Key Terms
Time value of money (TVM)
The concept that money today is worth more than the same amount in the future.
Future value
What a present amount grows to over time at a given interest rate.
Single-period example
$1,000 at 4% for 1 year FV = 1,000 x (1.04)^1 = $1,040
Compound interest
Interest earned on previously earned interest. Simple interest only applies in period 1.
Present value
What a future amount is worth in today's dollars. The reverse of future value.
Or written as
PV = FV x [1 / (1 + r)^n]
Discount rate
The interest rate used to find present value of a future amount.
Four methods available
Equations, financial calculator, Excel, FVIF tables. Tables are obsolete.
Solve
$1,000 grows to $1,125.51 in 4 years. What rate?
Enter
4 N, -1,000 PV, 1,125.51 FV, 0 PMT. CPT I/Y = 3.00%
Inflation
A general rise in prices and decline in purchasing power. Tracked by the CPI (Consumer Price Index), published by the Bu
Positive inflation
Money loses purchasing power over time. Spending now is preferable to spending later if inflation erodes the future valu
Negative inflation (rare)
Prices fall over time. In this case, waiting to spend is actually better.
Nominal rate
The stated rate. Not adjusted for inflation.
Fisher Effect formula
(1 + i) = (1 + R) x (1 + h)