Community Forex Questions
What is compound interest, and how does it differ from simple interest?
Compound interest is a financial concept where the interest earned on an investment or loan is added back to the principal, forming a new base for calculating future interest. This "interest on interest" effect causes the amount to grow at an accelerating rate over time. The formula for compound interest is:

A = P(1 + r/n)nt


Where A is the total amount, P is the principal, r is the annual interest rate, n is the number of compounding periods per year, and t is the time in years.

Simple interest, on the other hand, is calculated solely on the original principal for the entire duration of the loan or investment. Its formula is:

SI = P x r x t


The key difference lies in how interest is applied. In simple interest, the interest amount remains consistent over time, leading to linear growth. In compound interest, the accumulated interest is reinvested, resulting in exponential growth.

For example, with a $1,000 principal at 5% annual interest over three years, simple interest yields $150 ($50 per year). Compound interest, compounded annually, yields $157.63, as interest is earned on both the principal and previous interest.

Compound interest is advantageous for long-term investments, offering higher returns compared to simple interest.

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