Eli5: How do derive compound interest formula
In: 0
Consider for a moment that your grandmother is a firm believer in saving money and refuses to give gift cards or cash at holidays. Instead, she gives all of the grandchildren $500 invested in five-year CDs (Certificates of Deposit) with compound interest figured twice a year and a 2% interest rate. Set aside the delayed gratification for a moment — The question is, how much money will the CD be worth in 5 years? That is where compound interest kicks in.
Filling in the compound interest formula of A=P(1+r/n)^nt, your holiday gift looks like this: A = 500(1+.022)^25. Following the order of operations, we calculate the amount in the parenthesis first to get A = 500(1.01)^25. From there, we input the exponents to get A = 500(1.10). Now in our final calculation, the final value is A = $550. At the end of 5 years, your CD will be worth $550.
Latest Answers