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Lecture 3 Chpt 4 2011 d2l-2

Lecture 3 Chpt 4 2011 d2l-2 - Fin 320 Chapter 4 Time Value...

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Fin 320 Chapter 4: Time Value of Money Lecture 3
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Benjamin Franklin Benjamin Franklin provides us with an actual rather than a hypothetical case. When Franklin died in 1790, he left a gift of $5,000 to each of his two favorite cities, Boston and Philadelphia. He stipulated that the money was to be invested and could be paid out at two specific dates, the first 100 years and the second 200 years after the date of the gift.
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Benjamin Franklin After 100 years, each city was allowed to withdraw$500,000 for public works projects. After 200 years, in 1991, they received the balance — which had compounded to approximately $20 million for each city. Franklin’s example teaches all of us, in a dramatic way, the power of compounding. As Franklin himself liked to describe the benefits of compounding, “ Money makes money. And the money that money makes, makes money. ”
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Future Value, Present Value and Interest Rates: Roadmap Future Value Present Value Internal Rate of Return Bond Basics Real vs. Nominal Interest Rates
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Future Value: Definition The value on a future date of an investment made today. If you invest $100 today at 5 percent interest per year, in one year you will have $105.
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Future Value and Compound Interest If the present value is $100 and the interest rate is 5%, then the future value one year from now is: $100 + $100(0.05) = $105 This also shows that the higher the interest rate, the higher the future value. In general: FV = PV + PV( i ) = PV(1 + i )
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Future Value: Two Years $100+$100(0.05)+$100(0.05) + $5(0.05) =$110.25 Present Value of the Initial Investment + Interest on the initial investment in the 1 st Yr + Interest on the initial investment in the 2 nd Yr + Interest on the Interest from the 1 st Yr in the 2 nd Yr = Future Value in Two Years
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Future Value: General Formula Future value of an investment of PV in n years at interest rate i FV n = PV x (1+i) n (Remember: The interest rate is measured is a decimal so if 5%, i = .05) Fractions of percentage points are called basis points.
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