Time Value of Money (TVM)

ByAuthor

Introduction: Why Money Today is Worth More Than Tomorrow

Money has the power to grow over time. The Time Value of Money (TVM) is a financial concept that explains why ₹100 today is worth more than ₹100 in the future. The reason is simple: you can invest today’s money and earn interest on it.

For example, if you put ₹100 in a bank that offers 10% annual interest, after one year, you will have ₹110. In two years, this amount will grow to ₹121. This happens because the money is earning interest, and with time, interest is also earned on the previous interest.

Why is TVM Important?

TVM helps people and businesses make smart financial decisions. It is used for:

  • Saving for the future – Knowing how much your money will grow over time.
  • Investing wisely – Comparing different investment options.
  • Borrowing money – Understanding how much a loan will cost over time.
  • Business planning – Deciding if a project is worth investing in.

Key Ideas of TVM

There are two main ways to look at TVM:

  1. Present Value (PV) – How much a future amount of money is worth today.
  2. Future Value (FV) – How much your money today will be worth in the future.

Interest plays a big role in TVM. It can be:

  • Simple Interest – Earned only on the original amount.
  • Compound Interest – Earned on both the original amount and the interest already earned.
  • “The Time Value of Money is the concept that money available today is worth more than the same amount in the future because of its earning potential.”
    — Dr. Aswath Damodaran, a professor of finance at New York University.
  • “The Time Value of Money means that a dollar today is worth more than a dollar in the future due to the ability to earn a return on that money.”
    — Eugene F. Brigham and Michael C. Ehrhardt, from their book Financial Management: Theory & Practice.

Key Ideas of Time Value of Money:

  1. Present Value (PV): This is how much future money is worth in today’s terms. For example, if you expect to get ₹10,000 in the future, you can calculate how much that amount is worth today.
  2. Future Value (FV): This is how much your money today will grow into in the future if you invest it. For example, if you invest ₹5,000 today, the future value tells you how much that money will become after some time, with interest.
  3. Interest Rate (r): This is the rate at which your money grows. It can be simple or compound:
    • Simple Interest: You earn interest only on the original money you invested.
    • Compound Interest: You earn interest on both the original money and the interest that has been added over time. This helps money grow faster.
  4. Time Periods (n): The length of time (years, months, etc.) for which the money is invested or borrowed.

Simple Formulas:

Future Value Formula:

FV = PV × (1 + r)n

This formula shows how much your money today (PV) will be worth in the future (FV) after growing at a certain interest rate (r) over a certain number of years (n).

Present Value Formula:

PV = FV / (1 + r)n

This formula tells you how much future money (FV) is worth today (PV) when adjusted for the interest rate (r) over time (n).

Similar Posts

|

Understanding Income Statements and Revenue Recognition

ByAuthor

Introduction An income statement shows how much money a company makes and spends. One key part of this is revenue recognition, which means deciding when and how to record income. This article explains revenue recognition in simple terms, with clear examples. Basic Rules of Revenue Recognition Companies follow rules called accrual accounting to record income…

| |

Monetary Policy Reforms in Different Countries: A Comparative Analysis

ByAuthor

Monetary policy is a critical tool for managing a country’s economy, and its framework varies across nations based on economic conditions, institutional structures, and policy objectives. Below is a detailed analysis of monetary policy reforms in India, the United States, the European Union, the United Kingdom, and New Zealand. 1. India: Inflation Targeting and the MPC Background India adopted a…

| |

The Impact of U.S. Protectionist Policies Under Donald Trump on India’s Economy and Trade

ByAuthor

Introduction The re-election of Donald Trump as the 47th President of the United States has once again brought attention to his “America First” policies, which focus on protectionism, trade barriers, and strategic economic nationalism. For India, a key U.S. trading partner, these policies have both economic and geopolitical implications. The U.S.-India trade relationship has seen…

| |

Misconceptions About Monetary Policy

ByAuthor

Monetary policy might seem straightforward—central banks adjust interest rates to control inflation, right? Not quite! Even students who study economics or finance often misunderstand some of the hardest concepts. Let’s break down the 10 toughest misconceptions about monetary policy that even smart minds get wrong! 🚨 Mistake #1: Thinking “Inflation Targeting” Means Keeping Inflation at…

Common Misunderstandings About Asset-Backed Securities (ABS) from an Exam Point of View

ByAuthor

When students study Asset-Backed Securities (ABS) for exams, they often face certain misunderstandings or misconceptions. These misunderstandings can lead to mistakes in answering questions or applying concepts. Let’s break down the most common misunderstandings from an exam perspective and clarify them in simple terms. 1. Misunderstanding: ABS Are the Same as Regular Bonds Many students think that ABS…

| |

The Economics of Geopolitics: How Global Power Struggles Shape Markets

ByAuthor

In an increasingly interconnected world, economics and geopolitics are two sides of the same coin. Nations do not operate in isolation; their political decisions, alliances, and conflicts directly impact financial markets, trade relations, and global economic stability. From the rise of economic warfare to energy politics, understanding how geopolitics influences economics is crucial for businesses,…