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# chap004 - Chapter 4 Future Value Present Value and Interest...

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Chapter 4 Future Value, Present Value, and Interest Rates Chapter 4 Future Value, Present Value, and Interest Rates Chapter Overview This chapter continues the exploration of interest rates using the concept of present value and future value. The concepts are applied to the valuation of bonds, and the relationship between inflation and interest rates is also considered. Reading this chapter will prepare students to: Define present and future value. Calculate present and future values given different values of relevant variables. Apply the analysis of present and future values to basic financial decisions regarding investments and debt. Extend the analysis of present and future value to examine bond prices. Comprehend real versus nominal interest. Important Points of the Chapter In today’s world, interest rates are of enormous importance to virtually everyone; they link the present to the future, allowing us to compare payments made on different dates. They also tell us the future reward for lending today, as well as the cost of borrowing now and repaying in the future. But to make sound financial decisions we must learn how to calculate and compare different rates on various financial instruments. Application of Core Principles Principle #1: Time (page 63) A dollar deposited in an interest-bearing account today will earn a return and grow into a future value. Future value is the value on some future date of an investment made today. Principle #1: Time (page 66) The present value is the value today of a payment that is promised to be made in the future. It is the amount that must be invested today in order to realize a specific amount on a given future date. Principle #1: Time (page 68) The sooner a payment is to be made the more it is worth, and the rate of decline in present value is related to the same phenomenon that gives us the rule of 72. Principle #1: Time (page 80) The nominal rate agreed upon by a borrower and lender must be based on expected inflation over the term of the loan. Teaching Tips/Student Stumbling Blocks Instructor’s Manual t/a Cecchetti: Money, Banking, and Financial Markets 43

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Chapter 4 Future Value, Present Value, and Interest Rates The biggest challenge in this chapter is the mathematics of calculating future value and present value. The text does an excellent job in explaining the material, taking students through the calculations step by step, but you will probably want to reinforce this with a number of practice exercises. Emphasize that if someone has funds now those funds can be invested and will earn interest, growing into future value. Finding present value is, in essence, running that process in reverse. Discuss the material in the text with regard to credit card debt ( Your Financial World : Pay Off Your Credit Card Debt as Fast as You Can), and supplement the treatment in the text with a consideration of the dollar amounts involved. How much does an impulse purchase really cost someone?
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