Lesson One Time Value Of Money

Question 1

What is the time value of money?

Answer 1

The concept that money available today is worth more than the same amount in the future due to its potential earning capacity.

Question 2

True or False: A dollar today is worth less than a dollar tomorrow.

Answer 2

False

Question 3

What does ‘discounting’ refer to in finance?

Answer 3

The process of determining the present value of a cash flow that will be received in the future.

Question 4

Fill in the blank: The formula for future value (FV) is FV = PV × (1 + r)^n, where PV stands for ______.

Answer 4

Present Value

Question 5

What does ‘PV’ stand for in the time value of money calculations?

Answer 5

Present Value

Question 6

What is the formula for calculating present value (PV)?

Answer 6

PV = FV / (1 + r)^n

Question 7

True or False: The interest rate used in time value of money calculations is always fixed.

Answer 7

False

Question 8

What is an annuity?

Answer 8

A series of equal payments made at regular intervals over time.

Question 9

Multiple Choice: Which of the following is NOT a factor in calculating future value? A) Interest Rate B) Time Period C) Payment Frequency D) Current Inflation Rate

Answer 9

D) Current Inflation Rate

Question 10

What is the primary reason for the concept of time value of money?

Answer 10

To account for inflation and the opportunity cost of capital.

Question 11

Fill in the blank: The term ‘interest’ refers to the ______ paid for the use of borrowed money.

Answer 11

Fee

Question 12

What does ‘compounding’ mean in the context of finance?

Answer 12

The process of earning interest on both the initial principal and the accumulated interest from previous periods.

Question 13

True or False: Compounding can lead to exponential growth of investments over time.

Answer 13

True

Question 14

What is the effective annual rate (EAR)?

Answer 14

The interest rate on an investment or loan that is compounded annually.

Question 15

What is the relationship between present value and future value?

Answer 15

Present value is the current worth of a future sum of money, discounted at a specific interest rate.

Question 16

Multiple Choice: What is the main purpose of the time value of money concept? A) To increase spending B) To evaluate investment opportunities C) To minimize taxes D) To simplify accounting

Answer 16

B) To evaluate investment opportunities

Question 17

What is the formula for calculating the future value of an annuity?

Answer 17

FV = Pmt × [(1 + r)^n - 1] / r

Question 18

Fill in the blank: The term ‘opportunity cost’ refers to the ______ of a choice in terms of the next best alternative.

Answer 18

Cost

Question 19

What is a perpetuity?

Answer 19

A type of annuity that continues indefinitely and pays a constant amount each period.

Question 20

True or False: The longer the time period, the greater the effect of compounding.

Answer 20

True

Question 21

What is the formula for calculating the present value of a perpetuity?

Answer 21

PV = Pmt / r

Question 22

Multiple Choice: In which scenario would the time value of money be most relevant? A) Saving for a short-term goal B) Comparing loan options C) Determining the price of a stock D) Evaluating a one-time payment

Answer 22

B) Comparing loan options

Question 23

What is the difference between nominal and real interest rates?

Answer 23

Nominal interest rates do not account for inflation, while real interest rates do.

Question 24

Fill in the blank: The term ‘inflation’ refers to the ______ in the purchasing power of money over time.

Answer 24

Decrease

Question 25

What is the future value of a single sum?

Answer 25

The value of a current amount of money at a specified date in the future, based on a specific interest rate.

Question 26

True or False: An increase in interest rates will decrease the present value of future cash flows.

Answer 26

True

Question 27

What factors can influence the time value of money?

Answer 27

Interest rates, inflation rates, time periods, and payment frequencies.

Question 28

Multiple Choice: Which of the following is a common use of the time value of money concept? A) Setting a budget B) Valuing an investment C) Managing expenses D) Hiring employees

Answer 28

B) Valuing an investment

Question 29

What is the primary application of the time value of money in finance?

Answer 29

To assess the value of cash flows at different times in the future.

Question 30

What is the interest rate composed of?

Answer 30

Real risk free interest rate - it is a single period interest rate for a completely risk res security if no inflation was expected in economic theory the real risk free rate in reflects the time preferences of individuals for current versus future real consumption Inflation premium - to inflation premium compensate investors for expected inflation and reflex the average inflation rate expected over the maturity of the death in patient reduces the purchasing power of a unit of currency the amount of goods and services one can buy with it the sum of real risky interested and inflation premium is the nominal risk free interest rate Default risk premium - IT company says investors for the possibility that the borrower will feel to make a promise payment at the contract time and in the contracted amount. It is generally provided in the corporate investment not in the government investment because it is assume that the government will never default Liquidity premium - it compensats investors for the risk of loss relative to an investments fare value if the investment need to be converted to cash quickly. Government tables do not wear a liquidity premium because large amount can be bought and sold without effective their market price. Many bones of small issues by contrast trade in frequently after they are issued the interest rate of such pond in future liquidity premium reflecting the relative high cost of selling a position Maturity premium- compensates investor for the increased sensitivity of the market value of TET to a change in market interest rate as maturities extended the difference between the interested on longer maturity liquid treasury debt and that on the short term treasury debt reflects a positive maturity premium for the long term debt.

Question 31

Fill in the blank: the interest and on original investment is known as ________

Answer 31

Simple interest

Question 32

Compound interest

Answer 32

Compound interest is the interest calculated on the initial principal and also on the accumulated interest from previous periods. It allows investments or loans to grow at a faster rate compared to simple interest, as it takes into account the effect of compounding over time. A=p×(1+r/n)^(n-t)

Question 33

Cash flow patterns

Answer 33

cash flow patterns refer to how cash inflows and outflows occur over time and their impact on present and future values. Different cash flow patterns influence the calculation of TVM and related concepts like present value (PV) and future value (FV). 1. Single Cash Flow Pattern: A one-time payment or receipt at a specific point in time. Example: Receiving $1,000 today (present value). Receiving $1,000 five years from now (future value). 2. Annuity Pattern: Equal payments or receipts at regular intervals for a fixed period. Types: Ordinary Annuity: Payments occur at the end of each period. Annuity Due: Payments occur at the beginning of each period. Example: Monthly loan payments or regular rent payments. 3. Perpetuity Pattern: Equal payments or receipts at regular intervals that continue indefinitely. Example: Perpetual bonds or dividends that are expected to last forever. Key TVM Concept: PV of a perpetuity = Cash flow ÷ Interest rate. 4. Growing Annuity or Perpetuity Pattern: Cash flows grow at a constant rate over time. Types: Growing Annuity: Cash flows grow for a finite period. Growing Perpetuity: Cash flows grow indefinitely. Example: Dividend payments that increase by a fixed percentage annually. 5. Uneven or Irregular Cash Flows Pattern: Cash flows vary in size and timing. Example: Business cash flows from project investments or startup profits. Key TVM Concept: Discount each cash flow individually to find the net present value (NPV): Cf/(1+r)^t + cf/(1+r)^t+1.....

Question 34

True or false: Higher the period lower the rate

Answer 34

True

Question 35

Stated annual interest rate

Answer 35

The stated annual interest rate (SAIR), also known as the quoted interest rate, is the annualized interest rate that does not account for compounding within the year. It is typically expressed as a percentage and is commonly used for loans, investments, and savings accounts.

Question 36

What is the formula for non annual compounding

Answer 36

Fv=pv(1+r/m)^mn

Question 37

Fill in the blank: a) the farther in the future the amount to be received the _________ that amount Pv B) holding time being constant, the ________ the discount rate smallest the PV of a future amount

Answer 37

A) smallest B) larger