Week 2- Time value of money

Question 1

Why is money worth more today than in the future?

Answer 1

– one could put money in the bank and receive interest
– inflation makes tomorrow’s money less valuable than
today’s
– Also, uncertainty of receiving money in the future, some risk

Question 2

What is compounding? What is interest in interest?

Answer 2

• The process of accumulating interest on an
investment over time to earn more interest
• Interest earned on the reinvestment of
previous interest payments.

Question 3

What is compound interest? What is simple interest?

Answer 3

• Interest earned on both the initial principal
and the interest reinvested from prior
periods.
• Interest earned only on the original principal
amount invested.

Question 4

What is the general formula of investing for t periods? What are future value interest factors?

Answer 4

Vt=V0x(1+i)^t

Future value interest factors: (1+r)^t

Question 5

What is Presenr value?

What is the formula?

What are present value interest factors

Answer 5

• The current value of future cash flows discounted at the appropriate discount rate.

PV=V0=Vt/(1+r)^t

1/(1+r)^t

Question 6

What is discounting?

Answer 6

• Calculate the present value of some future amount.

Question 7

What are the formulas connecting PV and FV

Answer 7

PV x (1+r)^t=FV
PV=FVt/(1+r)^t
PV=FVt x (1/(1+r)^t)
PV=FVt x (1+r)^-t

Question 8

Finding r for multiple periods

Answer 8

FV=PV x (1+r)^n
FV/PV=(1+r)^n
(1+r)=n root (FV/PV)
r= {n root (FV/PV) - 1

Question 9

Finding the number of periods

Answer 9

FV=PV x (1+r)^n
FV/PV= (1+r)^n
ln(FV/PV)=ln{(1+r)^n)}= n x ln (1+r)
n=ln (FV/PV)6ln (1+r) 
n={ln(FV)-ln(PV)}/ln(1+r)

Question 10

What are real and nominal interest rates?

Answer 10

– Nominal prices & rates
• Prices and rates expressed in terms of currency

– Real prices & rates
• Prices and rates expressed in terms of purchasing power

Question 11

Formula of nominal to real

Answer 11

(1+Nr)=(1+rr)*(1+inflation rate)

real rate= (nr-inflation r)/ 1+inflation rate