Time Value of Money Application Paper Essay Example | Topics and Well Written Essays - 750 words

Time Value of Money Application Paper - Essay Example The following are some important concepts of time value of money: Future value of money at a particular point is equal to the original sum of money plus interest rate multiplied by original sum of money. Suppose a retirement plan financial service provider receives $100 at the rate of 8% per annum; the future value of that fund will be: Given above scenario, present value is a reverse of the future value in that it shows how much certain amount of dollar worth today. The above formula can equally be used to calculate present value, in this case it will be inverted; if the calculations involve compound interest then the amount in inner braces will be raised to a power of n. the resulting value is otherwise called discounted value. This is the cost for borrowing or lending money or can be viewed as the yield to which money can earn. This interest rate can be categorized into nominal rate of interest and effective rate of interest2. Nominal interest rate is that rate of interest not adjusted for inflation whereas effective interest rate has full effect of compounding and is adjusted for inflation. Commercial banks make good use of time value of money in all their transactions – accepting deposits, lending to firms and corporate organizations and even borrowing short-term instruments from other financial institutions. For example, if a commercial bank accepts savings from a client at 5% per annum, assuming the client deposits $200 every two months for a year; the client might unwittingly be glad for receiving the 5% in addition to security he/she enjoys from the bank. However, these funds can be lent out at 15% to a credit card company who now uses this to service its customers. The difference between 15% paid by Credit Card Company and 5% paid to this client with the commercial bank reflects the of time value of money. Using above example, credit card financial