According to the material, what does compound interest mean?

According to the material, what does compound interest mean?

• A. It means you earn interest on the money you deposit, called the principal, first.
• B. It means you earn interest only on the initial deposit
• C. It means you deposit money to earn no interest
• D. It means you earn interest on your entire balance regardless of the principal

Answer: (A)

Compound interest means your money earns interest on both the original amount you deposited (the principal) and on the interest that has already been added to your balance. This causes the balance to grow faster over time because each period’s interest is calculated on a larger and larger amount. The description that emphasizes earning interest on the principal first captures this idea: you start by earning interest on the initial deposit, and then that earned interest becomes part of the balance to earn more interest in future periods. For example, with a 5% rate compounded annually, a $100 deposit becomes $105 after the first year, and the next year you earn interest on $105 rather than just $100. The other statements either limit interest to the original deposit, say there’s no interest, or don’t convey how interest builds on prior interest, which is essential to compounding.

Compound interest means your money earns interest on both the original amount you deposited (the principal) and on the interest that has already been added to your balance. This causes the balance to grow faster over time because each period’s interest is calculated on a larger and larger amount. The description that emphasizes earning interest on the principal first captures this idea: you start by earning interest on the initial deposit, and then that earned interest becomes part of the balance to earn more interest in future periods. For example, with a 5% rate compounded annually, a $100 deposit becomes $105 after the first year, and the next year you earn interest on $105 rather than just $100. The other statements either limit interest to the original deposit, say there’s no interest, or don’t convey how interest builds on prior interest, which is essential to compounding.