Time Value of Money

Time Value of Money

The first step in understanding the relationship between the value of the money today and the value of money in the future is one must look at how money is invested. One must also monitor how the money will grow over a time based on the investment made. The conclusion based on the investment made will allow one to answer the following question. How much should be invested today to produce a specified future sum of money in the future?

The time value of money (TVM) is the process when money is calculated in the present or future (wikipedia). TVM is based on the assertion that one will prefer to receive a certain amount of money today than the same amount in the future. As a result, when one deposits money in a bank account, one earns interest. Today's earned money has more value than the money that one would earn in the future because of the interest that can build up over time. For example, if $90 today will accumulate to $100 a year from now, then the present value of $100 to be received one year from now is $90.

TVM allows the calculation of present value and future value of money. Present value and future value are different. Both have disadvantages and advantages; depending on how they are used. Of course, present value is what he or she has at this present time. While future value is the amount of money he or she will have at a given time in the future. Furthermore, a bond is composed of two types of payments, annuity and a lump sum return. As a result, when the bond matures one is eligible to receive future payment. Money is believed to be worth more now than in the future. The once a year annuity payment is considered the interest earned for that particular year. Therefore, one must decide if the annuity is going to be paid at the beginning or the end of the year.

Interest rate is the "rent" paid to borrow money (wikipedia). The interest rate earned over a period of time from the principle. Compounded interest is the interest added to the original principle (wikipedia). Due to daily fluctuation of interest rates in the method used, one can lose a great deal of money if the money is not invested wisely. Most people, if asked, would choose to receive $10,000 now rather than later. Any rational person would not defer payment into the future when he or she could have the same amount of money now. At the basic level, the time value of money demonstrates that it is better to have money now rather than later. Although the amount is the same, much more can be done with the money now. Over time, it can earn more interest. The more often interest are compounded, the faster the principle will mature.

Opportunity cost is the value of something in term of a chance