01 TVM

Time Value
of Money
Would you prefer to
have ₹ 1 crore now
or ₹ 1 crore 10 years
from now?
Terminology
of Time
Value of
Money
Future Value
An amount of money at
some future time period.
Period
A length of time
(often a year, but
can be a month,
week, day, hour,
etc.)
Interest Rate
The compensation
paid to a lender (or
saver) for the use of
funds expressed as a
percentage for a
period (normally
expressed as an
annual rate).
Discount Rate
The rate of return used to discount future cash
flows back to their present value.
Time Value of Money
• The value of money changes

with change in time.
• A rupee received today is
more valuable than a rupee
received one year later.
– Present Value concept
(PV concept)
– Future or Compounding
Value concept (FV
concept)
Time Value of Money
Reasons for Time Preference of Money
Uncertain future Risk involvement Present needs
Return
• Note: Annuity means series of constant cash flows starting from first year to nth year
(say up to 5th year, 10 years etc.).
Future
Value of a
Single
Amount
Compounding interest is defined as
earning interest on interest.
Compounding
Simple interest is interest earned
vs. Simple on the principal investment.
Interest
Principal refers to the original
amount of money invested or saved
Future
Value of a You have ₹1,000 today and you deposit it with a
financial institution, which pays 10 per cent
Single
interest compounded annually, for a period of 3
years. What is the total amount after 3 years?
Amount
Future value of a
single cash flow
FVn = Future value n years

PV = Present Value (cash today)
i = Interest rate per annum
n = Number of years for which compounding
is done
If you deposit ₹10,000 today in a
bank which pays 12% interest
Example compounded annually, how much
will the deposit grow to after 10
years and 12 years?
Doubling period
• How much time is

required to double my
investment?
• The length of period
which an amount is going
to take o double at a
certain given rate of
interest.
Rule of 72
If you deposit ₹10,000 today at 6
per cent rate of interest, in how
Example-1 many years will this amount
double? Workout this with the rule
of 72.
Rule of 69
If you deposit ₹20,000 today at 6
per cent rate of interest, in how
Example-2 many years will this amount
double? Workout this with the rule
of 69.
Interest may have to be
compounded more than once a
year.
Multiple
Compounding
Periods Example: Banks may allow interest
on quarterly or half yearly basis; or
a company may allow compounding
of interest twice a year.
Formula
FVn = PV×(1+ )m x n
FVn = Future value n years
PV = Present Value (cash today)
i = Interest rate per annum
n = Number of years for which
compounding is done
m = Number of times compounding is
done during a year
Example-3
Calculate the compound vale of ₹10,000 at the end of 3
years at 12% rate of interest when interest is calculated
on
– Yearly basis
– Half yearly basis
– Quarterly basis
Effective Vs. Nominal Rate
• Effective Interest rate: The percentage
rate of return on an annual basis. It
reflects the effect of intra-year
compounding. (Ex. 12.36%)
• Nominal Interest rate: Interest rate
expresses in monitory terms. (Ex. 12%)
Formula
ERI = (1 + )m – 1
ERI = Effective Rate of Interest
i = Nominal Rate of Interest
m = Frequency of compounding per year
Example-4 A bank offers 8 per cent nominal rate
of interest on deposits. What is the
effective rate of interest if the
compounding is done
i) half yearly
ii) quarterly &
iii) monthly
Example - 5
Suppose you deposit ₹1,000

Future annually in a bank for 5 years and
your deposits earn a compound
Value of an interest rate of 10 per cent. What
will be the value of this series of
Annuity deposits (an annuity) at the end of 5
years?
• 1000 (1.1)4 + 1000 (1.1)3 + 1000 (1.1)2 +
1000 (1.1)1 + 1000
• 1000 (1.4641) + 1000 (1.331) + 1000 (1.21) +
1000 (1.1) + 1000
• 6,105
Formula
(1 + i)n – 1
FVAn = A -----------
i
FVAn = Future value of an Annuity n years
A = Constant periodic flow
i = Interest rate per period
n = duration of the annuity
(1 +.1)5 – 1
FVA5 = 1000 --------------------
.1
Example - 6
Suppose someone promises

to give you ₹1,000 three
Present Value of a years hence. What is the
Single Amount present value of this
amount if the interest rate
is 10 per cent?
Formula
PV = FV x ( )
FV = Future Value
i = Interest rate
n = duration of the Annuity
Example - 7
Present Value of
An Annuity
• 1000 (1/1.1) + 1000 (1/(1.1)2) + 1000 (1/(1.1)3)
• 1000x.909 + 1000x.826 + 1000x.751
• 2486
Formula
Sinking Fund
It is an account earning compound interest into which
you make periodic deposits.
Example-8
Solution
Example-9
Mr. Lohit wants to set up an education account
for his child and would like to have ₹7,50,000
after 15 years. He finds an account that pays
5.6% interest, compounded semi-annually, and
he would like to deposit money in the account
every six months. How large must each
deposit be in order to reach his goal?
Solution
( ) ∗
FV = A *
A = FV *
( ) ∗
• FV= 7,50,000
• i = 5.6%
• m=2
• n = 15
Example (annuity)-10
Jai has just won the lottery and decides to take the 20 year
annuity option. The lottery commission invests his winnings in
an account that pays 5.8% interest, compounded annually.
Each year for those 20 years, Jai receives a check from the
lottery commission for ₹12,50,000. What is the present value
of Jai’s winnings? (Notice that this would be the amount that
Jai would get if he chose the lump-sum option). What is the
total amount of money that Jai gets over the 20 year period?
PV = A *
• A = 12,50,000
Solution • i = 5.8%
• n = 20
• m=1
Example
(annuity)-
11
Solution

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Time Value

• The value of money changes

Uncertain future Risk involvement Present needs

FVn = Future value n years

• How much time is

Suppose you deposit ₹1,000

Suppose someone promises

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