Time Value of Money

Question 1

Time Value of Money

Answer 1

The value derived from money due to investment and re-investment.

Question 2

Time Preference of Money

Answer 2

The preference of money now versus in the future

Question 3

Reasons for Time Preference of Money

Answer 3

1. Risk: Financial and non-financial risk; uncertainty about receipt of money in the future.
2. Preference for present consumption: Due to urgent need (consumer durable)
3. Inflation: Erodes value of money; a rupee today represents a greater value than a rupee tomorrow
4. Investment Options: benefit of additional cash flows through investment options

Question 4

Methods of Analysis

Answer 4

Compounding: Determining the future value of money based on present value
Discounting: Determining the present value of money based on future value

Question 5

Relevance of TVM

Answer 5

1. Evaluating long-term investment proposals; outflows/ investments undertaken during project commencement t0 compared with inflows/ returns at future points in time t1, t2, t3, etc
2. Meaningful evaluation of investment proposal
3. Trade-off between present cash flows and future cash flows dependent on interest rates due to investment

Question 6

SI and A

Answer 6

SI = P x N x R
A= P [ 1 + (N x R)]

Question 7

CI, A

Answer 7

A= P (1+R) ^(NK)
K= No. of times compounding done per year (monthly 12, quarterly 4)
R= interest rate p.a./ number of payment periods p/a = I/K

Question 8

Rule of 72

Answer 8

72/interest rate= number of years it will take for money to double

Question 9

Effective rate of interest

Answer 9

the rate at which investment grows when interest is credited more than once in a year
E = [(K+i)/k] ^ k - 1

Question 10

Compounding

Answer 10

Finding out the future value of money
1. Single cash flow: Principal (1+R)^n
2. Annuity: P x [( 1+ R)^n -1]/ R

Question 11

Annuity

Answer 11

A stream of regular periodic cash flows for a specified period of time, like recurring deposits, b) life insurance premium

Question 12

Sinking Fund

Answer 12

A sinking fund is a fund containing money set aside or saved to pay off a debt or bond. A company that issues debt will need to pay that debt off in the future, and the sinking fund helps to soften the hardship of a large outlay of revenue.

Question 13

PV

Answer 13

PV (present value of money)
Single cash flow=An ( 1+R)^n
Annuity = An x [(1+R)^n -1]/ [R(1+R)^n]

Question 14

Perpetuity

Answer 14

Perpetuity in the financial system is a situation where a stream of cash flow payments continues indefinitely or is an annuity that has no end. eg: Dividend on Irredeemable Preference Share Capital, Interest on Irredeemable Debt/ Bonds, Scholarships paid from an endowment fund

Question 15

PV

Answer 15

Constant Perpetuity = C/ R (C: Cash flow)
Growing Perpetuity = C/ (R-G) (G:rate of growth in cash flows)