Compound Interest

Compound Interest refers to interest calculated not only on the principal but also on previously accumulated interest, i.e., 'interest on interest.' In foreign trade, compound interest is commonly seen in usance letters of credit, buyer's credit, deferred payment, and overdue penalty interest, especially when the contract stipulates compound interest, which significantly increases the debtor's funding cost. Usage scenarios include: exporters providing deferred payment financing to importers with an agreed annual interest rate compounded monthly; banks charging compound penalty interest on overdue L/C payments; or long-term loans between foreign trade enterprises. Precautions: It is necessary to specify the compounding period (e.g., daily, monthly, quarterly, yearly) and the interest rate type (fixed or floating), and comply with relevant national laws on the upper limit of compound interest (e.g., China prohibits compound interest in private lending, but financial institution loans may stipulate it). The difference from Simple Interest is that simple interest is calculated only on the principal, while compound interest adds interest to the principal for repeated calculation; over long periods, compound interest returns or costs are much higher than simple interest. Foreign trade practitioners should clearly define compound interest clauses in contracts to avoid ambiguity.