What does the compound interest refer to?

Answer 1

It means that the interest is added to the capital, before calculating the interest for the next period.

For example - to simplify calculations, I'll use a 10% interest rate, and an initial capital of 1000 dollars:

With simple interest, you get 100 dollars every year, 300 dollars in 3 years (for a total capital of 1300 dollars).

With compound interest, the first year you get 100 dollars interest (10% of 1000).

This is added to the capital, so you have a capital of 1100. Next year, you get 10% of 1100 in interest, i.e., 110 dollars.

Now, your capital is 1210 dollars. The third year, you get 121 dollars capital.

After 3 years, with compound interest, you have a capital of 1331 dollars.

This calculation is simplified with powers: Every year, your capital increases by a factor of 1.1, so after 3 years, you have a total of 1000 x 1.1 x 1.1 x 1.1 = 1000 x 1.13 dollars.