Economics

Compare: Simple Interest vs. Compound Interest

Real-life application: Person A invests in a 2-year bond that pays 4% annual simple interest (paid semi-annually). Person A pays $1,000 for the bond and receives $20 (4% x $1,000 / 2) every 6 months.
The $20 payments are not being reinvested in the bond, so they do not accrue interest themselves.

Person B invests in a 2-year bond that pays 4% annual interest (interest reinvests semi-annually). Person B pays $1,000 for the bond and the bond grows by 2% (4% / 2) every 6 months. The interest with this bond is not paid out, but instead compounds.

PeriodSimple Interest Bond (A)Compound Interest Bond (B)
Month 0-$1,000-$1,000
Month 6$20$0
Month 12$20$0
Month 18$20$0
Month 24$1,020$1,082.43
Net Income (%)$80 (8%)$82.43 (8.24%)

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