UNIT 3: TIME VALUE OF MONEY
INTRODUCTION
We know that money has two general purposes: it serves as a store of value and as a
medium of exchange. The term time value of money refers to all aspects of converting
the value of cash flows at one point of time to their equivalent values at another time. It is
important that we know the value of current and future cash flows to facilitate the
financial planning process.
In Unit Two, we discussed the factors that are used to calculate interest rates and the
market conditions that influence the level of interest rates. In this unit, we focus on the
application of interest rates to specific debt instruments. You will learn how to calculate
the future value of cash in hand, given different interest rates and payment schedules. You
will also learn how to calculate the present value of future cash flows.
UNIT OBJECTIVES
When you complete this unit, you will be able to:
·
Explain how and why the value of money changes over time
·
Calculate simple and compound interest to determine the future value of
debt instruments
·
Discount future cash flows to present value for comparison with other cash
flows