25300 Lecture Notes - Lecture 3: Time-Based Currency, Interest, Compound Interest
A dollar today is worth more than a dollar tomorrow
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A dollar amount today (present value)
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Interest rate
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A period of time
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= dollar amount in the future (future value)
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Variables:
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PV = present value, principal
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i= interest rate
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n= number of periods
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FV = future value
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PMT = periodic payment
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Terminology
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Time line:
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Time value of money (TVM)
Calculate on the original principal (take no account of changes in principal)
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Sometimes called flat rate interest
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i= simple interest rate per year
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n= number of years
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FV= future value at end of term
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PV= principal value at beginning
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INT= interest amount over the time period = PV * i * n
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Future value with simple interest
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Present value with simple interest
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Simple interest
Interest is added to the principal each period (interest on interest, called compounding)
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i= the per period interest rate
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n= the number of compounding periods
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PV= the original principal
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Future value:
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Present value:
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Interest rate increase -> PV decreases
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Interest rate are typically quoted as per annum
Frequency of compounding:
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Compound interest
Lec 3 Time Value of Money 1
F Page 5
Document Summary
A dollar today is worth more than a dollar tomorrow. = dollar amount in the future (future value) Pv = present value, principal i= interest rate n= number of periods. Calculate on the original principal (take no account of changes in principal) Future value with simple interest i= simple interest rate per year n= number of years. Int= interest amount over the time period = pv * i * n. Interest is added to the principal each period (interest on interest, called compounding) Future value: i= the per period interest rate n= the number of compounding periods. Interest rate are typically quoted as per annum. A nominal rate is compounded more frequently than once-a-year. Is an interest rate with annual compounding m= number of compounding periods per year i= interest rate per period. Fv is positively related to the interest rate. Pv is negatively related to the interest rate.
