Time Value of Money
present value (beginning value)
the current value of a future amount of money to be received later
interest
the fee charged by a lender of money to the borrower. It is a rental fee to use someone else's money
Calculator signs
(N): number of time periods (I/Y): interest rate (PV): present value (PMT): payment (FV): future value
In finance, the concept that helps us understand how money grows exponentially over time or how to calculate a car payment is called:
time value of money.
When investing, you can expect to earn most of the interest in the later years because:
you earn interest on the interest.
Understanding the time value of money is fundamental to making good financial decisions like...
Buy a car Purchase a house Decide where to save or invest your money
simple interest
Interest earned only on the original principal amount invested
lump sum
a one-time payment or a single amount of money
4 types of TVM problems:
future value of lump sum (one-time deposit today, how much will it be worth in the future) present value of lump sum (some amount of money in the future, what was it worth today?) future value of annuity: (how much is that series of payments worth in the future?) present value of annuity: (how many is it worth right now?)
Compounding
interest calculated on the principle as well as any interest accumulated from previous periods
Annunity
series of equal payments
principle
the amount of money borrowed or lent, not including interest
future value (ending value)
the future value of a time value of money calculation
compounding periods (compounding frequency) per year:
Annual (once per year) Semiannual (twice per year) Quarterly (4 times per year) Monthly (12 times per year) Weekly (52 times per year) Daily (365 times per year)
interest rate per period
interest rate by the number of compounding periods per year: Annual (divide by 1) Semiannual (divide by 2) Quarterly (divide by 4) Monthly (divide by 12) Weekly (divide by 52) Daily (divide by 365)
find the total number of compounding periods.
multiply the number of years by the number of compounding periods per year Annual (multiply by 1) Semiannual (multiply by 2) Quarterly (multiply by 4) Monthly (multiply by 12) Weekly (multiply by 52) Daily (multiply by 365)
Ultimately, you...
must have agreement among the time periods, the interest rate, and the payments.
Jalen invested $100 and let it earn interest at 5% for five years. When he withdrew his money, there was $125 in the account. This account:
paid simple interest.
time value of money (TVM)
the idea that money is worth more today than the same amount of money in the future. money today can earn interest or add value until the specified time in the future.
