The Future Value (FV) is the amount of money an investment will grow to over a period of time, at a given interest rate (r).

A good understanding of the Time Value of Money will help you in making better decisions when faced with questions similar to those above.

The FV formula for the single period case may be stated in the following ways: FV = PV + PV * r FV = PV(1 + r)

Simple interest is the interest that one earns only from the initial capital (principal). This is the interest that you would earn in a bank account that takes out the interest earned and only renews the time deposit for the capital.

Some authors use the term compound interest only to refer to the interest on interest). The calculation of Future Values that include the interest on interest is called compounding.

Present Value formula is simply an algebraic restatement of the Future Value formula.

Where FV is the cash flow at the end of the first period and r is the interest rate. PV = FV / (1 + r)

Time value of Money problems in real life are seldom made up of single cash flows. Usually problems will involve numerous cash flows at different points in time. 

In order to deal with these types of problems we must learn how to deal with cases made up of a number of separate cash flows.

Someexamples of thesetype of cash flows include installment payments for the purchase of long-lived assets (refrigerators, cellular phones, TVs or even automobiles), mortgage payments for houses and bond payments.

An annuity is a series of equal cash flows that occur for a given period at regular intervals.

Examples of annuities include loan repayments in installments of equal amounts, interest payments on bonds, mortgage payments, insurance payments, rent payments, etc.

In addition to the ordinary annuities that we have seen, there are also annuities due. Ordinary annuity refers to annuities, which provide cash flows at the end of the period, whereas annuity due cash flows are at the beginning of the period. A common example of an ordinary annuity could be interest payments of bonds and for an annuity due could be insurance or rent payments.

A perpetuity is an annuity with an infinite life. Perpetuities are also commonly referred to as “consols” due to the fact that they were used by the British Government to consolidate debts(DMO 2014) from the previous years issued to finance military campaigns

A perpetuity is an annuity with an infinite life. The formula is PV=C/r

The periodic rate is the annual rate divided by the number of installments per year and the number of periods is calculated via multiplying the number of installments with the number of years.

Effective Annual Rate (EAR) is the rate which is actually earned on an investment and is the rate that should be used to compare alternatives.

Annual percentage rate (APR) is the stated rate of which banks, credit card companies, mortgage loan officers tell you they charge.

Pure discount loans are the most basic type of loans. The borrower pays a lump sum at maturity which includes the interest and principal.

Amortizing loans is another common type of loan where the initial amount borrowed and interest is repaid in equal periodic installments.