Finc 332 Chap 4

4.1: what is compounding? what is discounting?

1. compounding: accumulating interest in an investment over time to earn more interest (present to future) 2. discounting: discount money back to present (future to present)

Key Future Value Relationships

Assuming positive interest rates, future value is always greater than present value Future value as related to: Present value Time Interest rate

Key Present Value Relationships

Assuming positive interest rates, present value is always less than future value Present value as related to: Future value Time Interest rate Remember the value of a financial asset is determined by its present value

Present Value

Earlier value on the time line Impact of compound interest on present value Process of going from future value to present value is called discounting One period case Multi-period case

Future Value

Later value on the time line Difference between simple interest and compound interest Process of going from present value to future value is called compounding One period case Multi-period case

4.2: as you increase the length of time involved, what happens to future values? what happens to present values?

PV = FV / (1+r)^t FV = PV (1+r)^t PV: as time increases, PV decreases FV: as time increases, FV increases

4.3: what happens to a future value if you increase the rate, r? what happens to a present value?

PV: as r increases, PV decreases FV: as r increases, FV increases

Variables in TVM Equations

Present value (PV) Future value (FV) Time - number of periods (N) Interest rate (I/YR) Payment (PMT) Not all TVM problems have a value for every variable

Time Value of Money Overview

Time Value of Money (TVM) is a key foundational concept in finance A dollar today is worth more than a dollar in the future Time lines helpful in visualizing problems