Interest calculated not (as with simple interest) as a fixed amount per annum based on the capital to which it applies, but on an accumulating balance which consists of both capital invested and the interest already earned. e.g. £100 invested at 6 per cent simple interest for two years would increase by £6 in each year and provide £112 at the end of the two years. If, however, it were invested at compound interest, with interest added annually, it would earn £6 in the first year but but 6 per cent of £106 in the second year, i.e. £6-36, and would provide £112-36 after two years. This concept is very relevant to calculations relating to annuities and sinking funds, etc, as the annual sum put away at compound interest to realize £100,000 in twenty years would be much less than if simple interest only applied. It also relates to discounting back. where interest is always assumed to be compound.
|Reference: The Penguin Business Dictionary, 3rd edt.|