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Bafs s4 Personal Finance CH

This document provides an overview of key concepts related to the time value of money, including future value, present value, the rule of 72, net present value, future value of multiple cash flows, and the differences between nominal and effective interest rates. Some of the key points covered are how future value and present value are calculated using compound interest formulas, how net present value is used to evaluate investments, and that effective interest rates reflect the actual return while nominal rates are standardized.

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206 views3 pages

Bafs s4 Personal Finance CH

This document provides an overview of key concepts related to the time value of money, including future value, present value, the rule of 72, net present value, future value of multiple cash flows, and the differences between nominal and effective interest rates. Some of the key points covered are how future value and present value are calculated using compound interest formulas, how net present value is used to evaluate investments, and that effective interest rates reflect the actual return while nominal rates are standardized.

Uploaded by

api-516803253
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Ch.

1 Time Value of Money

● Future value
○ Compounding (reinvested, make even more profits)
○ Simple interest (no reinvestment, profits: same every year)
○ Future value: usually compounding
■ FV=PVx(1+r)n
○ Effect of compounding: the difference of compounding and simple
○ ⬆️principal/interest rate/number of periods, ⬆️FV

● Present value
○ Discounting (reverse of compounding)
○ Present value (the current value of an amount of money you will receive/pay in
the future)
■ PV=FV/(1+r)n
○ Interest rate(to calculate PV): discount rate/cost of capital/opportunity cost
○ ⬆️principal, ⬆️PV
○ ⬆️interest rate/number of periods⬇️PV
● Rule of 72
○ years to double an investment(approximation) = 72 / annual rate of return in
percent(the number before the % sign)

● Net present value (Multiple cash flows) (purpose: helps to determine if it’s a
worthwhile investment)
○ Initial/upfront cost (year 0)
○ Residue/scrap/salvage value (year 3)
○ Inflows(+)/outflows(-)
○ *draw timeline 0——1——2——3
○ Invest?
time weighted value NPV > 0

time weighted loss NPV < 0

neutral, consider other factors e.g. qualitative factors NPV = 0


■ If NPV is greater than cash flow therefore there’s time-weighted value ➡️
invest
■ If NPV is less than 0, there’s a time weighted loss ➡️✖invest
️

● Future value (Multiple cash flow)


○ Timeline 0——1——2
○ contribute money each year ➡️- money contributed ➡️money raised

● Nominal vs. Effective rate of return


○ Rate of return: (%) (how much profits will the investor earn) (=yield)
○ Effective return: the true/actual return an investor will earn
○ Interest-bearing period: e.g. compounded four times a year ➡️3 months
○ Compare different banks that have different interest-bearing period
● Nominal interest rate
○ The rate written on the document or financial security
○ All investors usually have the same nominal rate
● Effective interest rate
○ Reflects the actual return from the financial security
○ Used to compare different interest plans
○ May be different for each investor

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