Compound Interest
Financial institutions don't use simple interest. Instead they use compound interest. It is calculated not only on the beginning investment but also on any interest accumulated in the meantime. So if we use the same example as in the previous slide, someone to receive 5% compound interest on a beginning value of $100, the first year they would get the same thing as they would getting simple interest. You'd multiply it 5%, or .05, times $100 to get that value of $5. The second year, though, the interest would be calculated on that amount entering year 2, or $105, so the 5% still converted to .05, but that's multiplied by $105 to arrive at $5.25 in interest in year 2. Calculate years 3 through 5. The answer is provided in the note pages.