FinanceLesson 2 of 2 in the course Time Value of Money I: Single Payment Value

Time Value of Money: Discounting, Compounding, Inflation, and Financial Choices

5 flashcards · 5 quiz questions · 5 match pairs · 5 fill-in sentences · English

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Summary

Present value helps you determine how much money you need today to meet a future financial goal. This lesson introduces discounting, the discount rate, and the present value equation.

Future value describes how money invested today grows over time. Present value reverses that process: it translates a future amount into its equivalent value today. This process is called discounting.

All flashcards

Present value interest factor (PVIF)
The factor 1/(1+r)n1/(1+r)^n used to convert a future amount into present value.
Nominal and real interest rates
A nominal rate is stated before inflation adjustment; a real rate reflects changes in purchasing power.
Compound interest
Interest earned on the original principal and on previously accumulated interest.
Rule of 72
A shortcut that estimates doubling time by dividing 72 by the annual rate in percent.
Expected return and risk
An expected return is not guaranteed; greater uncertainty generally requires compensation.

Quiz questions

  1. What is the present value of $20,000 due in one year at a 5% annual discount rate?Answer: Approximately $19,047.62.
  2. With principal, quoted annual rate, and term held constant, what is the effect of more frequent compounding?Answer: It produces a slightly higher future value.
  3. What nominal rate corresponds to a 6% real rate and 2% expected inflation under the Fisher relationship?Answer: 8.12%.
  4. Using the Rule of 72, about how many years does growth at 9% per year take to double?Answer: About 8 years.
  5. What is opportunity cost?Answer: The value of the best alternative given up when making a choice.

Based on Principles of Finance by Julie Dahlquist, Rainford Knight (OpenStax), licensed CC BY 4.0. Adapted into a summary, flashcards and quizzes.

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