Definition of Simple-Compound Interest

The theme that concerns us is related to the banking activity and math financial and, more specifically, with customers who deposit their money in a Bank and they want to know how much they are going to get for it. In other words, if someone deposits money in a bank, he needs to know what interest he is going to get, that is, what is going to be the cost effectiveness economical. There are two ways of understanding interest, the simple and the compound.

An example of simple interest

A father of family You have saved $ 80,000 and his bank offers you 4% annual interest if he deposits the money for 3 years. To calculate interest from these data, the following should be applied formula: I = CxRxT, where I is interest, C is principal ($ 80,000), R is income (4%), and T is time (3 years). In this way, the father of the family will get additional capital (the interest that they will give) from the following formula: I = 80000x 4 / 100x3, the final result being $ 9600. Thus, with an initial capital of $ 80,000 at 4% per year, after 3 years you will get $ 89,600 (the initial 80,000 plus the 9,600 interest).

Compound interest

Compound interest is usually related to some equity investment. Thus, if you have a certain initial capital, after a certain time (for example, a year) the final capital will be equivalent to the sum of the principal plus the interest on the initial principal. Now, the capital obtained after the second year will be equal to the sum of the capital obtained during the previous period. In other words, the capital that is obtained over time includes the interests obtained in previous periods. Thus, in compound interest the interest is compounded.

In short, in compound interest there are two circumstances

1) the interest earned during each period is reinvested and

2) the interests are calculated on a different basis after each period and in this way the interests are increasing.

Compound interest can be understood mathematically as a geometric progression

From a mathematical point of view, compound interest is based on geometric progressions. Thus, if we deposit $ 6,000 in a bank for 3 years and the entity agrees to pay 10% per year, in the first year the $ 6,000 plus 10% will be obtained, that is, $ 6,600. At the end of the second year, $ 6,600 plus 10% will be available, $ 7,260. And at the end of the third year, $ 7,260 plus 10% will be available, or $ 7,986.

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