Term Paper on "Value of Money"

Term Paper 4 pages (1326 words) Sources: 3 Style: APA

[EXCERPT] . . . .

Value of money represents the amount of goods, products and services which consumers can buy with one unit of the currency. The greater the value is, the more products it can buy, therefore being a strong currency. On the other hand, if one unit of the currency can acquire for the consumer a reduced amount of goods and services, the currency is weak. Economically, the value of money is referred to as the purchasing power of money and it can be measured in absolute and relative quantities.

The value of money is different from one time to another, varying based on numerous economical components and events. For instance, the amount of products that we currently buy with one U.S. dollar is highly different from the amount of products we were able to buy with the same unit of currency one hundred years ago. "The time value of money (TVM) is a way of calculating the value of a sum of money, at any time in the present or future."

Aside from the purchasing power, the value of money also refers to the investment and profit opportunities granted by the sum of money an individual possesses. In this order of ideas, university professors T. Gallager and J. Andrew point out that "TVM is based on the concept that a dollar that you have today is worth more than the promise or expectation that you will receive a dollar in the future. Money that you hold today is worth more because you can invest it and earn interest."

2. Key components of TVM

The main concept of TMV, as emphasized by economists D. Kieso and Jerry Weygandt, is that "a single sum of money or a series of equal, evenly-spaced payments or receipts promised in the future can be converted to an equivalent value today. Conversely, you can determine the value to which a single sum or a series of future payments will grow to at some future date."

In order to be able to best calculate the time value of money, economists have to fully comprehend and apply the five major components of the time value of money. These components are: the present value (PV), future value (FV), the present value of an annuity (PVA), the future value of an annuity (FVA) and finally, the perpetuity.

The present value of money represents the current amount of money possessed by an individual, whereas the future value of money represents the potential gains due to an investment of the current financial resources. In the specialized literature, in an attempt to better explain the concepts of present value of money and future time of money, numerous economists have given the following example: I give you 100 dollars. You take it to the bank. They will give you 10% interest rate per year for two years. The present value is that of 100 dollars, whereas the future value is increased 121 dollars, the initial money plus the 21 dollars interest rate from the bank.

The Present Value of an Annuity represents the value of an annuity (set amount of money individuals have to pay based on a mutual contract, such as mortgages) under today's conditions. The PVA directly influences the sizes of the current annuity, provided that the individual is financially capable of making further payments towards its creditor for the time period specified in the contract.

The Future Value on an Annuity represents the actual value of money in the years to come, based on the fact that the final amount of money is achieved after yearly deposits (annuities). For instance, an individual desires to open a savings account within a commercial bank and his annuities are of $15,000. After 10 years, and with an interest rate of 10%, the future value of the annuity will be of $165,000 ($150,000 deposits and $15,000 from interest rates).

The Perpetuity is generally perceived as an annuity of indefinite time period. "Since most financial instruments have a specified end, this… READ MORE

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