Compound interest - Intermediate and Higher
Most savings accounts will pay a special type of interest called compound interest. This arises when interest on an investment is calculated and added and then this interest payment also earns interest. is when you have interest on your interest. This increases your end amount!
Example
Rhiannon has decided to use a savings account that pays a rate of 4% Annual Equivalent Rate, a rate of interest worked out on an annual rate taking into account compound interest.. She decides to invest £800 in a savings account for three years. Will Rhiannon be able to fund a trip which she anticipates to cost £1,000? You must show all your workings and give a reason for your answer.
This means Rhiannon will not be able to fund her trip as she will be approximately £100 short.
There is also a shorter method. We know we want the interest added on to the original amount of 100%.
That means we want 104% for each year.
Therefore, we get:
800 × 1.04 × 1.04 × 1.04
or 800 × 1.043 = £899.8912
You can find out how to calculate AER in Business finance.
