculation, the net accumulated compound interest is higher.
How Much is Compound Interest Greater than Simple Interest?
The compound interest can be greater than the simple interest. The compound interest value varies and increases for successive time periods. An initial principal of $100 invested over a period of time would give a simple interest of $10, $10, %10... over successive time periods of 1 year, but would give a compound interest of $10, $11, $12.1, $13.31..... Thus the compound interest is greater than the simple interest. Only for the first year, or for the first cycle of calculation, the compound interest, and the simple interest values are equal.
Can Compound Interest be Greater than Principal?
The compound interest can be greater than the principal. The compound interest value varies and increases for successive time periods. An initial principal of $100 invested over a period of time would give a compound interest of $10, $11, $12.1, $13.31....over successive time periods of 1 year each. Thus the compound interest increases over a period of time and can be greater than the initial principal value.
How Do you Calculate Compound Interest for Half Year?
The formula for calculation of compound interest for half year is CI = p(1 + {r/2}/100)^{2t}. p. Here in this formula 'A' is the final amount, 'p' is the principal, and 't' is the time in years. In the formula we can observe that the rate of interest is halved and the time is doubled, to account for the calculation of compound interest for half a year.
What Is the Information Required to Calculate Compound Interest?
The calculation of compound interest requires us to know the principal, rate of interest, and the time period. Also, we need to know the time interval for which the interest is to be calculated.
What Are the Units of Compound Interest?
The units of compound interest are the unit of currency and are the same as the unit used for the principal value. If the principal is in dollars, or yen, the compound interest would also be in dollars or yen.
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