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Lecturer notes on Financial Mana calculations, concepts and theories.
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UNIT 2: TIME VALUE OF MONEYDEFINITION
Time value of money is the concept that money you have now is worth more than the
identical sum in the future due to its potential earning capacity. This core principle of
finance holds that provided money can earn interest, any amount
of money is worth more the sooner it is received.
TIME VALUE OF MONEY TERMINOLOGY
Future value: This is a value in rands that an investment or series of
investments will grow to over a stated time period at a specified interest rate.
Compound interest: This is the addition of interest to the principal sum of a
loan or deposit.
Ordinary Annuity: is a series of equal payments paid at the end of each period
for defined amount of time.
Present value: the value of an investment at the beginning of a period,
sometimes referred to as principal sum.
Simple interest: This is the money you earn by initially investing some money.
Annual Effective Rate
It is useful to be able to convert a quoted or nominal interest rate into an effective
interest rate for many reasons, particularly in order to compare investment
alternatives with different compounding periods We can accept that two interest
rates are equivalent if they have the same effect, that is, if a single amount invested
at one rate and compounded annually for a length of time accumulates to the same
future value as another rate compounded more frequently The effective annual rate
of interest is the annual rate that if compounded once a year would give us the same
result as the interest per period compounded a number of times per year. The
annual effective rate formula will be given below under formulae.
The concept of time value of money is based on three fundamentals:
Compensation for the time value of money. From the lender’s
point of view, this represents the opportunity cost of forfeiting
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