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Compound Interest
Definition of Compound Interest
Examples of Compound Interest
By the end of first year, your account balance would be
$500 + 2% of $500 = $500 + $10 = $510.
For the second year, this $510 will be considered as the principal and the interest will be worked out for this amount.
That means, the interest for the second year will be calculated on the principal $500 and the interest $15.
The same process will continue for 4 years.
Solved Example on Compound Interest
Charlie deposited $1,000 for 3 years. The bank pays 3% compound interest annually. Find the balance in the account at the end of 3 years. Use a table to calculate the compound interest.
Choices:
A. $1,092.73
B. $1,047.89
C. $1,085.69
D. $1,023.58
Correct Answer: A
Solution:
Step 1: The balance in the account is equal to the sum of the principal and the simple interest.
Step 2: The rate of interest is 3% = 0.03.
Step 3: To calculate the compound interests for three years, make a spreadsheet as shown below.
Principal at the beginning of each year |
Interest |
Balance |
Year 1: $1,000.00 |
1,000.00 × 0.03 = 30 |
1,000.00 + 30 = 1,030.00 |
Year 2: $1,030.00 |
1,030 × 0.03 = 30.90 |
1,030.00 + 30.9 =
1,060 .90 |
Year 3: $1,060.90 |
1,060.90 × 0.03 = 31.83 |
1,060.90 + 31.827 = 1,092.73 |
Step 4: So, the balance at the end of 3 years is $1,092.73.
Related Terms for Compound Interest
- Rate of Interest
- Principal
Real-world Connections for Compound Interest
Additional Links for Compound Interest
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