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Refers to the calculation of interest on the combined, or compounded, principal and previously accumulated interest. For example, if $100 is deposited at an interest rate of 10 percent after one year the interest will be $10 and principal and interest together will amount to $110. Using simple interest the interest in the second year would be 10 percent of $100, so the principal and interest together would amount to $120. Using compound interest the interest in the second year would be 10 percent of $110, so the principal and interest would amount to $121. In the third year the interest would be 10 percent of $121 so the principal and interest would amount to $133.10.
See also: Simple Interest, Compound Annual Growth Rate