Almost every introductory finance class starts with time value of money. Its the foundation of finance. In a word, its the idea that holding money now, is better than holding it in the future. It creates the link between having money now (PV) and holding money in the future (FV). Think of it this way, why would you ever give someone $100 if they were going to give you the exact same $100 in the future. You would want to be compensated for them having access to your money. Yeah, I agree this totally falls apart in 2016 where there is between $10 trillion to $12 trillion in negative yielding sovereign debt, but thats a topic for another post.
This is the foundation of interest rates; depositing money in the bank earns you a return. The bank is essentially compensating you for having access to your money. However this principle works in reverse to. If you know the rate, you can calculate what $100 in the future is worth today. The terms: FV = Future Value -- the value that one will receive in the the future PV = Present Value -- The current value of a future payment I = Interest Rate -- the rate of return on the money N = Periods -- the number of periods that the money is being held for The basic equation: FV = PV(1+I)^n Example 1: What is the future value of $1000 that is deposited in a bank account, that pays 6% Interest compounded annually, 3 years from now. Solution: $1191.02 So how did we get there? There are multiple ways to go about solving this. Most people will use either a financial calculator or a graphing calculator with a financial solver to evaluate the problems. But first, lets start with just plugging it into the equation so we can understand how this works. Here is the original Equation: FV = PV(1+I)^n we know everything but the Future Value so its just a case of inserting our numbers into the formula. FV = 1000(1+.06)^3 which gives us the answer of $1191.02 We can use the basic TVM formula to solve for any of the missing variable not just future value and present value.
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