L8 TIME VALUE OF MONEY

• Compound interest – The interest in the first compounding period is added on the principal, which

  will be the basis for the interest computed for the next period.
• Compounding Frequency – The number of times interest is computed on a certain principal in one

  (1) year.

  • If the investment pays annually, the interest is the same as computed above since = 1.

  • If the investment pays semi-annually, the total interest will be equal.
• Effective annual rate – It is the actual interest paid or earned. It should be distinguished from the

  nominal rate or the stated contractual rate, which is the interest charged by a lender or promised by

  a borrower. It does not reflect the effect of compounding frequency.
• There are three (3) reasons why a peso today is worth more than a peso in the future:

  1. Preference for present consumption
  2. Inflation
  3. Risk
• Risk – If there is any uncertainty or risk associated with the cash flow in the future, people will

  think it is better to spend their money now.
• Inflation – When there is inflation, the value of the currency decreases over time. The greater

  the inflation, the greater the difference in value between a peso today and a peso tomorrow.
• • Preference for present consumption - Individuals prefer present consumption to future

  consumption. There needs to be a strong incentive to convince people to give up present

  consumption for future consumption. For example, a businessman would be willing to deposit

  money if he is assured that it will bring a higher interest.
• A loan is a money lent at an interest rate for a certain period of time. Loans are normally secured

  from different financial institutions, and the most common are banks.
• A bond is also a form of a loan but can be traded through Philippine Dealing and Exchange (PDEX)

  System.
• loan amortization refers to the computation of equal periodic loan payments. These

  payments provide the lender with a specified interest return and loan principal repayment over a

  specified period.
• loan amortization process involves finding out the future payments over the term of the loan,

  which will pay the loan plus the interest. Lenders use the loan amortization schedule to determine

  these payment amounts and allocate each payment to interest and principal.