Chapter 3 Book Notes FIN 301 UIC
Chapter 3 Book Notes FIN 301 UIC Fin 301
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This 3 page Class Notes was uploaded by David Kavalerchik on Tuesday February 2, 2016. The Class Notes belongs to Fin 301 at University of Illinois at Chicago taught by Ozgur Arslan Ayaydin in Spring 2016. Since its upload, it has received 81 views. For similar materials see Intro to Finance in Finance at University of Illinois at Chicago.
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Date Created: 02/02/16
____________________________________________________________ Future Value and Compounding Interest Time value of money (TVM) refers to a dollar in hand today being worth more than a dollar received in the future because you can invest today’s dollar in an interestbearing account that grows in value over time. We call this the future value (FV). The SinglePeriod Scenario Principal x Interest Rate = interest earned The principal + interest earned = the future value of the principal. Deposit initial principal of $100 @ 5% interest. You’re paid out in a lump sum end of the year. That $105 is the future value of your $100 principal. The MultiplePeriod Scenario Let’s say you leave that $105 in the same account for another year. That $105 will earn another 5% > $100 × 0.05 + $5.00 × 0.05 = $5.25 The additional 25 cents is interest on interest and reflects the compounding of interest. At the end of two years, the account has $110.25. future value = deposit × (1 + r) × (1 + r) or FV = PV × (1 + r)^n __________________________ Key FV = future value PV = present value r = interest rate n = number of time periods __________________________ ____________________________________________________________ ____________________________________________________________ Present Value and Discounting The SinglePeriod Scenario Determine how much $x one year from now is worth today at x% interest over the year. How much do I need to put away now for it to become $x in the future at x% interest rate? *You don’t need to memorize both the PV & FV equations. When given a problem just use the FV equation and use simple algebra to solve for PV. The MultiplePeriod Scenario As stated before, use the same FV equation, plug in your values and solve for PV. ____________________________________________________________ Rearranged to solve for the interest rate: Rearranged to solve for the # of periods: Rule of 72: To find the length of time it takes to double your money, just divide 72 by the interest rate.