Defining compound interest

If you make an investment and hold it for a period of time, the future value of your investment depends on the rate of return over the investment holding period.

For instance, consider an investment of $100 in a simple debt instrument with an annual fixed interest rate of 10.0% and a five-year maturity and where all owed amounts (principal plus interest) are paid in one lump sum at the end of the five year period. The significance of this type of debt instrument is tied to the fact that interest income generated each year is effectively reinvested or added to the amount that is owed, thereby enabling the interest income to compound over the holding period.