Finance Chapter 3

What is an annuity?

An annuity is a stream of equal payments that are received or paid at equal intervals in time.

Define compounding.

Compounding is the process of earning interest on interest.

What is the formula for determining the future value of a single sum when using the future value interest factor table?

FV = PV * FVIFi,n

How does your time horizon affect future values?

If you have your money invested for longer periods of time it will grow more, same thing with having debt for larger periods of time.

Describe some instances when determining the present value of an amount is useful.

If you want to have $20,000 for a down payment on a house in three years, then you would want to know how much money you need to invest right now in order to reach that goal based on an interest rate you could earn. If you want to save $2,000 dollars for a vacation in two years, you would want to calculate how much money you would need to invest at that moment.

To what types of cash flows is the time value of money concept most commonly applied?

In general, the value of a given amount of money is greater the earlier it is received. A dollar today has more value than a dollar received in one year. It is commonly involved in investments and spending.

How is it used in financial planning?

It is used in financial planning by growing your savings so over time your have more money in your saving account.

Lakesha recently found out that her credit card balance was compounded daily rather than monthly. How will this compounding frequency impact the outstanding debt she owes on her credit card?

It will rapidly increase the amount of debt she has, as it builds upon itself much faster with a daily compound rather than a monthly one.

Stacey would like to have $1 million available to her at retirement. Her investments have an average annual return of 11%. If she makes contributions of $300 per month, will she reach her goal when she retires in thirty years.

No, she will make $716,475 with these calculations

How is it related to opportunity costs? (Be warned this was completed by Eric)

TVM is something that you must take into account when calculating opportunity cost because even if a opportunity in the future provides more money it still may be better to take a smaller sum now depending on TVM.

What information must be known to find the correct future value interest factor?

The amount of your deposit (or other investment) today The interest rate to be earned on your deposit The number of years the money will be invested

Compounding Frequency

The amount you owes will increase more as the compounding frequency increases. The interest due at the end of each day is added to the amount you owes and the next days interest will be computed on that larger amount.

How does the rate of interest affect future values?

The higher the interest rate, the more your money will grow in the future.

Winston will receive $100,000 on his 25th birthday. Which time value of money concept would you use to compute the value of his future inheritance?

The present value of a single sum

What is the time value of money? (Be warned this was completed by Eric)

The time value of money is the concept that money available at the present time is worth more than the identical sum in the future due to its potential earning capacity

One reason why time value of money is an important concept

The value of a given amount of money is greater the earlier it is received, and you could also put the money in a financial institution and earn interest on it for a longer amount of time

What two methods can be used to calculate future values?

Using the future value table Using a financial calculator

The process of obtaining present values.

You need to know: The future amount of money Interest rate Number of years $ will be invested for

How does deferring student loan payments affect the future value of your debt?

You will accrue interest on the loan and will end up having to pay more, increasing your debt.

In determining the future value of an annuity to be invested monthly over a five-year period, what number of periods should you use?

You would multiply 12 by 5 because you're investing monthly for 5 years... should get 60. Then use 60 as your number of periods.

How can understanding of the time value of money motivate you to save more money?

Your money can grow substantially over time when you invest periodically future value of annuity might encourage you to developing a savings plan because you see the reward as a result of you saving