Compound Interest — Concept and Features

Under compound interest (CI), the interest earned at the end of each period is added to the principal, and the interest for the next period is then calculated on this new, larger sum. In effect the interest itself starts earning interest. The sum on which interest is computed therefore grows period after period, instead of staying fixed as it does under simple interest.

The period after which interest is added to the principal is called the conversion period or compounding period. When nothing is said, compounding is taken to be annual (once a year). The principal-plus-interest carried forward into the next period is called the amount at the end of that period.

How compounding builds up (a worked illustration). Suppose ₹10,000 is invested at 10% per annum compounded annually:

The yearly interest rises from ₹1,000 to ₹1,100 to ₹1,210 — not because the rate changed, but because the base on which it is charged keeps growing. Under simple interest the yearly figure would have stayed a flat ₹1,000 every year.

Key features of compound interest:

• Interest is charged on the accumulated amount, not on the original principal alone — so it is interest on interest.
• The interest amount increases every successive period, so the total grows faster than under simple interest.
• Growth is geometric (multiplicative), not linear: each period multiplies the running amount by the same factor. …