"The time value of money is the widely accepted conjecture that there is greater benefit to receiving a sum of money now rather than an identical sum later."
The concept that a dollar today is worth more than a dollar in the future due to the opportunity cost of not having that money today.
Present Value: Present value is a financial term that refers to the value of a sum of money today, as opposed to some point in the future. It takes into account the time value of money, or the concept that money is worth more today than it will be in the future due to inflation and opportunity costs.
Future Value: Future value is the value of a sum of money in the future, taking into account interest and inflation rates. It is the amount that a sum of money invested today will be worth at some point in the future.
Discount Rate: The discount rate is the interest rate used to determine the present value of a future cash flow. It represents the opportunity cost of money and the rate of return required by investors.
Compound Interest: Compound interest is the interest earned on both the principal amount and any accumulated interest, resulting in exponential growth over time. It is an essential concept in the calculation of future and present values.
Annuities: An annuity is a financial instrument that provides a fixed stream of payments over a specified period. It can be either an ordinary annuity or an annuity due, and its present value and future value can be calculated using time value of money concepts.
Perpetuities: Perpetuities are a type of annuity that provides an infinite stream of payments. They are commonly used in finance and can be valued using time value of money calculations.
Amortization: Amortization is the process in which a loan is paid off over time through regular payments that combine both interest and principal. It involves the calculation of periodic payments based on the time value of money.
Internal Rate of Return (IRR): IRR is a financial metric used to measure the profitability of an investment. It represents the rate of return that makes the net present value of an investment zero.
Net Present Value (NPV): NPV is a financial metric used to determine the value of an investment by calculating the present value of its future cash flows and subtracting the initial investment.
Bond Pricing: Bond pricing refers to the process of determining the value of a bond by calculating its present value based on the bond's interest rate, time to maturity, and face value. It is an essential concept in fixed-income securities.
Time Horizon: The time horizon is the length of time over which an investment is expected to yield returns. It is an important factor in time value of money calculations as it affects the future and present value of cash flows.
Opportunity Cost: Opportunity cost refers to the cost of choosing one investment over another. It is the return of the best alternative investment that is forgone.
Risk and Return: Risk and return are two fundamental concepts in finance. Risk refers to the possibility of loss or uncertainty, while return refers to the profit or income earned from an investment.
Capital Budgeting: Capital budgeting is the process of determining whether to invest in long-term projects or assets by comparing the project's present value to its future cash flows.
Capital Markets: Capital markets are markets where long-term financial instruments such as bonds and stocks are traded. Time value of money concepts are essential in the pricing and valuation of these instruments.
Continuous Compounding: Continuous compounding is a method of calculating compound interest where the interest is calculated continuously, resulting in a higher return compared to interest calculated at fixed intervals.
Nominal vs. Real Interest Rates: Nominal interest rates are the rates at which money grows before adjusting it for inflation, while real interest rates are adjusted for inflation, providing a more accurate measure of investment return.
Inflation: Inflation is the increase in the general price level of goods and services over time. It is an essential consideration in time value of money calculations as it reduces the purchasing power of money over time.
Time Preference: Time preference is the concept that people generally prefer to have money sooner rather than later, and therefore value money received today more than money received in the future.
Time Value of Money Formulas: There are several formulas used in time value of money calculations, including present value, future value, annuity, perpetuity, and loan payments. Understanding and applying these formulas are essential when learning about time value of money.
Present Value: The value of a future sum of money discounted to its current value.
Future Value: The value of the current sum of money after it has earned interest and compounded over a period of time.
Annuity: A series of equal payments occurring over a period of time.
Perpetuity: An infinite series of equal payments.
Growing Annuity: A series of payments that increase over a period of time.
Growing Perpetuity: An infinite series of increasing payments.
Payback Period: The amount of time it takes for an investment to pay for itself.
Internal Rate of Return: The discount rate at which the net present value of all cash flows equals zero.
Net Present Value: The difference between the present value of cash inflows and the present value of cash outflows.
Profitability Index: The ratio of the present value of cash inflows to the present value of cash outflows.
Amortization: The process of paying off a debt with regular payments.
Sinking Fund: A fund set up to accumulate money over time to repay a debt.
Time-weighted Rate of Return: A measure of investment performance that eliminates the effects of timing and cash flows.
Modified Duration: A measure of the sensitivity of a bond’s price to changes in interest rates.
Effective Annual Rate: The annual interest rate that takes into account the effects of compounding.
Yield to Maturity: The total return anticipated on a bond if it is held until maturity.
Yield to Call: The total return anticipated on a bond if it is called before it matures.
Present Value of a Perpetuity: The current value of an infinite series of equal payments.
Present Value of a Growing Perpetuity: The current value of an infinite series of increasing payments.
Interest Rate Parity: The theory that the difference in interest rates between two countries is equal to the expected change in exchange rates.
"It may be seen as an implication of the later-developed concept of time preference."
"The time value of money is among the factors considered when weighing the opportunity costs of spending rather than saving or investing money."
"Interest, whether it is on a bank deposit or debt, compensates the depositor or lender for the loss of their use of their money."
"Interest compensates the depositor or lender for the loss of their use of their money."
"Investors are willing to forgo spending their money now only if they expect a favorable net return on their investment in the future."
"The increased value to be available later is sufficiently high to offset both the preference to spending money now and inflation (if present)."
"See required rate of return."
"The time value of money is among the reasons why interest is paid or earned: interest, whether it is on a bank deposit or debt, compensates the depositor or lender for the loss of their use of their money."
"There is greater benefit to receiving a sum of money now rather than an identical sum later."
"The time value of money is among the factors considered when weighing the opportunity costs of spending rather than saving or investing money."
"Investors are willing to forgo spending their money now only if they expect a favorable net return on their investment in the future."
"Interest compensates the depositor or lender for the loss of their use of their money."
"The increased value to be available later is sufficiently high to offset both the preference to spending money now and inflation (if present)."
"See required rate of return."
"The time value of money is among the factors considered when weighing the opportunity costs of spending rather than saving or investing money."
"There is greater benefit to receiving a sum of money now rather than an identical sum later."
"Interest compensates the depositor or lender for the loss of their use of their money."
"Investors are willing to forgo spending their money now only if they expect a favorable net return on their investment in the future."
"The increased value to be available later is sufficiently high to offset both the preference to spending money now and inflation (if present)."