Introduction:
Regardless, if you are a finance professional, a student, or someone who works outside the financial and economic industry, it is important to understand the fundamentals of “Time Value of Money”. It is axiomatic that a present value of a dollar today is worth more than the value of it in the future. In its basics, it is consisted of interest rates, the periodicity, number of years, a certain coupon rate, and a face value. As referenced before, there is an excel model attached below the post, which would allow you find the yield, present value, future value, and/or payments. The calculations, shown in the next bolded line, are demonstrations on how money literally changes in value (in real terms). Therefore, to help distinguish your returns of any investments you make, do understand the Time Value of Money. Two Fundamental Equations: (increase in rates, decrease in the present value) 1. Future Value = PV * (1+i) ^n 2. Present Value = FV/ ((1+n) ^n) 3. EAR = Effective Annual Rate = [1+ (periodic interest rate/m)^m] -1; Rate that accounts for the effect of compounding interest, which differs from Annual Percentage Rate (“APR”) which accounts for annual interest. 4. Continuous compounding EAR=e^r-1 Instructions for the Spreadsheet: Specific instructions are provided in the spreadsheet download. Overall instructions are the following: 1. The yellow highlighted cells are intended to signal the user where to input their assumptions. 2. The purple highlighted cells would pull the assumption references to give the answers. 3. If you want a shortcut to delete the data from the yellow tabs, you may click on the macro button (“Reset”) to return to your default settings. Takeaway: This post was not intended to necessarily be a lesson on the Time Value of Money principles, but rather briefly discuss the reasons of why it is important. Moreover, it was meant to provide the excel spreadsheet tool as a means to help better optimize your analysis, improve efficiency for basic calculations, and of course, to better your economic self.
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