CME

The additional growth or additional interest, resulting from the compounding effects of - for example - interest on interest.

Another example is the compounding effect of growth on growth.

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

• Compound interest
• Compounding factor
• Continuously compounded rate of return