Running head: Finance- Compound interest 1

EPortfolio Assignment: Compound Interest

Kaley Gill
Fin 1050

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EPortfolio Assignment: Compound Interest
Compound Interest is calculated periodically over the life of the loan or investment.
Compound interest is calculated on the principal and is adjusted as the principal changes.
Therefor compound interest is the interest on the principal plus the interest of prior periods. The
final amount of the loan or investment is called the Future Value. For example, lets say we have
$1 in the bank for 5 years at 7% annually. The present value of our investment would be $1. Each
year, our investment would gain 7% compound. After one year, we would have $1.07 in the
bank. Compounding interest takes the present value of the dollar and determines the future value.
Compound interest can be compounded annually (Once a year), semiannually (every six
months), quarterly (Every 3 months) , monthly, and daily. Once how the interest will be
compounded, you then break it down into periods. To make it simple, we will use semiannually
for 5 years at 10%. Our investment would be broken down into 10 periods ( 5 years x 2). You
would also divide the rate by the number of times the interest in compounded. For our example,
it would be 5% (10% 2).
Understanding how compound interest works can help people and businesses invest their
money effectively and double the amount they have. The main difference between simple interest
and compounded interest is that compound interest gains interest on the principal and the interest
gained. Therefor making it easier and more likely to double your money. You can determine how
long it will take to double your money by the rule of 72. The Rule of 72 states that if you divide
your annual return by 72, it will give you the amount of years it would take to double your
money. Simple interest on the other hand, multiplies the interest by the time and the principal.
The interest is only applied to the principal.
Now that we have a basic understanding of compounding and simple interest, we will go
over how it is used in everyday life. In businesses, Compounding interest is used to generate
profits, ensuring pension payments, and can be used as a benefit. Compounding interest can turn
into a liability, If you have a loan that uses compounding interest, it can take the loan longer to
pay off because your payments are being applied to the interest and not the principal. On the
other hand, if you have invested money in stocks, retirement plans or other forms of investments
that have compounding interest, it can benefit you by increasing your money not only on
principal but the interest as well.
Reflection

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Compounding and simple interest is important to know because it can either make you
lose a lot of money or help you double your money. If your borrowing money, you want the
money to compound less which means youll owe less. On the other hand, if you are investing,
the more times your money is compounded a year, the more money you will earn. One way
interest affects our life, whether it is compound or simple, is through our retirement plans. Some
plans allow you to withdraw an amount of your choice and save it until you retire. In return you
earn interest on the amount of time your money sits. Understanding your goals and how interest
works can help you decide which interest to invest in.

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References
Mcgraw Connect (2016). Compounding Interest. Chapter 12 Pages 302 -320

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