Question

1. How is the compounding process related to the payment of interest on savings? 3 full sentences please!

Answer 1

The interest that is paid on a deposit becomes a part of the principal at the end of the period. the interest that is paid on the principal amount which is initial deposit is calculated either annually, semi annually or quarterly, daily or even continuosly .The principal is the amount on which the interest is due to be paid. Annual compounding is the most common form.

Suppose we deposit $1000 which pays a an interest of 8% compounded annually.

Now, the principal at the end would be = 1000* 1.08 = $1080

Now, if we calculate the interest for the second year we would be calculating on the amount of $1080, this is how the interest becomes a part of the principal.