Compounding effect
The additional growth or additional interest, resulting from the compounding effects of - for example - interest on interest. For example, interest quoted at 6% per annum, compounded annually, for two years maturity, means that the interest accumulated after two years is:
= [1.06 x 1.06] - 1
= 12.36% for the two year period.
Without the additional interest on interest, the total interest would have been simply 6% per annum x 2 years = 12.00%. So the compounding effect of interest on interest here = 12.36% - 12.00% = 0.36% over the two year period (= 6% x 6%).
When both the number of periods and the rate of growth/interest are low, compounding effects are relatively small. When either the number of periods or the rate of growth/interest - or both - are greater, compounding effects become very much larger.
See also
