Time Value of Money

On this post I will share with you the basic concept of the value of money and its

Most of the information is extracted from TheStreet website´s post What Is the Time Value of Money and Why Does It Matter? by Michelle Rama-Poccia.

Money is worth more more in the present than in the future because there’s an opportunity cost to waiting for it. In addition, there´s also the concept of inflation that gradually is eroding its value and purchasing power.

Important factors: time preference and money being materialized in the future (would you get your money back securely?).

Money interest is an effort to maximize the time value of money.

Measuring time value of money:

Formula: FV = PV x [ 1 + (i / n) ] ^(n x t)

where:

  • (PV) Present Value = What your money is worth right now.
  • (FV) Future Value = What your money will be worth at some future time after it (hopefully) earns interest.
  • (I) Interest = Paying someone for the time their money is held.
  • (N) Number of Periods = Investment (or loan) period.
  • (T) Number of Years = Amount of time money is held

An example:

If you start with a present value of $2,000 and invest it at 10% for one year, then the future value is:

FV = $2,000 x (1 + (10% / 1) ^ (1 x 1) = $2,200

Simple interest: one interval, in other words where N = 1.

Compound interest: various intervals, in other words, where N > 1.

Fixed interest rate: interest rate that will NOT change over time.

Variable interest rate:  interest rate that changes depending on how much benchmark rates rise or fall in the open market.

Anual Percentage Rates: rate that reflects what it will actually cost you to borrow money from a credit card, mortgage or other loan on a yearly basis.

In summary: money received in the present is more valuable than the same sum in the future because of its potential to be invested and earn interest just because you have the money right away and you can do anything you want with it instead of being insecure of losing it.

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