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Compound interest formula and how it is calculated

Compound and simple interest formula

Suppose there is an account or a particular investment. If we would like to calculate the interest on that account, then we will have to make use of the compound interest formula. The amount in consideration is the amount that is reinvested. So based on compounding effect, the investment will bear a good amount. But before going straight to the interest formula, let us start by talking about the concept of compounding since, in order to understand compound interest, you will have to understand what compounding means.

So any amount that is earned on a particular investment and has the capability of being reinvested in order to create extra earnings which will not be calculated in the principal or the original balance is known as compounding. On the other hand, the interest that is formed on the original balance will be known as the simple interest. If the additional interests are added to the simple interest amount, then you will get the total interest amount that is earned from the compound interest. Now that we know what simple and compound interest mean, let us move to the interest formula.

C = P [( 1 + r )n – 1], where C stands for Compound interest, P stands for Principal which is the original balance, r stands for the rate per period whereas n refer to the number of periods we are considering. You might be asked to write an asa paper on simple and compound interest where you will be expected to elaborate on the interest formula and how it was derived.

Period and rate of compound interest

There is an interrelation between the number of periods that are considered in order to compute compound interest and the rate for each of the periods. These two factors give us an idea about the compounding effect on the interest. If there is an account that is compounded on a monthly basis, the each and every month will be counted as a single period. In the same way, if there is an account that is compounded on a daily basis, then each day will be counted as one period and the number of periods as well as the rate will accommodate it.

Let us explain the concept of interest through an example. Suppose an account has an initial balance of $1000 and the amount is increasing at a percentage of 12% annually. At the same time, it is being compounded on a monthly basis. Since it is being compounded on a monthly basis, thus the number of periods will go up to 12 and the rate will come to 1% for every month. If we put all of these variables into the compounded interest formula which we had highlighted above, the interest amount that we will get will be $126.83. This is how we compute the interest rate on a principal amount.

Difference between simple and compound interest

If we use the same example that we used in the previous section, we will understand that the simple interest has to be calculated as the multiplication of principal amount, rate and the time period. Thus, the interest would be $1000 multiplied by 1 year which will be multiplied by 12%. Hence, the simple interest based on the calculation above will give us an amount of $120 as simple interest. But in this case, what happens to the additional $6.83 which we were getting in case of compound interest? This is where the concept of compounding comes into the picture that we had explained earlier. If the amount in question is compounded on a daily basis, then the amount that will be earned will be much higher. You can write an elaborated case study analysis explaining all the points in question.

Alternate interest formula for compounding

There is a formula per which you can compute the compound interest based on the ending balance. It involves the same parameters as the general formula.

C = P(1 + r)n, where P is the principal amount and r is the rate whereas n is the number of periods. Thus, when you know the rate, time and the principal amount, then you can easily calculate the simple interest.

Seeing compound interest from a bank’s perspective, it is perfect if you are earning it instead of losing it. Compound interest is when you are lucky enough that the bank pays you interest on the original principal amount as well as the interest that the amount has earned already. You need to have a proper understanding of the terms related to interest in order to comprehend it better.

Essays on present and future value related to interest

Inflation is a word that we have been hearing a lot for a long time. But have you ever wondered how it affects the economy and does the interest rate provided by bank fluctuate according to the interest rate? So how will your value of money be affected because of inflation? The formula in the previous section of the article gives a proper idea as to what the present and future value mean. You will be asked to write narrative essays on simple and compound interest formula in college and you will have to make sure that your research is good enough to explain the concepts to someone who does not have much knowledge regarding the term. All you have to do is search for the best college essays on Google and pick the best one out of it.

Future of maturity value

So now we talk about how loans work and how interest rates vary for different banks. Let us say you got a loan from a bank in order to purchase a property. Now the amount which you have to pay back to the back is called as the future value of the loan which differs from the initial value. This value is usually termed as maturity value. The formula of this value is quite simple. A, which is the future value of loan equals the sum of principal and the interest amount that you have to pay. In this way, the future value on a loan is always greater than the original value of the loan. Once we invest the principal amount, the value of the loan in future will be the total amount that you will have at the end of the loan period once the simple interest applies to it.

Making use of the interest formula which is the product of principal, time and rate, a formula can be derived to compute the future value of a loan. For college essays, you need to know what is an annotated bibliography and how are you supposed to put it in the essay that you are writing on compound interest.

Hence, understanding how principal and compound interest work is immensely important since you will need to know how the economy is impacted by variable interest rates. There are lots of ways by which you can explain how interest rate works. For different types of loans, the interest rates vary. If you are applying for a home loan, then your interest rate will be relatively lesser than that of a personal loan if you are applying for one. Also, it depends on the moneylender whether they are willing to negotiate the interest rate if you are borrowing money from them. Usually, private money lenders tend to charge a really high-interest rate on loans and this is one of the reasons why people tend to go for banks as the interest rates are much less.

Understand that if you are taking a loan, then there is a possibility that the final value which you will have to pay to the bank might be almost double of the amount that you borrowed from the bank. This is how the loan system works and they also tend to charge a penalty in case if you try to pay up your loan amount in one go. The reason for the same lies in the fact that it is the loss of the bank if you choose to pay the loan early since they will not be able to get the extra interest amount from you if you end up paying the loan earlier. Hence, these things require lots of planning especially when you are going for a home loan. Understand the schemes that are running in the market and choose accordingly so that it becomes easier for you to repay the loan at the end of the loan period.

The interest formula will help in computing the interest rate, but if you want to measure the interest rate based on the percentage of inflation in the market, then you will have to apply other formulae that might be more complex in nature. People who invest in stock markets and keep a track of the market trends usually have an idea about the interest rate and they tend to know whether the fluctuation of interest rate will be beneficial for them or not. On the basis of that, they make an educated guess of whether to invest in a particular stock and also calculate the amount that they will receive at the end.

Hence, make sure you do enough research to comprehend how the financial system works and how inflation affects the interest rate in the market. On the basis of that, you can compute the compound and simple interest on a loan that you have taken from a bank. The interest formula can be explained in multiple ways, so you need to do enough research to make sure you understand it properly.

Over the course of past few decades, many economists have predicted the trends of an economy based on elaborated complex calculations and this has helped us in knowing when the economy is moving towards recession. Finally, you need to understand how financial institutions function and how their instruments impact the economy. The concept of compound and simple interest has always been debated since people tend to comprehend it in a different way.

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