2.

Time Value of Money

(Lectr.2)
Tehmina Akbar
 • Present value: The value today of a future cash flow or series of cash flow.

• Discounting : The process of finding the present value of a cash flow or a

series of cash flows. Discounting is the reverse of compounding.

Present
Value (PV)
TimeLine of
Finding PV
 • What is the present value of a security that
Example promises to pay you Tk.5000 in 20 years?
Assume that you can earn 7 percent if you
were to invest in other securities of equal
risk.
Solution
Solution
(Contd.)
Alternative
Formula of
PV
Finding Interest Rate ( i = ?)
Way of finding
Interest Rate
(i)
Equation of n
Annuity

• An annuity is a series of equal dollar payments that are made at the end or beginning of
equidistant points in time.
Characteristics
• An annuity is a series of payments
• It has fixed intervals of time.
• It has a limited life time.
• The payments (deposits) may be made weekly, monthly, quarterly, yearly, or at any other
interval of time.
• The valuation of an annuity entails concepts such as time value of money, interest rate, and
future value.
Example of Annuity

Examples of annuities are

• regular deposits to a savings
account,
• monthly home mortgage
payments,
• monthly insurance payments
and
• pension payments etc.
Types of Annuity

• There are two types of annuity formulas.

1. Ordinary Annuity
2. Annuity Due
We will derive the ordinary annuity formula first.
Ordinary Annuity

• If a series of payment is
made at the end od each
payment period, then it
is an Ordinary Annuity.
One formula is based on
the payments being
made at the end of the
payment period. This
called ordinary annuity.
FV of Ordinary Annuity
(Future Value of an Ordinary Simple Annuity)
Assume that there are four(4)
annual $1000 payments with
interest at 4%
 FV of an
Ordinary
• • FVn = FV of annuity at the end of nth period. Annuity
• • PMT = annuity payment deposited or received
at the end of each period
• • i = interest rate per period
• • n = number of periods for which annuity will last
 FV of an Ordinary Annuity
• Example: How much money will you accumulate by the end of year
10 if you deposit $3,000 each for the next ten years in a savings
account that earns 5% per year?

• FV = $3000 {[ (1+.05)10 - 1] ÷ (.05)}

= $3,000 { [0.63] ÷ (.05) }
= $3,000 {12.58}
= $37,740