How is the interest rate calculated?

Interest or money paid as a motivation for saving or investment is calculated using a direct formula where the balance is multiplied by the percentage of interest expressed as a decimal decimal school. For example, 10 % interest out of $ 1,000 in the US (USD) would be calculated as $ 1,000 x $ 0.10 or $ 100. Where the calculation of the interest of the deposit can be confused, it is what is called the composition. The merger is a process of taking interest that has been obtained over a period of time and adding to the balance, and then calculating again for the next period starting with an increased balance. Also requires a definition of how the balance will be calculated; For everyday composition, this is generally understood as an account balance at the end of the previous day. For other conditions of combining, ie quarterly, per month other, this is important because it can affect the amount of interest obtained from the deposit.

In the above example, the formula changes for:balance x interest rate/365 + balance = new balance. Replacing, we find ($ 1,000 x 0.10/365) + $ 1,000 = $ 1,000.27 USD. The new balance of $ 1,000.27 is then placed at the beginning of the equation for the next day. Merging daily would bring a balance of $ 1105.16 after one year. If it was calculated as a simple annual interest, the balance would be $ 1,100.

For other combining variants, the only difference would be depending on the number of the interest rate to be divided; For monthly combinations, 12 would be divided, for quarterly combining four. So for the monthly composition, the calculation would be: ($ 1,000 x 0.10/12) + $ 1,000 USD. At the end of 12 months, the balance remains be 1 104.71 USD. A quarterly merger would bring a balance of $ 1,103.81. It can be seen that the more often the composition, the higher the interest rate.

Some institutions or providers of accounts may set conditions as on average balance to provide a lower amount for whichIt includes interest of the deposit. If the CD stipulated that the monthly merger would occur on a balance that equals the average of the previous three -month balances, which would result in a lower amount of interest rate and therefore to a lower return. Similar tactics are used by credit cards to increase balance on which interest fees are calculated for their card holders.