Which type of interest is calculated using the principal amount plus accumulated interest from prior periods?

• A. Compound Interest
• B. Simple Interest
• C. Interest
• D. Time Value of Money

Answer: (A)

Interest that grows by earning on both the original principal and the interest earned in prior periods is compound interest. In this approach, each period’s interest is added to the balance, so the next period’s interest is calculated on a larger amount. That creates faster growth over time compared to how simple interest works, which is computed only on the original principal.

For example, $1,000 at 5% for two years: with simple interest you’d earn $50 each year—$100 total—ending at $1,100. With compound interest, after year one you have $1,050; year two adds 5% of $1,050, which is $52.50, bringing the total to $1,102.50. You can see how interest on previously earned interest makes the balance grow more.

The other terms don’t describe this process. Simple interest doesn’t reinvest earned interest, time value of money is a broader concept about valuing money across time, and “Interest” by itself is just a general term rather than a specific method of calculation.