Time Value Of Money

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Time Value of Money

One might know that time is one of the most valuable assets in our lives. In the financial world the value of money is linked to time, primarily because investors expect progressive returns on their cash over periods of time, and they always compare the return from certain investments with the going or average returns in the market. Inflation on other hand erodes the purchasing power of money causing future value of one dollar to be less than the present value of a dollar. This paper will examine time value of money and the applications that determine successes or failures. An examination of the different vehicles that can be used to generate financial security for corporations and individuals will be provided. After defining the applications that generalize time value of money, an explanation will be offered regarding the components of interest rates by expanding on the concept that interest rate equates the future value of money with present value.

Time Value of Money Applications

Capital markets are markets "where people, companies, and governments with more funds than they need (because they save some of their income) transfer those funds to people, companies, or governments who have a shortage of funds (because they spend more than their income)" (Woepking, ¶3). The two major capital markets are stock and bond markets. Capital markets promote economic efficiency by moving funds from those who do not have an immediate need for it to those who do. Individuals or companies will put money at risk if the return on the intended investment is greater than the return of holding risk-free assets. An example of this would be those that invest in real estate or purchase stocks and bonds. Those that invest want the stock, bond, or real estate to grow in value or appreciate. An example of this concept would be if an individual or company invested an amount saved over the course of a year. While investing may be riskier, these individuals hope that the investment will yield a greater return than leaving the money in a savings account drawing nominal interest. In this example the companies that issue the stocks or bonds have spending needs that exceed their income so the company will finance their spending needs by issuing securities in the capital markets. This is a method of direct finance because the "companies borrowed directly by issuing securities to investors in the capital markets" (Woepking, ¶5).

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