Final answer:
Compound interest uses the accumulated balance (principal plus interest to date) at each year-end to compute interest in the succeeding year. The formula to calculate compound interest is Compound Interest = Future Value - Present Value.
Step-by-step explanation:
Compound interest uses the accumulated balance (principal plus interest to date) at each year-end to compute interest in the succeeding year.
This is done by multiplying the principal by (1 + interest rate) to the power of the number of years, and then subtracting the present value of the principal. The formula to calculate compound interest is:
Compound Interest = Future Value - Present Value
For example, if you have a principal of $100, an interest rate of 5%, and a time period of 3 years, the compound interest can be calculated as follows:
Future Value = $100 x (1 + 0.05)3 = $115
Compound Interest = $115 - $100 = $15