Time Value of Money (TVM) Flashcards
What is the time value of money (TVM)?
TVM states that money available today is worth more than the same amount in the future due to its earning potential.
Why does a lender charge an interest rate?
- Risk: Higher for riskier borrowers and longer terms.
- Inflation: Ensures money retains its purchasing power.
- Deferred Consumption: Provides compensation for postponing spending.
Who is typically the safest borrower in a country?
The government, as it is less likely to default compared to companies or individuals.
What is the formula for future value (FV) using simple interest?
FV=C[1+(in)]
- C: Initial capital (principal).
- š : Interest rate (annual, unless specified otherwise).
- š: Number of years or fraction for periods less than a year.
How do you calculate simple interest?
For 1 year: Interest = š¶š
For a fraction of a year:
Interest=Ci* (Months/12)
ā
.
What is the future value of $100 invested at 5% for 3 months?
FV=100ā [1+(0.05ā (3/12)]=101.25
What is the future value of $100 at 5% for 5 years?
FV=100ā [1+(0.05ā 5)]=125
What is compound interest?
Compounding occurs when interest is earned on both the principal and previously earned interest.
What is the formula for future value (FV) using compound interest?
FV=PVā
(1+i)^n
PV: Present Value.
* š: Interest rate.
* š: Number of periods.
How is present value (PV) calculated?
PV= FV/ (1+i)^n
ā
What is the FV of $1000 invested at 8% for 4 years?
FV=1000ā (1.08) ^4=1360.49
What is an annuity?
A series of equal cash flows (payments or receipts) made at regular intervals for a finite period.
What is the formula for the future value of an annuity (FVA)?
FVA= (A/i)*[(1+i) ^n ā1]
A: Annual payment.
š: Interest rate.
š: Number of years.
How much will accumulate if $1200 is invested annually at 8% for 40 years?
FVA= (1200/0.08)*[(1+0.8)^40 -1] =310,867.82
What is the formula for the present value of an annuity (PVA)?
PVA= (A/i)*[1-1/(1+i)^n]
