Investment: Time Value of Money Essay

Investment is the use of coin for a coming(prenominal) pecuniary gain. Investments whitethorn come in the form of sh atomic upshot 18s of stock, animation insurance, governing bonds, or putting up a savings account. Every coronation decision has its key take a chances and uncertainties. Various factors discharge affect enthronement decisions and outcomes such(prenominal) as annuities and sentence treasure of currency.Money has a full point measure. A vaulting horse nowadays is worth more than a one dollar bill to be received at whatsoever subsequently term. Many economic decisions have-to doe with investing coin now in the hope of receiving more property later on. Various economic factors affect the duration nurse of money such as risk, puffiness, fortune cost, and others. According to Robert C. Higgins (1999), time cherish of money exists for at least collar reasons. Robert C. Higgins (1999) stated that inflation reduces the purchase force-out of f uture dollars relative to current ones, uncertainties touch the receipt of dollar increases as the date of receipt draw away, and because of the presence of opportunity cost.In economics, inflation is a lessen in the value of money in relation to the goods and services it jakes buy. Inflation potty affect time value of money and enthronization decisions. due(p) to inflation, borrowers usually benefit while lenders suffer, because mortgage, personal, business, and government loans argon paid with money that loses purchasing power over time (Encarta, 2004). It is of import to understand however, that borrowers however benefit when the inflation is unexpect, when inflation is expected by creditors, the vex deem they charges rises to compensate for the unexpected decline in the purchasing power of the trail loan (Encarta, 1999).Risk or financial risk is defined as the misfortune of loss in an enthronization. Investment decisions enquire some type of risk because of the tim e value of money. Lenders should take into consideration non-homogeneous factors before extending credit such as the borrowers ability to pay or collaterals. fill targets on loans can also be based on the degree of risk involved. The higher the risk involved the higher pertain consecrate. On the other snuff it, lower sideline is compel on low-risk loans. As mentioned above, investment decisions has its underlying risk and uncertainties, therefore before devising investment decisions it is important to understand the risks and uncertainties involved. opportunity cost is defined as the expected income on the next best alternating(a) or the income foregone if an investor chooses one achieve over some other (Higgins, 1999). A dollar today is worth more than a dollar in the future since money today can be invested for it to repeat in the future. Opportunity cost depends on what action is to be considered. Before make decisions, an investor must first look for and fix an un derstanding of all the available option courses of action. After determining the various alternatives, the differential effects of each alternative should be considered to avoid potential problems in the future.Interest is the payment made for the use of another persons money and is regarded as a payment made for not bad(p) (Encarta, 2004). Interest can be impact by economic factors such as inflation. When interest is computed based on the trader amount, it is called simple interest. However, when interest is computed not only on the principal amount further also on the cumulative come of past interest payments, the c ar for of interest computation is now called colonialing. Compounding is the process of determining the future value of a present sum (Higgins, 1999). The interest rate use on compounding is called the compound interest rate. Discounting, on the other hand is the exact opposite of compounding. Discounting is the process of decision the present value of a futur e sum (Higgins, 1999). The interest rate used in discounting is called the discount rate. The amount of money to be received in a future date is usually a combination of the original investment and the interest on that investment. Discounts are rewards or considerations stipulation on the purchase of negotiable instruments such as bills of exchange and promissory notes in advance of their maturity date. When these negotiable instruments are said to be discounted, discounts are regarded as advance collection of interest on the loans.An annuity is a type of investment that can provide a poise stream of income over along period of time (Understanding annuities, 2006). Annuity is an annual allowance, payment, or income derived from funds especially designated for the purpose (Encarta, 2004). At times, it is required to compute for the present value of a series of equal amounts to be received at the end of a series of long time. Annuity earnings upgrade tax-deferred and are usually pu rchased by investors who are primarily concerned with limiting their taxes (Understanding annuities, 2006).The find oneself of 72 is a method of estimating an investments doubling time or halving time (Rule of 72, 2006). The Rule of 72 estimates the number of years it takes for an investments value to double at a specialized interest rate or rate of return and the result can be obtained by dividing the expected growth rate into 72 to determine the number of years it will take to double. By victorious into consideration the rule of 72, investors can pass judgment the length of time in which their investment can double and to determine if their investments are feasible.Investing involves the decision of committing resources such as money for a period of time. Evaluating investment decisions involve the determination and assessment of the affirmable inherent risks and uncertainties. An effective investing decision requires a consideration of the time value of money.ReferencesEncar ta Reference Library 2004. Microsoft CorporationHiggins, R. (1999). psychoanalysis for financial management. Evaluating investment opportunities (pp 231-266). Washington. Irwin McGraw Hill.Rule of 72 (2006). Wikipedia, the free encyclopedia. Retrieved declination 3, 2006 from http//en.wikipedia.org/wiki/Ruleof72Understanding annuities (2006). Retrieved December 3, 2006 from http//www.tdi.state.tx.us/consumer/cb078.html