Time Value of Money
“One of the basic principles of finance is the time value of money. This essential insight allows us to make several important calculations that are fundamental to financial management. The time value of money concept states that a dollar received today is worth more than a dollar received in the future” (Freeman, 2000). This is because interest can be earned on a dollar received today. The money today can be invested to earn interest and therefore will be worth more in the future. Time value of money (TVM) is the process of calculating the value of an asset in the past, present, or future (Brealey, Myers, & Marcus, 2007, 89). This paper will briefly address how annuities affect TVM and investment outcomes, the impact of interest rates and compounding, present value, future value, opportunity cost, and the rule of 72 on the time value of money.
Annuities
The term annuity is used in finance theory to refer to any terminating stream of fixed payments over a specified period of time. The term is derived from the word ‘annual’, which would mean an equal series of payments or deposits made annually; however, in finance the annuity could be monthly, quarterly, semi-annually, or any equal time period. An annuity is an evenly spaced number of payments or money received in the same amount (Brealey, Myers, & Marcus, 2007, 95).
Interest Rates and Compounding
Interest is a fee paid on borrowed capital. By far the most common form in which these assets are lent is money, but other assets may be lent to the borrower. Interest is the multiplier that makes the fact that money has a time value a true statement. Interest rates are the percentage of initial investment or loan received or charged during a period of time. Simple interest is comp ...