Bens Time Value of Money

Bens Time Value of Money - Introduction to The Time Value...

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Introduction to   The Time Value of Money  Economics 4
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The Starting Point Dollar$  in-hand  today are worth more than the  same dollar$ not  in-hand  (until a day in the future).   In other words, we do not arrange exchanges of  dollar$ today for the same number of dollar$  tomorrow.  We  discount   promises  to pay later . We  compound  $ money  we have today . A dollar now (a) involves no risk  of actually  receiving that dollar and (b) can  be invested to earn  a return or lent to earn interest.
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Why? A dollar now – call this a present dollar: involves no risk of actually receiving that dollar, as a future dollar does; The present dollar can be invested or lent to earn a return, making it more than a dollar in the future – this is the compounding process.
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Background   Some people have more present dollar$ than they  need while other need cash today.   Those who have more present dollars can lend  them to those who don’t have present dollars but  need them.   This means the lender sells  a present dollar in  exchange for a promise to be repaid  (by the  borrower) that dollar plus  compounding  at some  point in the future.
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The Problem   Is a pricing problem.   How much  and in what way  does the borrower pay  in  future  – compounded - dollars for the  present  dollars  purchased?    Obviously, the price for $ One  present  dollar is  going to be more than $ One  future  dollar.    So we can write that: $ Present Dollar x (Something > 1) = $ Future Dollar
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Two Scenarios 1. We can trade single sums of money across  discrete time periods for single sums in return.  1. We can trade single sums of money at one point  in time for multiple payments or deposits of  money periodically over several periods of time.
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The Basic Relationship The earning power of a dollar in-hand today is based on the  Compounding process , written: [1] FV = PV x (1+r)   t   where there are two values  and two parameters :  1.   FV  = future value  2.   PV  = present value, the value of dollars in-hand today  3.      r  =  an annual rate  of return, an interest rate  4.      t  =  number of years  between today and the “future”
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Some symmetry We can reverse the  Compounding process  by inverting the 
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This note was uploaded on 06/11/2008 for the course ECON 201900 taught by Professor Willoughby during the Spring '08 term at UCSD.

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Bens Time Value of Money - Introduction to The Time Value...

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