This blog post was created as a part of the CFA exam review series to help you in your level 1 exam revision, whether done regularly or shortly before your CFA exam.
Time Value of Money (TVM) Explained
USD 100 is worth more today than in a year or two.
So USD 100 today > USD 100 in one year's time > USD 100 in two year's time, and so on...
interest rate = price of money
interest rate = real risk-free interest rate + inflation premium + default risk premium + liquidity premium + maturity premium
Interpreting Interest Rates
Interest rates can be perceived as:
- required rates of return what are the expected future profits from an investment?
- discount rates what is the present value of a certain future amount?
- opportunity costs what future profits do we forgo in favor of current consumption?
The PV & FV Formulas
Present Value (PV)& Future Value (FV)
Formula for the future value:
Formula for the present value:
\(FV_N\) – future value,
PV – present value,
r – periodic interest rate,
N – number of periods.
Characteristicsof PV and FV
A number of relations characterize the present value and the future value:
- The higher PV, the higher FV.
- The higher FV, the higher PV.
- The higher N, the higher FV.
- The higher N, the lower PV.
- The higher r, the higher FV.
- The higher r, the lower PV.
- The more frequent the compounding, the higher the FV.
- The more frequent the compounding, the lower the PV.
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LAST UPDATE: 5 April 2022