Module 2: Time Value of Money Flashcards
(22 cards)
What does TMV stand for?
Time value of money
What does TMV mean (definition)? why is it so?
The same amount of money in different periods has different values, and it is due to the concept of opportunity costs
If you keep money as cash in your wallet, then…
you forgo opportunity to earn interest on it if the money is invested
What is interest? (two definitions)
- it is the reward for lending money or the cost of borrowing it
- it is the difference between the amount loaned and the amount repaid
The amount of money today __ can be related to the future amount __, by the interest amount __ and the help of interest rate __.
P;F;I;i
What does P represent?
Present worth
What does F represent?
Future worth of P
What does i represent?
interest rate
What is the formula for Future worth (F)?
F = P + I
= P + P(i)
= P(1+i)
What is the dimension of an interest rate (units)?
(dollars/dollars)/time
If $1 is lent at a 10% interest rate, then what would be paid in interest per time period?
$0.10/year
What is “interest period”?
it is the amount of time between when interest is calculated
What does the interest period “Semiannually” mean?
interest is calculated twice per year (aka once every 6 months)
What does the interest period “Quarterly” mean?
interest is calculated four times per year (aka once every 3 months)
What does the interest period “Monthly” mean?
interest is 12 times per year (aka every month)
What does the interest period “Weekly” mean?
interest is calculated 52 times per year (aka every week)
What does the interest period “Daily” mean?
interest is calculated 365 times per year (aka every day)
What does the interest period “Continuously” mean?
For infinitesimally small periods
What does compounding mean? give quick example
It is a process that involves more than 1 period of calculations.
- think of it like this. Each time interest is added, it becomes part of your existing total, and next time, you earn interest on that new total.
Ex: you invest $100 at 10% interest. After 1 year, you’ll have $110. After 2 years, you’ll have an additional 10% of the $110, totalling to $121. After 3 years, you’ll have 10% of $121, totalling to $133.10.
Why is compounding good when investing?
because it grows your money faster each time, as you’re earning interest on top of interest
The conventional approach for computing interest is _____ ____.
compound interest
