Time Value of Money
Time Value of Money (TVM) is a core principle in finance and banking. It states that money available at the present time is worth more than the same amount in the future. This is because money has the potential to grow in value over time. If you have money now, you can invest it and earn interest. For example, if you put ₹1,000 in a bank account today at a 5% interest rate, you will have ₹1,050 after one year. Therefore, receiving ₹1,000 today is better than receiving ₹1,000 one year from now.
Concepts (3)
Discounting is the reverse of compounding. It helps us find the Present Value of money that we expect to receive in the future. We 'shrink' the future amount by a discount rate to see what it is worth today.
Discounting is the reverse of compounding. It helps us find the Present Value of money that we expect to receive in the future. We 'shrink' the future amount by a discount rate to see what it is worth today. This is very important for bankers when they decide how much to lend against future income. For example, ₹110 to be received in one year is worth ₹100 today if the rate is 10%.
An annuity is a sequence of equal payments made at equal intervals. Examples include monthly insurance premiums or yearly pension payments.
An annuity is a sequence of equal payments made at equal intervals. Examples include monthly insurance premiums or yearly pension payments. There are two types: Ordinary Annuity (payment at the end of the period) and Annuity Due (payment at the beginning). Bankers use annuity formulas to calculate EMI amounts for car loans and home loans.
Compounding is the method used to find the Future Value of money. It assumes that the interest earned in one period is added to the principal. In the next period, you earn interest on this new, larger total.
Compounding is the method used to find the Future Value of money. It assumes that the interest earned in one period is added to the principal. In the next period, you earn interest on this new, larger total. This creates a 'snowball effect' where your wealth grows faster over time. For example, ₹100 at 10% becomes ₹110 in year one, and ₹121 in year two.
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