Time Value of Money

These flashcards cover key concepts related to the Time Value of Money, including definitions of terms and explanations of important processes.

Future Value (FV)

The value of an investment at a specific date in the future, accounting for interest or returns.

Present Value (PV)

The current worth of a future sum of money, calculated by discounting the future amount.

Recurring Periodic Equal Payment (PMT)

Payments that are made at regular intervals and are of equal amounts.

Number of Periods (N)

The total number of payment periods in an investment or loan.

Periodic Interest Rate (i/y)

The interest rate applicable for each compounding period.

Compounding

The process of accumulating interest on previously accrued interest, leading to exponential growth of an investment.

Discounting

The process of reducing the future value of an investment to determine its present value.

Annuity

A series of equal payments made at regular intervals for a specified period.

Perpetuity

An endless series of cash flows occurring at regular intervals.

Ordinary Annuity

An annuity where payments are made at the end of each period.

Annuity Due

An annuity in which payments are made at the beginning of each period.

Effective Annual Rate (EAR)

The actual interest rate earned on an investment when compounding is taken into account.

Amortization Table

A table that shows a loan's repayment over time, detailing the portions going toward interest and principal.

What is the fundamental principle of the Time Value of Money (TVM)?

The principle stating that a dollar today is worth more than a dollar promised in the future, due to its potential earning capacity (interest or returns) and the impact of inflation.

How does increasing the number of compounding periods per year generally affect Future Value (FV), Present Value (PV), and Effective Annual Rate (EAR)?

• FV: Increases (more frequent interest on interest).

• PV: Decreases (a future sum is discounted more heavily).

• EAR: Increases (the actual annual rate goes up).

Distinguish between the 'Nominal (Annual/Stated)' interest rate and the 'Effective Annual Rate (EAR)'.

The Nominal Rate is the stated annual interest rate without considering compounding frequency. The EAR is the actual interest rate earned or paid, accounting for the effects of compounding over the year.

In a standard amortizing loan, describe how the components of each equal payment (PMT) change over the loan's life.

The total PMT remains constant. The portion allocated to Interest decreases over time as the principal balance declines. Conversely, the portion allocated to Principal increases with each subsequent payment.

What is the key distinction between an 'Annuity' and a 'Perpetuity'?

An Annuity is a series of equal payments for a finite, specified period. A Perpetuity is an endless series of equal payments that continues indefinitely.

What are the '5 TVM buttons' (N, I/YR, PV, PMT, FV) used for on a financial calculator?

These are used to solve time value of money problems. Given any four of these variables, you can compute the fifth: N (number of periods), I/YR (periodic interest rate), PV (present value), PMT (payment), FV (future value).

What is the primary function of the 'Net Present Value (NPV)' feature with 'Cash Flow Stream (CFS)' on a financial calculator?

It calculates the present value of a series of uneven future cash flows by discounting them back to the present using a specified discount rate, useful for investment analysis.