Interest is the extra money that a bank gives you for saving or depositing your money with them. Similarly, when anybody borrow money, they pay interest.
In a Simple interest, the interest is calculated on the same amount of money in each time period, and, therefore, the interest earned in each time period is the same.
If Principal(P), Rate of interest(R%) per annum and Time(T) then the simple interest is given by
S.I = .
Compound interest is calculated on the principal and the interest for the previous period. The principal amount increases with every time period, as the interest payable is added to the principal. This means interest is not only earned on the principal, but also on the interest of the previous time periods. So that the compound interest calculated is more than the simple interest on the same amount of money deposited.
When interest is compounded, the total amount is calculated using the formula A = P ( 1 + )n
Interest is generally calculated on a yearly basis. Sometimes, it can be compounded more than once with in a year. It can be compounded half yearly, which means twice a year, or quarterly, which means four times a year.
The period for which interest is calculated is called the conversion period. At the end of the conversion period, the interest is added to the principal to get the new principal.
The formula to calculate the new rate of interest with respect to the conversion period is
Time period = number of years x
When interest is compounded half yearly, the interest rate will be half of the annual interest rate.
When interest is compounded half yearly, the time period will be doubled.
Applications of Compound Interest
The formula for compound interest can also be used in finding the growth rate of population, rate of increase of bacteria, rate of increase of land rates, etc.