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1
Chapter 3
Understanding The Time Value of
Money:
Time Value of Money
• A dollar received today is worth more than
a dollar received in the future.
• The sooner your money can earn interest,
the faster the interest can earn interest
the faster the interest can earn interest.
Interest and Compound Interest
• _______________________
(i)  is the
return you receive for investing your
money.
•Compound interest  is the interest that
your investment earns on the interest that
your investment previously earned.
• ______________________
(r) – is when
rising prices reduce the purchase power of
money.
The effect of 3% interest on a
___________________
of $100
• Reminders……3% = .03 in decimal form
• On your calculator hit the 3 key and then
hit the % key (4
th
row from the top left
hand side
hand side)
The effect of 3% interest on a
one time deposit
of $100
•
Deposit ($X)
• + Deposit ($X) times interest rate (i)
• = new account balance
• For example:
•
$100 ($X)
• + $
3
[100 (.03) = $X(.03)]
•
$103
Or in one easy step:
• Your deposit ($X) multiplied by (1 + the
interest rate—in decimal form) = new acct.
balance
•=
$X(1 + i) = new account balance
• = $100(1.03) = $103
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The effect of compounding interest
over time (long form)
•=
$X
1
+ [$X
1
(i)] = $X
2
•=
$X
2
+ [$X
2
(i)] = $X
3
•=
$X
3
+ [$X
3
(i)] = $X
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 Spring '09
 B

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