learning compounding

How learning compounding can be a real life skill for students

Education

It is crucial to learn compound interest as a chief academic subject. However, learning compound interest is also necessary for real-life application. This is why studying the NCERT solutions for class 8 maths thoroughly will help you understand its relevance in studies and real life.

 How to apply Compound Interest in real-life scenarios

The CI calculation is used in various situations as

  • Banks and Savings
  • Population census
  • Commodity prices
  • Inflation

The effectiveness of learning compound interest calculation is necessary to learn the significance of saving and how to level up that saving. The amount accrued can help students when applying for higher education to pay off fees.

People can utilize the advantages of compound interest knowledge while augmenting and multiplying their cash amount.

As a matter of fact, compound interest is a magical tool. If we put more emphasis, people can use it as a saving tool.

Moreover, it makes sense to start investing as early as possible since time is an important factor in determining the final amount.

So then, before we proceed, let’s understand the basic concepts first.

Interest on Amount

So, as we are all aware that when we borrow money from a bank or financial institution, we pay back the money.

However, we rarely pay back, we always pay an extra amount from what we borrowed.

The extra amount people pay is nothing but the Interest Amount. The interest rate is a predefined percentage calculated over a predetermined period of time.

Additionally, two types of interest rates are there:

  • Simple Interest
  • Compound Interest

The extra amount people pay is nothing but the Interest Amount. The interest rate is a predefined percentage calculated over a predetermined period of time.

Simple Interest

In the case of Simple Interest,

We compute the interest rate on the initial or principal amount

The determination of the payback amount depends on a fixed interest rate over a predefined period of time.

Learning Compounding Interest

In the case of Compound Interest, one can earn in two ways.

Firstly, on the initial amount people invest, and secondly, from the interest people earn from the principal sum.

So, compound interest is like a bonus.

How do we calculate compound interest?

There is a formula to calculate compound interest. Let’s understand with the help of the mathematical formula.

How do derive Simple Interest?

The formula to derive SI is

SI= SI= Principal Amount x Rate of Interest x Time, where R is expressed as r/ 100
Hence SI = Px R xT / 100
And the final amount is calculated as A = Principal amount + SI

Let’s understand with the help of numbers

For example

I have Rs 100. I want to grow my money by investing in a scheme where that offers a 10% rate of interest on simple interest for one year. So, how much will I gain at the end of the year by investing in this scheme?

Well, let’s calculate, shall we?

Firstly, we calculate the value of r or the rate of interest.

Therefore,
r= 10/100= 0.1
Now, we can calculate SI by applying
SI= 100 x 0.1 x 1= Rs 10

Therefore, the summation that we will receive by the end of one year will seem like,

Amount = SI + P= 10 + 100= Rs 110.

Hence, it is the way to calculate Simple Interest.

The Calculation Of Compound Interest

In the case of Compound Interest, the interest rate is not fixed.

Additionally, the calculation of compound interest requires both the principal amount and the interest amount.

Come on, let’s do some calculations again!

Suppose, we want to invest Rs. 100 at 10% pa for two years.

If we want to gain compound interest on the principal amount, what would be the amount we will get by the termination period?

Answer:

Since we know the formula as we will start inserting the values
Therefore, P = 100, R = 10%, n = 2 years
A = 100(1+10/100)2
= 100(1+0.1)2
= 100(1.1)2
also = 100(1.21)
= Rs. 121

Furthermore, CI=A-P
Hence, CI= 121- 100= Rs. 21.
Therefore, we observe that CI= Rs 21, whereas SI= Rs 10.

If we want to gain compound interest on the principal amount, what would be the amount we will get by the termination period?

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Important considerations to augment compound interest amount

– Rate of Interest

Clearly, a  high rate of interest while saving will offer higher benefits. Conversely, the same principle applies when paying back a loan. If you take a loan at an excessive interest rate, you will always need to pay a higher amount by the end of the period.

– The Duration

Likewise, the duration matters a lot. If the investment continues for a prolonged time period, you will enjoy return in abundance.

–  Frequency

Frequency also plays an important role.

It is a fundamental fact.

The more the frequency is, the more you gain.

Here, the frequency implies the compounding period numbers.

For example, interest paid out on monthly, quarterly or biannually basis, are more as against one annual payment

– Principal or Original Amount

Likewise, a greater principal sum invested will fetch larger returns as interest amount. Similarly, it means a higher payback if loan amount taken is large and is calculated on CI.

How to Avoid Common Mistakes

Many students make some small mistakes while calculating the Compound Interest formula. This can be avoided if you pay attention and follow all the steps well. Many students also apply for loans for higher studies.

Consequently, they should be aware that it is advisable to pay back on time and avoid compound accumulation. Understanding about Compound Interest is a very important skill.