Final answer:
In the Compound Interest System, the interest rate applies to both the principal and the accumulated interest from previous periods. The formula involves calculating the future value and then subtracting the present value to obtain the compound interest.
Step-by-step explanation:
In the Compound Interest System, in each cycle, the interest rate applies to both principal and interest. This is a key distinction between compound interest and simple interest, where the latter applies only to the principal amount. To calculate compound interest, one must add the accumulated interest from previous periods to the principal before computing the interest for the current period.
The formula for compound interest is as follows:
- Future Value = Principal x (1 + interest rate)^time
- Compound interest = Future Value - Present Value
When we calculate the future value, we are determining how much the initial investment will grow after a certain number of periods, factoring in the compounded interest.