- When someone lends money to someone else, the borrower usually pays a fee to the lender. So the due
**interest**is a sum paid or charged for the use of money or for borrowing it. The interest depends on: - 1) the duration of the loan
- 2) the initial amount of money lent or borrowed, called principal
- 3) the interest rate (the percentage of the principal charged as interest)
- 4) the compound frequency.

- Number 4 in the list above, the frequency of the compounding interest, also makes the difference between compound and simple interest.
#### 1. Simple Interest...

- ... is calculated only at the end of the loan period as a fixed percentage of the borrowed amount.
#### 2. Compound Interest...

- ... is calculated not only at the end of the loan period, but periodically, over shorter periods of time, for example daily, weekly, monthly, ... These shorter periods are called
__compounding periods__. __The interest compounding frequency__shows us how often is the interest calculated over the loan period. If the interest is calculated daily - then we have a daily compounding frequency, and the interest is said to be compounded daily. If it is calculated weekly - then we have a weekly compounding frequency, and the interest is said to be compounded weekly. And so on, monthly, quarterly, half-yearly, annually, ...- The amount that results as an interest at the end of such a shorter compounding period is immediately added to the principal amount, so that the interest accrued up to that point contributes to the calculation of the interest for the next compounding period, and not only the principal amount, as it was in the case of simple interest.
- Thus, in the end, the interest also earns interest and not just the principal. It follows that the compound interest will produce a slightly higher amount in the form of interest than the simple interest.

- If the annual interest rate is r% and the interest compounding frequency is annual, then it means that the compounding period is one year long and the interest is calculated once a year.
- 1. In one year, for the amount of P, an interest of (r% of P) is earned:
- C
_{1}= r% × P - The total amount accumulated after one year is:
- A
_{1}= P + C_{1}= P + r% × P = P × (1 + r%) - 2. After the second year, the interest is:
- C
_{2}= r% × A_{1}= r% × P × (1 + r%) - And the total amount is:
- A
_{2}= A_{1}+ C_{2}= P × (1 + r%) + r% × P × (1 + r%) = P × (1 + r%) × (1 + r%) = P × (1 + r%)^{2} - 3. After three years, the accrued interest is:
- C
_{3}= r% × A_{2}= r% × P × (1 + r%)^{2} - And the total amount is:
- A
_{3}= A_{2}+ C_{3}= P × (1 + r%)^{2}+ r% × P × (1 + r%)^{2}= P × (1 + r%) × (1 + r%)^{2}= P × (1 + r%)^{3} - n. After n years, the interest is:
- C
_{n}= r% × A_{n-1}= r% × P × (1 + r%)^{n-1} - And the total amount is:
- A
_{n}= A_{n-1}+ C_{n}= P × (1 + r%)^{n-1}+ r% × P × (1 + r%)^{n-1}= P × (1 + r%) × (1 + r%)^{n-1}= P × (1 + r%)^{n}