Interest can be computed in two ways. With simple annual interest, the interest is computed on the principal only and is given by:
Interest = Principle x Interest Rate x Time
If interest is compounded, then interest is computed on the principal as well as on any interest already earned.
Example 1: If $8,000 is invested at 6 percent simple annual interest, how much interest is earned after 3 months?
Since the annual interest rate is 6%, the interest for 1 year is (0.06)*($8000) = $480
The interest earned in 3 months is $120.
Example 2: If $10,000 is invested at 10 percent annual interest, compounded semiannually, what is the balance after 1 year?
The interest rate for each 6-month period is 5%, which is half of the 10% annual rate.
The balance after the first 6 months would be
10,000 + (10,000)(0.05) = $10,500
The balance after one year would be
10,500 + (10,500)(0.05) = $11,025