Compounded interest is the process of interest being added to the principal sum so that from that moment on, the interest that has been added also itself earns interest.
For example, a bank account starts with $100 principal in January and earns 10 per cent compound interest each month.
In February the balance would be $110 (the principal plus the 10 per cent interest).
In March the balance would be $121 (the principal plus last week’s interest, plus 10 per cent interest).
The formula you must use to solve your equation is:
N
FV = PV (1+i)
FV and PV represent the future and present value of a sum. N represents the number of periods. I is the effective interest rate per period and n represents the number of periods.
Where it gets confusing is that in order to define an interest rate fully, enabling the customer to compare it with other interest rates, the interest rate and the compounding frequency must be disclosed.
Most people like to think of rates as a yearly percentage so many governments require financial institutions to disclose the equivalent yearly compounded interest rate on deposits or advances.
So the yearly rate for a loan with 1 per cent interest per month is approximately 12.68 per cent per annum.
This equivalent yearly rate may be referred to as APR (an abbreviation of annual percentage rate)
So in your example, you must first work out whether 8 per cent is the monthly compound interest, or the APR.
It appears to be the APR so first you must calculate the monthly figure and then apply it to the formula above.
For example, a bank account starts with $100 principal in January and earns 10 per cent compound interest each month.
In February the balance would be $110 (the principal plus the 10 per cent interest).
In March the balance would be $121 (the principal plus last week’s interest, plus 10 per cent interest).
The formula you must use to solve your equation is:
N
FV = PV (1+i)
FV and PV represent the future and present value of a sum. N represents the number of periods. I is the effective interest rate per period and n represents the number of periods.
Where it gets confusing is that in order to define an interest rate fully, enabling the customer to compare it with other interest rates, the interest rate and the compounding frequency must be disclosed.
Most people like to think of rates as a yearly percentage so many governments require financial institutions to disclose the equivalent yearly compounded interest rate on deposits or advances.
So the yearly rate for a loan with 1 per cent interest per month is approximately 12.68 per cent per annum.
This equivalent yearly rate may be referred to as APR (an abbreviation of annual percentage rate)
So in your example, you must first work out whether 8 per cent is the monthly compound interest, or the APR.
It appears to be the APR so first you must calculate the monthly figure and then apply it to the formula above.
