How to calculate Compound Interest

One of the most important topics in competitive exams is Simple Interest and
Compound Interest. And in bank exams you will find at least one question from
this concept. Please dont call this method as short trick or short cut as I
personally dont like these words and this method is a mere extension of the
basic concept of what Compound Interest actually is:
Some terminologies:
Principal (P): The money borrowed or lent out for a certain period is called the
principal or the sum.
Rate of Interest (r): Rate at which sum is borrowed.
Time (t): Time period for which sum is borrowed.
Simple Interest (SI): If the interest on a sum borrowed for certain period is
reckoned uniformly, then it is called simple interest.
General formula for calculation of Simple interest is P*r*t/100
Where r is rate of interest per annum and time is the time period in years.
We can always change rate and time to desired units if they are not given in
standard form
For ex: A sum of 1000 is lent out on SI for 3 years at rate of interest as 10% pa.
What will be the SI after the duration of three years?
We can calculate SI by using above mentioned formula
SI= P*r*t/100 SI= 1000*10*3/100=300
We can also calculate interest for one year and simply multiplying one year
interest with the time period will also fetch us our answer.
For eg. Interest for 1 yr will be= 10% of 1000=100
So our SI for 3 years= 100*3= 300
Now on to the Compound Interest:
Compound Interest (CI): Compound interest is interest added to the principal
of a deposit or loan so that the added interest also earns interest from then on.
This addition of interest to the principal is called compounding.
When interest is compounded annually:
Amount = P [1 + (r/100)] ^n
When interest is compounded half yearly:
Amount = P [1 + ((r/2)/100)] ^ (2n)
When interest is compounded quarterly:
Amount = P [1 + ((r/4)/100)] ^ (4n)

In all the above case our Compound Interest will be = Amount- Principal
i.e. CI= A P
Above method of calculating CI is a cumbersome process and usually not
recommended in exams as it is a time taking exercise. So we need to devise a
method which is simpler than the above method.
For this we need to first understand what exactly happens in case of CI.
In SI case we had uniform interest throughout the whole time. But in case of CI
after one time period, Interest gets added to the principal and in the next time
period interest is levied upon the amount after first time period.
For example after 1 year 1000 @ 10% pa rate will fetch you interest= 1000*
10/100=100
This 100 will be added to the principal amount after one year and new principal
will be
1000 + 100= 1100
Now in second year @ 10% rate interest will be 1100*10/100= 110
So your total interest of two years will be 100+110= 210
Recall that our SI after two years would have been only 200 instead of 210,
this difference in interest is due to the compounding effect of CI.
We can always calculate CI this way or we can calculate total Interest according
to compounding and then can calculate CI.
Now on to our method of calculating total Interest for the given time period.
We know for the first years interest will be 10%, what about the second year?
So our second year interest will be nothing but 10% of our first year interest
added to first year interest:
i.e. 10 + 10*10/100= 10+1=11%
So our total Interest will be =10 +11=21%
Important formula for CI= P/100 * total Interest
CI= 1000/10 * 21= 210
So by this method also we get same answer and if we know second year interest
rates on our tips , we can always added it to first year interest rate and calculate
total interest and we will be able to calculate CI in no time.
Now if we want to know the CI for the same problem after three years?
So Interest for the third year will be = second year interest + second yr interest *
actual rate/100
= 11 + 11*10/100= 11+1.1= 12.1%
So our total interest after three years will be =10 + 11+12.1= 33.1%

And our CI will be equal to 1000/10 * 33.1= 331

Now question arises as to how to remember these second year and third year
rates. I am keeping this to 3 years only as most of the questions asked are
limited to 3 time periods.

How to remember second year rates?

Lets say rate= 4% then second year rate will be nothing but 4.16
You can observe that in second year rate figure after decimal is nothing but
square of first year rate.
So for ex : second year rate for 5% will be = 5.25
For 6 , it will be 6.36 . For 9 ,it will be 9.81
For 10% it will be 10.100 , here when you get 3 digit number as square ,just take
one carry and 10.100 will become 11.00
Similarly for 11%; it will be 11.121 = 12.21
For 12%, it will be 12.144 = 13.44 and so on.

How to remember interest rate for third year?

Method for calculating third year rate is same as I have mentioned before .There
is no method for directly writing third year rate so you will have to remember this
part. Initially I also found it difficult but trust me its very easy and we only need
to remember up till 15% because we are rarely asked question with rate of
interest more than 15%.
Lets see one more time the method of calculating rate for third year.
Lets say rate is 5%
So first yr rate=5% ; second yr rate= 5.25 ; therefore third yr rate= 5.25 +
5.25*5/100
=5.51 % .I am providing you table for second year and third year rates for
common interest rates with this post.
Rate : first year
3
4
5
6
7
8
9
10
12

Second year
3.09
4.16
5.25
6.36
7.49
8.64
9.81
11
13.44

Third year
3.18
4.32
5.51
6.74
8.01
9.33
10.69
12.1
15.05

15

17.25

19.83

There is one more method of calculating CI after 3 years but it is an

approximation method. Answer we get from this method is usually less than the
actual CI but this method comes handy in exams when CI answer options are not
close , then we can always estimate our answer.
Approximation method for CI after 3 years:
Recall our question of P=1000, rate=10% and time =3 years.
For our method we need total interest after 3 years to calculate CI.
So first multiply rate with time= 10*3= 30
Now multiply this 30 with the rate again= 30*10=300
So our total interest = 30.300 and take this 3 carry {we wrote first product
before decimal and second product after decimal}
Total interest= 33.00
So our CI= P/100 * Total interest= 1000/100 * 33 =330
Actual CI would have been = 1000/100 * 33.1= 331
You can observe that we approximation we got 330 as answer which is obviously
less than 331.
Approximation and actual CI calculation are quite close for lower rate of interest
but as you get higher with rate of interest, the gap is bigger. So this method is
only advisable in case where rate of interest is on lower side or options are not
close and there is a possibility of approximation.

Another important formula in this chapter is for the difference in CI and

SI
So CI-SI for two years is = P (r/100)^2
CI SI for three years= P (r/100)^2 * (r/100 + 3)
or CI SI for 3 years= CI-SI for two years * (r/100 +3)
One direct formula to find rate (r ) when CI and SI for two years is given
CI /SI = (r+200)/200