EDEXCEL GCSE FOUNDATION MATHS - What is Compound Interest

Edexcel GCSE Foundation Maths: Compound Interest

What is Compound Interest?

Compound interest is when interest is calculated on the original amount of money plus any accumulated interest. This means that your money grows faster over time than with simple interest, as you're earning interest on interest!

How does it work?

Imagine you have £100 in a savings account with a 5% annual interest rate. Here's how compound interest works:

• Year 1: You earn 5% of £100, which is £5. Your balance becomes £105.
• Year 2: You earn 5% of £105 (the new balance), which is £5.25. Your balance becomes £110.25.
• Year 3: You earn 5% of £110.25, which is £5.51 (rounded to the nearest penny). Your balance becomes £115.76.

Notice how the interest earned each year increases because the interest is calculated on a larger and larger balance.

Calculating Compound Interest

You can use the following formula to calculate compound interest:

Total amount = Original amount x (1 + (interest rate/100))^Number of years

Let's break it down:

• Original amount: This is the initial amount of money you invest or borrow.
• Interest rate: This is the percentage at which interest is calculated.
• Number of years: This is the time period over which interest is calculated.

Example:

Let's calculate the total amount after 3 years if you invest £500 at a 7% annual interest rate:

Total amount = 500 x (1 + (7/100))^3
Total amount = 500 x (1.07)^3
Total amount = 500 x 1.225
Total amount = £612.50

Therefore, after 3 years, your investment will be worth £612.50.

Real-World Examples

• Savings accounts: Most savings accounts offer compound interest, allowing your savings to grow faster over time.
• Loans: Compound interest can also be applied to loans, leading to higher repayment amounts over time.
• Investments: Investments such as stocks and bonds often grow through compound interest.

Key Takeaways

• Compound interest is a powerful tool that can help your money grow faster over time.
• The longer you invest, the more the effects of compounding will benefit you.
• It's important to understand how compound interest works so you can make informed financial decisions.