Chapter 4: Time Value of Money Flashcards
What is the Time Value of Money (TVM)?
The Time Value of Money (TVM) is the concept that money available today is worth more than the same amount in the future due to its earning potential.
What is Accumulated Value?
The Accumulated Value is the total amount of money at a future date, including the initial principal and any interest or returns earned over time. It reflects the growth of an investment or savings due to interest accumulation.
What is Simple Interest?
Simple Interest is the amount of interest you earn only on the original money you invested or borrowed. It doesn’t include interest on the interest that builds up over time.
What is the formula for calculating the future value with Simple Interest?
Future Value =C (1+n*i)
where C is the principal amount, i is the interest rate per period, and n is the number of periods.
What is Compound Effective Interest?
Compound Effective Interest is the interest rate that accounts for compounding over time. It reflects the total interest earned or paid when interest is calculated on both the principal and previously accumulated interest.
What is the formula for calculating the future value with compound interest?
Future Value =C*(1+i)^n
Where C is the initial amount, i is the interest rate per period, and n is the number of compounding periods.
What is accumulation in finance?
Accumulation is the process of growing an investment or savings by adding interest to the principal, which then earns more interest over time.
What is the formula for the Accumulation Factor between two payment streams, T1 and T2?
A(T1, T2) = Capital 2 / Capital 1
What does “effective” mean in the context of interest rates?
In finance, “effective” refers to the actual interest rate after accounting for compounding. The effective interest rate reflects the true rate of return or cost, showing the real impact of interest over time.
What is nominal interest?
Nominal interest is the stated interest rate on a loan or investment, not accounting for compounding or inflation effects. It’s the rate you see quoted, without adjustments for how frequently interest is compounded.
What is Present Value?
Present Value is the current worth of a future amount of money, discounted at a specific interest rate. It shows how much a future sum is worth today, considering the time value of money.
What is the formula for calculating Present Value?
Present Value = Future Value / (1 + i)^n
where Future Value is the amount of money in the future, i is the discount rate, and n is the number of periods.
What is the discount rate in finance?
The discount rate is the interest rate used to calculate the present value of future cash flows. It represents the rate of return required or the cost of capital, showing how much future money is worth today.
What is the difference between discount rate and interest rate?
The interest rate shows how much money will grow over time. The discount rate shows how much future money is worth today. Interest rates are for future growth, while discount rates are for finding present value.
How do you convert between the effective discount rate (d) and the effective interest rate (i)?
To convert from effective interest rate (i) to effective discount rate (d):
d = i / (1 + i)=i*v
v=1-d
