In transactions involving compound interest earned by an invested amount of money (or principal) is reinvested so that it too earns interest. That is, interest is converted (or compounded) into principal and hence there is “interest on interest”.

Interest may be converted into principal annually, semiannually, quarterly, monthly or at any other regular periods of time. The frequent of conversion is a number indicating how many times interest is compounded in one year. The time between two successive conversion of interest is called the conversion period. Thus, if interest is compounded quarterly, the frequency of conversion is 4 and the conversion period is 3 months. The total amount due at the end of the last period is called the compound amount. The different between the compound amount and the original principal is called the compound interest.

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