Compound interest is the concept of adding accumulated interest earned back to the original amount invested, so that interest is earned on interest from that moment on. The act of adding interest to the nominal amount is called compounding (i.e. interest is compounded).

A bond for example, may have its interest compounded every year:

A bond with Eur 10,000 nominal and 7% interest per annum would pay interest of Eur 700, therefore the balance would be Eur 10,700 at the end of the first year.

On the second year the interest of 7% would be calculated on Eur 10,700 and therefore the interest recieved would be Eur 749.

On the third year the interest of 7% would be calculated on Eur 11,449 (Eur 10,700 + Eur 749) and therefore the interest recieved would be Eur 801.43. This process would continue until the bond is either redeemed or is sold.

You may use the link below to calculate various scenarios when compounding interest.

Financial Calculator

Compound interest may be contrasted with simple interest, where interest is not added to the principal (there is no compounding). Compound interest predominates in finance and economics, and simple interest is used infrequently (although certain financial products may contain elements of simple interest).