Answer to Question #160798 in Algebra for Bjn

Question

using visuals/examples if necessary to support your explanation, answer the following:

a) What is the major difference between simple interest and compound interest? 

b) Why does an investment that earns compound interest grow at a faster rate than an investment that earns simple interest? 

Answer 1

 a)Simple interest is based on the principal amount of a loan or deposit. While compound interest is based on the principal amount and the interest that accumulates on it in every period. Simple interest is calculated only on the principal amount of a loan or deposit, so it is easier to determine than compound interest.

Simple interest is calculated using the following formula:

​Simple Interest=P×r×t

where:

P=Principal amount

r=Annual interest rate

t=Term of loan, in years

Compound interest is calculated by the following formula

​Compound Interest=P×(1+r)t

−P

where:

P=Principal amount

r=Annual interest rate

t=Number of years interest is applied

​

b) Compound interest makes a sum of money grow at a faster rate than simple interest because, in addition to earning returns on the money you invest, you also earn returns on those returns at the end of every compounding period, which could be daily, monthly, quarterly or annually.