As the name suggests, Time Value of Money (TVM) refers to the concept that money has a time value, meaning that the value of money changes over time due to various factors such as inflation, interest rates and opportunity cost. TVM is a fundamental concept in finance and plays a crucial role in financial decision-making. This post will cover the basics of TVM and answer some of the most popular questions regarding it.
Future Value (FV) of money refers to the value of an asset or investment at a specific point in time in the future, based on an assumed interest rate. In other words, FV is how much your investment will be worth in the future after compounding interest rates over time.
Present Value (PV) of money refers to the current value of an asset or investment, based on an assumed interest rate. In other words, PV is how much your investment is worth today.
Compounding Interest Rates refer to when interest is calculated on both the principal amount and accumulated interest from previous periods. This means that over time, your investment grows at a faster rate due to compounding.
Discounting Cash Flows refers to calculating the present value of future payments or cash flows by taking into account an assumed discount rate. This allows us to compare different investments with varying payment schedules or maturities.
Annuity Payments refer to a series of equal payments made at regular intervals over a set period. Annuity payments can be either ordinary annuity or annuity due, depending on when payments start.
TVM affects financial decisions by helping investors compare different investment options by taking into account the time value of money. By knowing the present value or future value of an investment, investors can make informed decisions on whether to invest in a particular asset or not.
Some practical examples of TVM include calculating the cost of borrowing, comparing mortgage rates, and evaluating investment opportunities.
Overall, understanding the concept of Time Value of Money plays a crucial role in financial decision-making. By knowing the Present Value and Future Value of an investment, investors can make informed decisions that appreciate over time.
