Which term describes the process of adding earned interest back into the principal to grow funds?

Which term describes the process of adding earned interest back into the principal to grow funds?

• A. Compound Interest
• B. Simple Interest
• C. Windfall Interest
• D. Growth Interest

Answer: (A)

Compounding is the process of earning interest on both the initial principal and on previously earned interest because that interest is added back into the balance. This reinvestment makes the fund grow faster over time, since each period’s interest is calculated on a larger amount. For example, $100 at 5% compounded annually becomes $105 after year one, about $110.25 after year two, and approximately $115.76 after year three. If you only earned simple interest, you’d have $115 after three years with the same 5% rate. The terms windfall interest or growth interest aren’t standard in finance and don’t describe reinvesting interest, whereas compound interest does.

Compounding is the process of earning interest on both the initial principal and on previously earned interest because that interest is added back into the balance. This reinvestment makes the fund grow faster over time, since each period’s interest is calculated on a larger amount. For example, $100 at 5% compounded annually becomes $105 after year one, about $110.25 after year two, and approximately $115.76 after year three. If you only earned simple interest, you’d have $115 after three years with the same 5% rate. The terms windfall interest or growth interest aren’t standard in finance and don’t describe reinvesting interest, whereas compound interest does.