Q:

What does it mean when interest is compounded semiannually?

A:

Quick Answer

When interest is compounded semiannually, it means that the interest on an account is computed and added to the account's balance every six months, according to the Department of Mathematics at the University of Hawaii at Manoa. This new balance is then used to compute the next interest amount.

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Full Answer

The Department of Mathematics lists the formula for computing the compound interest rate as the nominal rate of interest (the annual percentage rate) times the compounding period for that year, as shown in fraction form. For a semiannual rate, that fraction is 1/2. This rate is then multiplied by the balance at the beginning of the compounding period to determine the interest amount. The interest amount is added to the balance, along with any other deposits made to the account during the compounding period, to create the balance number for the next period.

In this way, the account grows faster and presents a greater return on investment than an account that uses simple interest that is sent directly to the investor rather than applied directly to the account, notes the Department of Mathematics. For example, a $10,000 investment compounded semiannually at a nominal rate of 10 percent is $11,025 at the end of a year, while the simple interest account only ends with $11,000, the balance of $10,000 plus two interest payments of $500 each.

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