Interest rate definition
Interest rate
An interest rate is the percentage of money charged above the lender's principal – the amount of money loaned – for using its capital. Global central banks set base interest rates to manage their domestic economies. Base rates are the benchmark all banks use to decide their borrowing and investment rates.
What is compound interest?
Compound interest is the interest calculated on loans or deposits; it includes the initial principal and accumulated interest from previous periods.
Interest gets added on the principal sum, which also has the previously accumulated interest, and becomes the new principal balance. This cycle leads to increasing interest and account balances rising at an increasing rate.
Three variables are needed to calculate compound interest: the principal (P), the nominal annual interest rate (i), and the number of compounding periods in full years (n).
Investing $10,000 over ten years at 10% interest rate, with the interest compounded monthly, would generate a final balance of $27,070.41.
$17,070.41 is the interest earned and the effective annual interest rate is 10.471%.