Time Value of Money

Topics: Time, Interest, Monetary policy Pages: 5 (1934 words) Published: July 24, 2007
Time Value of Money
The time value of money serves as the foundation for all other notions in finance. It affects business finance, consumer finance and government finance. Time value of money results from the concept of interest. The idea is that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received. Time value of money can be illustrated by the fact that a dollar received today is worth more than a dollar received a year from now because today's dollar can be invested and earn interest as the year elapses. Implicit in any consideration of time value of money are the rate of interest and the period of compounding. This paper will list various financial applications of the time value of money and explain the components of the discount/interest rate. Time Value of Money

The present value of a certain amount of money is greater than the present value of the right to receive the same amount of money in the future. Stanley Block and Geoffrey (2005), state a few essential rules relating to the time value of money: 1. Money has a time value associated with it and therefore a dollar received today is worth more than a dollar received tomorrow, 2. The future value and present value of a dollar are based on the number of periods involved and the going interest rate, and 3. Not only future value and present value be computed, but other factors suck as yield (rate of return) can be determined as well. The concept of the time value of money is essential, not only to large corporations that are looking to make large gains in profits, but to lenders that are expecting to receive the best interest rates on payments for their used capital. In addition, individual citizens research the best securities to invest in order to get the most return on their risk involved. The financial applications that make up the time value of money are vast in the scope represented. Time value of money applications assist with domestic as well as international market transactions. Applications of the time value of money are essential in the following: International Capital Markets, United States Capital Markets, the supply of Capital Funds, the organization of securities markets, and finally, the regulation of securities markets. International Capital Markets are a place where the concept of time value of money is applied. As a result of a growing global economy, "international capital markets have increased in the last decade to become larger, more efficient, and more competitive in the new millennium" (Block & Hirt, 2005). Many companies, especially those from the United States search the international markets in order to raise debt capital and increase company liquidity. Businesses invest in international markets, not to expect a return on present value, but on the expectation of an increased value in the future. The next opportunity for an application of the time value of money is in Government Securities, federally sponsored credit agencies, as well as state and local securities. Government Securities are ways that the, "U.S. Treasury can manage the federal governments debt to balance the flow of funds in and out of the U.S. Treasury" (Block & Hirt 2005). The Treasury sells short –term or long-term securities to cover financial deficits experienced by the U.S. Government. An individual that chooses to invest money in a security offered by the Treasury can expect returns based on the amount of the investment as well as the length of time the investment is held. In addition to Government securities, federally sponsored credit agencies extend capital to individuals that seek to finance homes with Federal Home Loan Banks or Fannie Mae. The US Government also extends credit to college students through programs like the Student loan...

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