Time Value of Money
The primary theme of time value of money is that a in hand dollar is treasured as compared to a dollar in future. The time value of money serves as the cornerstone for all other whims in finance. It impacts finance of consumer, government and business. Time value of money are consequences from the fiction of interest.
The value of money in hand is believed as more eminent than the value to put claim on the some amount in the near future. These opinions are due to the following reasons:
1. To lay claim on the delivery of money run a risk of default in the future.
2. Due to price rising prices the real value of money over time is brought down.
3. One can do investment with the money in hand for the future.
The time value of money computes an amount of interest gained over a time period. The time value of money is the cardinal idea in the theory of finance. All of the standard computations for time value of money are inferred from the primary algebraic expression for the present value of a future sum, discounted to the present by an amount equal to the time value of money.
A form of investment with periodic payments is an annuity. The annuitant generates a complete payment consisting of a single sum of money now to get n payments at regularly scheduled intervals over a specific period of time. In such case, there is no return of principal amount. The amount compensated for the annuity should equal the present value of the periodic payments, which is adjudicated by:
PV = A*(1-1/(1+i)^n)/i
Here A = value of a single payment,
i = assumed interest rate over the period of the payments.
A perpetuity is a bond which has no maturity and yields interest forever. It is like an annuity the only difference is that it is marketable and thus the owner can trade it any time. A individual who possesses the bond receives periodic payments, A, for as long as he accommodates it. In essence, n = infinity for a perpetuity. As long assumed interest rate over the period of the payments i.e i > 0, the value of money held decreases with time.
The annuity equation mentioned above demonstrates that the present value of a perpetuity is finite and equal to:
PV = A/i
During 18th century, , , the British console short for consolidated annuities was sold by the government to change over its eminent issues of reformable government bonds to an individual bond. Over the time, the console has had several alterations such as paying 2.5% of its face value to the proprietor per year at present.
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