Introduction - Time Value of Money
Let’s say that you are given a choice to receive $100 today or $100 one year from now. Which choice will you prefer? The more likely answer is that you will want to receive $100 today. You could purchase something with that $100 today or you could deposit it in a savings account. If you deposit it in a savings account or any other form of investment, what you will get after one year is likely to be more than the $100 that you started with. This means that money is more valuable today than it is tomorrow or after one year.
Another important principle inherent in the time value of money concept is that your investments earn compound interest. The investments that you make will not only earn interest on the original principal but will also earn interest on the interest that has been accumulated over the period.
Your objective in this reading should be to be able to solve the time value problems as quickly as possible using the financial calculator prescribed by CFA Institute. You may be asked to calculate the present value or future value of the cash flows arising from different types of investments.
Use of Calculator
For the CFA exam, there are only two calculators allowed by the CFA Institute. The candidates can buy either of these and must carry them to the Exam Centre on exam day. The two calculators are:
- Texas Instruments BA II Plus Financial Calculator (including BA II Plus Professional)
- HP 12C Financial Calculator (including the HP 12C Platinum, 12C Platinum 25th anniversary edition, 12C 30th anniversary edition, and HP 12C Prestige)
In this reading we will demonstrate the use of BA II Plus calculator for solving time value of money problems.
- Introduction - Time Value of Money
- Interest Rates
- Interest Rate Equation
- Nominal Interest Rate and Effective Yield
- Time Value of Money for Different Compounding Frequencies
- Future Value of a Single Cash Flow
- Present Value of a Single Cash Flow
- Future Value and Present Value of Ordinary Annuity
- Present Value and Future Value of Annuity Due
- Present Value of a Perpetuity
- Present Value and Future Value of Uneven Cash Flows
- Annuities with Different Compounding Frequencies
- Using a Timeline to Solve Time Value of Money Problems