Lecture4 - Eco635.02 Prof.Zhylenko Lecture5...

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Lecture 5 Introduction to Valuation:  The Time Value of Money Introduction to Valuation: The Time Value of Money Eco 635.02                                                                                               Prof. Zhylenko 1
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Basic Definitions Present Value – earlier money on a time line Future Value – later money on a time line Interest rate – “exchange rate” between earlier  money and later money Eco 635.02                                                                                               Prof. Zhylenko 2
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Suppose you invest $X today at an interest rate of r.  What is the future value in one year? Value in one year = principal + interest =       = $X + $X∙r = $X(1 + r) Future Value (FV) = $X(1 + r) Suppose you leave the money in for another year.   How much will you have in two years from now? FV = $X(1 + r)(1 + r) = $X(1 + r) 2 Future Value Eco 635.02                                                                                               Prof. Zhylenko 3
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FV = PV(1 + r) t FV = future value PV = present value r = period interest rate, expressed as a  decimal t = number of periods Future value interest factor = (1 + r) t Future Value: General Formula Eco 635.02                                                                                               Prof. Zhylenko 4
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Simple interest  Compound interest If you invest X for two years at interest rate of  r: FV with simple interest = X + X∙r + X∙r = X (1 + 2r) FV with compound interest = X (1 + r) 2 General case: FV with simple interest = X (1 + t∙r) FV with compound interest = X (1 + r) t Effects of Compounding Eco 635.02                                                                                               Prof. Zhylenko 5
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Suppose you have $500 to invest and you  believe that you can earn 8% per year over  the next 15 years. - How much would you have at the end of 15  years using compound interest? - How much would you have using simple 
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Lecture4 - Eco635.02 Prof.Zhylenko Lecture5...

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