Anda di halaman 1dari 24

Unit No.

2
zaheerswati@ciit.net.pk



































Never spend your money before you have it ThomasJ efferson
Interest
Motives for Holding Money
Types of Interest
Types of Interest Rates
Investment
Evaluation by
TVM
FV of Lump sum (Annual
Compounding)
FV of Lump sum
(Intra Year Compounding)
Yield Curve


Unit 2
Roadmap

Fixed
Combined
Floating
Simple

Continuous Compound
DiscreteCompound
General Formula

Factor Formula
General Formula

Factor Formula
Transaction

Speculative
Precautionary
Finance


Work Book Foundation Level 14 Time Value of Money
Unit 2
TIME VALUE OF MONEY (TVM)
Rupee today is worth more than will tomorrow
Because Inflation (Persistent rise in the general price level over a period of time) and
Opportunity Cost (The cost of next best alternative forgone)
If Cash Flow certain than TVM =Interest Rate
If Cash Flow uncertain than TVM =Interest Rate +Risk Premium

2.1 The Interest
Fee paid on borrowed money
Compensation to lender for foregoing other useful investment
Equilibriumprice at which demand and supply of fund meet

Formula


I =Interest (The charge for the privilege of borrowing money, typically expressed as an annual percentage rate APR)
RR =Real Rate (An absolutely risk-free investment over a specified period of time)
IF =Inflation Factor (The rate at which the general level of prices for goods and services is rising)
DR =Default Risk (Default risks that companies or individuals will be unable to make the required payments on their
debt obligations)
MR =Maturity Risk (Risk associated with interest rate uncertainty. The longer the time to maturity, the higher the
premium)

2.2 Types of Interest
It is cost to borrow money. The rent one pays for the use of money is called the interest.
There are three types of interest

2.2.1 Simple Interest
Interest calculated on principal amount only
Although the interest rate is often specified for a year, it may be specified for a week, a month, or a quarter, etc.

Formula


SI
n
=Simple Interest for n time period P =Principal Amount
i =Rate of Interest n =Time period

Example 2.1: Mr. Salman has three options for investment. Option first offered by Allied Bank is deposit Rs. 100 in a
five-year certificate of deposit paying 10% simple interest p.a. How much will he have at the end of the fifth year?
I =RR +IF +DR +MR +..

SI
n
=P +(P * i * n)

Finance


Work Book Foundation Level 15 Time Value of Money
Unit 2


Solution






2.2.2 Discrete Compound Interest
Interest on principal as well as on interest is called discrete compound interest or compound interest

Formula


CI
n
=Compound Interest for n time period P =Principal Amount
i =Rate of Interest n =Time period

Example 2.2: Mr. Salman has second option offered by National Bank is deposit Rs. 100 in a five-year certificate of
deposit paying 10% discrete compound interest. How much will he have at the end of the fifth year? Find out the
difference of interest between compound and simple interest?

Solution







Difference of Interest =Compound interest - Simple Interest
Difference of Interest =161.05 150 =Rs. 11.05
This mean interest on principal is Rs. 50 and interest on interest is Rs. 11.05

2.2.3 Continuous (Exponential) Compound Interest
As the name suggests that it has exponentially increased rate of interest
When interest is compounded "many times", we say that the interest is compounded continuously

Formula



EI
n
=Continuous interest for n time period P =Principal amount
e =exponent with constant (2. 718) i =Rate of return
n =Number of years
CI
n
=P (1 +i)
n

EI
n
=P * e
i * n

SI
n
=P +(P * i * n)
SI
5
=100 +(100 * 0.10 * 5)
SI
5
= Rs. 150
CI
n
=P (1 +i)
n
CI
5
=100 (1 +10/100)
5
CI
5
=100 (1.10)
5

CI
5
= Rs. 161.05
Finance


Work Book Foundation Level 16 Time Value of Money
Unit 2

Example 2.3: Last option for Mr. Salman which offered by United Bank is deposit Rs. 100 in a five-year certificate of
deposit paying 10% continuous compound interest. How much will he have at the end of the fifth year? Which is best
choice?

Solution





Option No. Type of Interest Bank Future Value
1 Simple Allied Bank Rs. 150
2 Discrete Compound National Bank Rs. 161.05
3 Continuous Compound United Bank 164.86 (Best choice)

If you are depositor select Continuous Compounding Interest assuming same rate for all other alternatives
If you are lender select Simple Interest assuming same rate for all other alternatives








2.3 Types of Interest Rates
There are three types of interest are generally used






2.3.1 Fixed Interest Rates
Stated and unchanged rate of interests

2.3.2 Floating / Market Interest Rates
Fluctuating rate of interest based on market conditions

2.3.3 Combined / Dictated Interest Rates
Mix of fixed and floating rate of interests
EI
n
=P * e
i * n

EI
5
=100 * 2.718
0.10 * 5
EI
5
= Rs. 164.87
Continuous
Compound
Simple
Interest Rates
Fixed Floating Combined
Finance


Work Book Foundation Level 17 Time Value of Money
Unit 2

2.4 Investment Evaluation by Time Value of Money
There are two Time Value of Money techniques are used to evaluate investments











2.4.1 Future Value of Lump sum amount (Annual Compounding)
The value of lump sumamount (one time cash flow) at some future time evaluated at a given interest rate
assuming that compounding take place one time in a year (Annually)
Two methods for calculation


















Or



Or




FV
n
=Future value of n years PV =Present value i =Interest rate or Compound rate
n =Number of years FVIF =Future Value Interest Factor
FV of Lump sum (Annual Compounding)
General Formula Factor Formula
Floating Rate Constant Rate
FV
n
=PV (1 +i) * (1 +i) * (1 +i) *..* (1 +i)
for n times

General Formula
Floating Rate
FV
n
=PV (1 +i)
n

General Formula
Constant Rate
FV
n
=PV (FVIF
i%, n
)
Factor Formula
Constant Rate
Lump sum Annuity Lump sum Annuity
Time Value of Money
Future Value / Compounding Present Value / Discounting
Finance


Work Book Foundation Level 18 Time Value of Money
Unit 2

Example 2.4: Ms. Nosheen puts Rs. 10,000 in a savings account today, that pays 5% compounded annually. How much
will she have in her account after ten years; by above mentioned three equations?

General Formula Floating Rate








General Formula Constant Rate









Factor Formula









Example 2.5: Find the value of Rs. 10,000 today at the end of 10 periods at 5% per period by using scientific calculator
and by Excel sheet?

Scientific Calculator:
1. Enter 10,000 (1 +0.05)
2. Press x
n

3. Enter the exponent 10
4. Enter =
5. Answer Rs. 16,288.95


KEY RELATIONHSIP
FV
n
= PV (1 + i)
n

FV
n
=PV (1+i) * (1+i) * (1+i) * (1+i) * (1+i) * (1+i) * (1+i) * (1+i) * (1+i) *(1+i)
FV
10
=10,000 (1.05) * (1.05) * (1.05) * (1.05) * (1.05) * (1.05) * (1.05) * (1.05) * (1.05) * (1.05)
FV
10
=10,000 * 1.6289
FV
10
= Rs. 16,289
FV
n
=PV (1 +i)
n
FV
10
=10,000 (1 +0.05)
10

FV
10
=10,000 * 1.62889
FV
10
= Rs. 16,289
FV
n
=PV (FVIF
i%, n
)

FV
n
=10,000 (FVIF
5%, 10
)
FV
n
=10,000 (1.6289)
FV
10
= Rs. 16,289
Finance


Work Book Foundation Level 19 Time Value of Money
Unit 2

Spreadsheet:


2.4.2 Future Value of Lump sum amount (Intra Year Compounding)
The value of lump sumamount (one time cash flow) at some future time evaluated at a given interest rate
assuming that compounding takes place more than one time in a year (Intra Year)
Interest rate reduced while periods of time increase by frequency of compounding (m) i.e. i/mand n*m
Two methods for calculation









Or




FV
n
=Future value of n years PV =Present value
i =Interest rate or Compound rate m=Frequency of compounding
n =Number of years FVIF =Future Value Interest Factor

Example 2.6: Mr. Naveed purchased a 3-year, 6-percent savings certificate for Rs. 25,000. If interest is compounded
semi-annually, what will be the value of the certificate when it matures by above mentioned two equations?
General Formula









FV
n
=PV (1 +i / m)
n * m

FV
3
=25,000 (1 +0.06 / 2)
3 * 2

FV
3
=25,000 (1.1941)

FV
3
= Rs. 29,852.5

FV of Lump sum (Intra Year Compounding)
General Formula Factor Formula
FV
n
=PV (
m n
m
i
FVIF
* ,
%
) Factor Formula
FV
n
=PV (1 +i / m)
n * m
General Formula
Finance


Work Book Foundation Level 20 Time Value of Money
Unit 2

Factor Formula












2.5 Yield Curve
The yield curve is the relation between the interest rate and the time to maturity of the debt
More formal mathematical descriptions of this relation are often called the termstructure of interest rates









2.6 Motives for holding money
Usually there are three defined motives of holding money

2.6.1 Transactions Motives
Need money to be able to spend it, and so hold balances of money appropriate for that
Like the amount of money that you have in your pocket

2.6.2 Precautionary Motives
Unexpected bills or contingencies may mean that we need to hold a
little extra money in case
Like the money we hold in bank current accounts

2.6.2 Speculative Motives
o The speculative motives for money is the amount held for the potential
purchase of assets
o There are of course a number of different ways, which can briefly split it into interest bearing assets or non-
interest bearing assets
o The interest rate and the ease of access may be two important factors in determining this decision

FV
n
=PV (
m n
m
i
FVIF
* ,
%
)


FV
3
=25,000 (
2 * 3 ,
2
6
FVIF )


FV
3
=25,000 (1.1941)

FV
3
= Rs. 29,852.5

Finance


Work Book Foundation Level 21 Time Value of Money
Unit 2

END-OF-UNIT ASSIGNMENT
(PROBLEMS & MULTIPLE CHOICE QUESTIONS)
Problem 2.1: Calculate simple interest and compound interest assuming that principal amount is Rs. 10,000; interest rate
is 9% for three years. What is the amount difference between compound and simple interest?



Year

Simple I nterest Calculation

Compound I nterest Calculation
Simple Interest
Calculation
Simple
Interest
Accumulated
Year-end
Balance
Compound
Interest
Calculation
Compound
Interest
Accumulated
Year-end
Balance
Yr 1 Rs. 10,000 * 9% Rs. 900 Rs. 10,900 Rs. 10,000 * 9% Rs. 900 Rs. 10,900
Yr 2 10,000 * 9% 900 11,800 10,900 * 9% 981.00 Rs. 11,881.00
Yr 3 10,000 * 9% 900 12,700 11,880.10 * 9% 1069.29 Rs. 12,950.29
Total Rs. 2,700 Rs. 2,950.29

Difference = 2,950.29 - 2,700 = Rs. 250.29

Problem 2.2: You are scheduled to receive Rs. 13,000 in two years. When you receive it, you will invest it for six more
years at 8 percent per year. How much will you have in eight years?
Solution: 13,000 (1 +0.08)
6

Answer: Rs. 20,629.37

Problem 2.3: You have Rs. 9,000 to deposit. ABC Bank offers 12 percent per year compounded monthly, while King
Bank offers 12 percent but will only compound annually. How much will your investment be worth in 10 years at each
bank?
Solution: ABC Bank 9,000 (1 +0.12/12)
10* 12
Answer: Rs. 29,703.48
King Bank 9,000 (1 +0.12)
10
Answer: Rs. 27,952.63
Variance Rs. 1,750.85

Problem 2.4: You invest Rs. 10,000. During the first year the investment earned 20% for the year. During the second
year, you earned only 4% for that year. How much is your original deposit worth at the end of the two years?
Solution: FV =10,000 (1.20) (1.04)
Answer: Rs. 12,480

Problem 2.5: Ali deposited Rs. 2,500 in an account that pays 6% simple interest. How much money will he have at the
end of 3 years?
Solution: 2,500 +(2,500 * 0.06 * 3)
Answer: Rs. 2,950

Finance


Work Book Foundation Level 22 Time Value of Money
Unit 2

Problem 2.6: What is the future value of Rs. 26 invested for 32 years at an average rate of return of 7%?

Solution: FV = 26 (1.07)
32

Answer: Rs. 226.60

Problem 2.7: If interest is compounded quarterly, how much will you have in a bank account?
(a) If you deposit today Rs. 8,000 at the end of 3 months, if the bank pays 5.0% APR?
Solution: 8,000 (1 + 0.05 / 4)
Answer: Rs. 8,100

(b) If you deposit today Rs. 10,000 at the end of 6 months, if the bank pays 9.0% APR?
Solution: 10,000 (1 + 0.09 / 4)
2

Answer: Rs. 10,455.06

(c) If you deposit today Rs. 80,000 at the end of 12 months, if the bank pays 8.0% APR?
Solution: 80,000 (1 + 0.08 / 4)
1* 4

Answer: Rs. 86,594.57

(d) If you deposit today Rs. 5,000 at the end of 24 months, if the bank pays 5.0% APR?
Solution: 5,000 (1 + 0.05 / 4)
2* 4

Answer: Rs. 5,522.43

Problem 2.8: Find the future value of Rs. 100,000 for 15 years. The current five-year rate is 6%. Rates for the second
and third five-year periods and expected to be 6.5% and 7.5%, respectively.
Solution: FV = 100,000 (1.06)
5
(1.065)
5
(1.075)
5

FV = 100,000 (1.3382) (1.37009) (1.43563)
FV = 100,000 (2.6322)
Answer: Rs. 263,220

Problem 2.9: The Green Corporation needs Rs. 50 million to repay a loan which is due at the end of seven years. If
Green makes the following sinking fund payments, will there be sufficient funds available to repay the loan on schedule?
Sinking fund contributions
Amount funded Date invested Rate earned
Rs. 12 million today 11%
10 million in two years 10%
8 million in four years 9%

Solution: FV of the Rs. 12 million =12(1.11)
7
=Rs. 24.9139
FV of the Rs. 10 million =10 (1.1)
5
=Rs. 16.1051
FV of the Rs. 8 million =8(1.09)
3
=Rs. 10.3602
Answer: Rs. 51.382 Million


Finance


Work Book Foundation Level 23 Time Value of Money
Unit 2

Problem 2.10: If farm land is currently worth Rs. 1,750 per acre and is expected to increase in value at a rate of 5
percent annually, what will it be worth in 5 years? In 10 years? In 20 years by factor formula and table?
Solution: 5 years: Rs. 1,750 * 1.2763 = Answer: Rs. 2,233.53
10 years: Rs. 1,750 * 1.6289 = Answer: Rs. 2,850.58
20 years: Rs. 1,750 * 2.6533 = Answer: Rs. 4,643.28

Problem 2.11: A Visa credit card company charges a 1.5% simple interest charge each month on the unpaid balance. If
Miss Sehrish owes Rs. 2,350 and has not paid her bill for three months, how much does she owe?
Solution: 2,350 +(2,350 * 0.015 * 3)
2,350 +105.75
Answer: Rs. 2,455.75

Problem 2.12: If Rs. 3,500 is invested at 9% compounded continuously, what will the future value be in four years?
Solution: 3,500 e
0.09 * 4



Answer: Rs. 5,016.65

Problem 2.13: What is the future value of Rs. 20,000 that grows at an annual interest rate of 12% per year for two years?
Solution: 20,000 (1 +0.12)
2

Answer: Rs. 25,088

Problem 2.14: What is the future value of Rs. 25,000 which grows at an annual interest rate of 11% per year for five
years with compounding takes place semi-annually?
Solution: 25,000 (1 +0.11/2)
5*2

Answer: Rs. 42,703.61

Problem 2.15: What is the future value of Rs. 7,000 which grows at a nominal annual interest rate of 8% per year,
compounded monthly, for four years?
Solution: 7,000 (1+0.08/12)
4*12

Answer: Rs. 9,629.66

Problem 2.16: Suppose you make an investment of Rs. 1,000. This first year the investment returns 12%, the second
year it returns 6%, and the third year in returns 8%. How much would this investment be worth?
Solution: 1,000 (1.12) (1.06) (1.08)
Answer: Rs. 1,282.18

Problem 2.17: If you put Rs. 100 in the market today at 10%, how much would you end up with in 20 years?
Solution: 100 (1+0.10)
20

Answer: Rs. 672.75

Problem 2.18: You apply for a loan of Rs. 5,000 fromthe bank. Interest will be calculated at a rate of 8.9% compounded
monthly and the loan must be repaid in full within 6 years. What is the total amount you will end up paying back?
Solution: 5,000 (1 +0.089/12)
6*12
Answer: Rs. 8,511.92

Finance


Work Book Foundation Level 24 Time Value of Money
Unit 2

Problem 2.19: Mr. Ali had opened a savings account on 31
st
December, 2008 with Rs. 100,000. What will be his account
balance in 31
st
December, 2012 when compound interest rate is 5 percent per annum?

Date Description Balance (Rs.)
31
st
, December 2008 Opening an account Rs. 100,000
31
st
, December 2009 100,000 * 0.05 =Rs. 5,000 Rs. 105,000
31
st
, December 2010 105,000 * 0.05 = Rs. 5,250 Rs. 110,250
31
st
, December 2011 110,250 * 0.05 = Rs. 5,512.50 Rs. 115,762.50
31
st
, December 2012 115,762.50 * 0.05 =Rs. 5,788.13 Rs. 121,550.63

Problem 2.20: Rs. 400 is invested over a period of 20 years at the following nominal rates of interest:
Years 1-5: 3% per annum compound half yearly
Years 6-10: 5% per annum compound quarterly
Years 11-20: 4% per annum compound yearly
Calculate the total accumulation after 20 years

Solution: Years 1-5: 3% per annum compound half yearly 400 (1 +0.03/2)
5*2
= Rs. 464.22
Years 6-10: 5% per annum compound quarterly 464.22 (1 +0.05/4)
5*4
= Rs. 595.15
Years 11-20: 4% per annum compound yearly 595.15 (1 +0.04)
10
= Rs. 880.97
Answer: Rs. 880.97

Problem 2.21: You decide to invest Rs. 300 for 2 years in securities that earns 6.2% simple interest
(a) How much interest will this investment earn?
Solution: (300 * 0.062 * 2)
Answer: Rs. 37.2
(b) How much money will you have in total at the end of the term?
Solution: 300 +(300 * 0.062 *2)
Answer: Rs. 337.2

Problem 2.22: Find the value of Rs. 80,000 for 10 years by factor formula and table. The investment earns 8 percent per
annum?
Solution: FV
10
=80,000 (FVIF
8%, 10
)
FV
10
=80,000 (2.1589)
Answer: Rs. 172,712

Problem 2.23: Find the value of Rs. 11,500 compounding quarterly by using continuous compounding method when rate
of interest is 5% and for 3 years?
Solution: FV
3
=11,500 * 2.718
(0.05 / 4) * (3 * 4)

Answer: Rs. 13,361.094
Finance


Work Book Foundation Level 25 Time Value of Money
Unit 2

Problem 2.24: Which loan should you accept (assuming you want to pay as little interest as possible)? Show all your
work.
Option A:
Rs. 6,000 at an interest rate of 12% compounded monthly for 6 years
Solution: 6,000 (1 +0.12/12)
6*12
Answer: Rs. 12,282.60

Option B:
Rs. 6,000 at an interest rate of 9.8% compounded weekly for 6 years
Solution: 6,000 (1 +0.098/52)
6*52
Answer: Rs. 10,796.33

Option C:
Rs. 6,000 at a simple interest rate of 13.4% for 6 years
Solution: 6,000 +(6,000 * 0.134 * 6)

Answer: Rs. 10,824
Accept B

Problem 2.25: For each of the following, compute the future value by factor formula?
Present Value Years Interest Rate
Factor
Future Value
Rs. 3,150 3 16%
1.5609
Rs. 4,916.84
Rs. 7,810 10 6 %
1.7908
Rs. 13,986.15
Rs. 89,305 17 12 %
6.8660
Rs. 613,168.13
Rs. 227,382 22 5 %
2.9253
Rs. 665,160.56


Problem 2.26: Find the value of Rs. 200 by factor formula and table for 120 years. The investment earns 7 % per year.
Solution: FV
120
=2,000 (FVIF
7%, 40
) * (FVIF
7%, 40
) * (FVIF
7%, 40
)
FV
120 =
2,000 (14.974) * (14.974) * (14.974)
Answer: Rs. 671,496.080

Problem 2.27: Compute the future value of Rs. 5,000 compounded annually for
a. 10 years at five percent
Solution: 5,000 (1 +0.05)
10
Answer: Rs. 8,144.47
b. 10 years at seven percent
Solution: 5,000 (1 +0.07)
10
Answer: Rs. 9,835.76
c. 20 years at five percent
Solution: 5,000 (1 +0.05)
20
Answer: Rs. 13,266.49

Finance


Work Book Foundation Level 26 Time Value of Money
Unit 2

Problem 2.28: Compute the future value of Rs. 1,000 continuously compounded for
a. Five years at a stated annual interest rate of 12 percent
Solution: 1,000 e
0.12 * 5
Answer: Rs. 1,822.12
b. Three years at a stated annual interest rate of 10 percent
Solution: 1,000 e
0.10 * 3
Answer: Rs. 1,349.86
c. 10 years at a stated annual interest rate of five percent compound semi-annually
Solution: 1,000 e
(0.05/2) * (10*2)
Answer: Rs. 1,648.72

Problem 2.29: Choose the investment that will earn you the most money at the end of 10 years?
Option A:
Invest Rs. 7,500 at 8.3% simple interest
Solution: 7,500 (7,500 * 0.083 * 10)

Answer: Rs. 13,725

Option B:
Invest Rs. 7500 at 6.2% interest, compounded quarterly
Solution: 7,500 (1 +0.062/4)
10*4
Answer: Rs. 13,875.81

Option C:
Invest Rs.7500 at 5.3% interest, compounded daily
Solution: 7,500 (1 +0.053/365)
10*365
Answer: Rs. 12,741.50

Option D:
Invest Rs. 7500 at 6.0% interest, compounded monthly
Solution: 7,500 (1 +0.06/12)
10*12
Answer: Rs. 13,645.48

Accept B

Problem 2.30: Find the future value of Rs. 200 after 10 years, compounded at an annual rate of 8 percent by using both
general and factor formula?
Solution: FV
10
=200 (1 +0.8)
10
Answer: Rs. 431.8

FV
10
=200 (FVIF
8%, 10
)
FV
10
=200 (2.159)
Answer: Rs. 431.8

Finance


Work Book Foundation Level 27 Time Value of Money
Unit 2

Problem 2.31: Calculate the value of Rs. 25,000 earning 12 % interest per year for three years, if compounding takes
place monthly. Solve by factor formula and table?
Solution: FV
3
=25,000 * (FVIF
0.12 / 12, 3* 12
)
FV
3
=25,000 * (1.4308)
Answer: Rs. 35,770

Problem 2.32: What if Rs. 700 compounded (a) Semi-annually, (b) Quarterly, (c) Monthly, (d) Weekly and (e) Daily at
an interest rate of 12 % for 5 years?
Solution: FV
5
= 700 (1 +0.12 / 2)
5* 2
Answer: Rs. 1,253.59

FV
5
= 700 (1 +0.12 / 4)
5* 4

Answer: Rs. 1,264.28

FV
5
= 700 (1 +0.12 / 12)
5* 12

Answer: Rs. 1,271.69

FV
5
= 700 (1 +0.12 / 52)
5* 52
Answer: Rs. 1,274.602

FV
5
= 700 (1 +0.12 / 365)
5 * 365
Answer: Rs. 1,275.36

Problem 2.33: Find the future value of Rs. 1,000 compounded continuously at an annual rate of 6% for 3 years?
Solution: FV
3
=1,000 * 2.718
0.06 * 3
Answer: Rs. 1,197.22

Problem 2.34: First City Bank pays 7% p.a. interest compounded annually on its savings account balances, whereas
Second City Bank pays 7% p.a. interest compounded quarterly. If you made a Rs. 6,000 deposit in each bank; how much
more money would you earn fromyour Second City Bank account at the end of 8 years?
Solution: First City Bank FV
8
=6,000 (1 +0.07)
8

Answer: Rs. 10,309.12

Second City Bank FV
8
=6,000 (1 +0.07 / 4)
8* 4
Answer: Rs. 10,453.28
Variance 144.16

Problem 2.35: An investor has the possibility to deposit Rs. 500 in one of two potential bank accounts for six years.
Account A offers an interest rate of 5% p.a. compounded semi-annually while Account B offers an interest rate of 4.9%
p.a. compounded quarterly. Which will yield the highest future value?

Solution: Account A 500 (1 +0.05/2)
6* 2
Answer: Rs. 672.44
Account B 500 (1 +0.049/4)
6* 4
Answer: Rs. 669.70
Accept A
Finance


Work Book Foundation Level 28 Time Value of Money
Unit 2

Problem 2.36: For each of the following, compute the future value?

Present value Years Interest rate Future value
2,250 30 12% 67,409.82
9,310 16 9 36,963.55
76,355 3 19 128,670.32
183,796 7 5 258,619.42

Problem 2.37: If interest is compounded monthly, how much will you have in a bank account?

A. If you deposit Rs. 8,000 today, what will be its worth at the end of 3 months, if the bank pays 5.0% APR?
Solution: 8,000 (1 +0.05/12)
3
Answer: Rs. 8,100.42

B. If you deposit today Rs. 10,000 at the end of 6 months, if the bank pays 9.0% APR?
Solution: 10,000 (1 +0.09/12)
6
Answer: Rs. 10,458.52

C. If you deposit today Rs. 80,000 at the end of 12 months, if the bank pays 8.0% APR?
Solution: 80,000 (1 +0.08/12)
12
Answer: Rs. 86,639.96

D. If you deposit today Rs. 5,000 at the end of 24 months, if the bank pays 5.0% APR?
Solution: 5,000 (1 +0.05/12)
24
Answer: Rs. 5,524.71

Problem 2.38: An art collector has the opportunity to invest in paintings; the investment requires an outlay of Rs. 2 million.
He is certain that he will be able to sell the paintings for Rs. 2.18 million in one year. He also has the opportunity to invest in
certificates of deposit (CDs) which pay 10% per year. Is the investment in the paintings a good investment?
Solution: 2 (1 +0.10)

Answer: Rs. 2.2 million (Investment in CDs)

Problem 2.39: If you deposit Rs. 45,000 into an account earning 4% interest compounded quarterly, how much would
you have in 5 years?
Solution: 45,000 (1 +0.04/4)
5*4
Answer: Rs. 54,908.55

Problem 2.40: If you invest Rs. 2,000 (lump sum) in a retirement account, how much will you have in 40 years at 12
percent?
Solution: 2,000 (1 +0.12)
40
Answer: Rs. 186,101.94

Finance


Work Book Foundation Level 29 Time Value of Money
Unit 2

Problem 2.41: For each of the following, compute the future value if compound rate is 14 percent?

Cash flows 1 2 3 4 5 Total
W 100 200 300 400 500 1,500
X 600 ----- 400 200 300 1,500
Y ----- ----- 1,200 ---- 300 1,500
Z 500 ----- 400 600 ---- 1,500


Solution:
(Round all figure to two decimal places)
Cash flows 1 2 3 4 5 Total
W 168.90 296.31 389.88 456 500 1,811.09
X 1,013.38 ---- 519.84 228 300 2,061.22
Y ---- ---- 1,559.52 ---- 300 1,859.52
Z 844.48 ---- 519.84 684 ---- 2,048.32

Problem 2.42: How much will you pay for a Rs. 200,000 automobile after 10 years if the inflation rate is 20%?
Solution:
FV
10
=200,000 * (1 +0.20)
10
Answer: Rs. 1,238,347.28

Finance


Work Book Foundation Level 30 Time Value of Money
Unit 2

MULTIPLE CHOICE QUESTIONS (MCQS)
1. Interest paid (earned) on only the original principal borrowed (lent) is often referred to as ______________?
(a) Compound interest (b) Future value
(c) Present value (d) Simple interest
2. How much will Rs. 10,000 grow into in 5 years if you earn 10%?
(a) Rs. 13,102 (b) Rs. 16,105 (c) Rs. 16,289 (d) None
3. With continuous compounding at 10% for 30 years, the future value of an investment of Rs. 2,000 is closest to?
(a) Rs. 40,171 (b) Rs. 44,898 (c) Rs. 164,500 (d) None of Above
4. (1 +i)
n

(a) PVIF (b) FVIF (c) FVIFA (d) PVIFA
5. As a borrower, you should prefer the bank that ____________________ compound per year?
(a) Less times (b) More times (c) Interest (d) None of the above
6. You deposit Rs. 45,000 into an account at 4% interest compounded quarterly, how much would you have in 5 years?
(a) Rs. 57,908 (b) Rs. 50,602 (c) Rs. 55, 687 (d) Rs. 54,909
7. The Future Value (FV) of Rs. 1,000 in 5 years at 5% interest rate will be?
(a) Rs. 1,000.00 (b) Rs. 1,276.28 (c) Rs. 999.99 (d) Rs. 1,500.52
8. Interest paid (earned) on both the original principal borrowed (lent) and previous interest allowed (earned) is often
referred to as __________?
(a) Compound interest (b) Double interest (c) Simple interest (d) Present value
9. What is the future value of a Rs. 10,000 college tuition fund if the nominal rate of interest is 12 percent compounded
monthly for five years?
(a) Rs. 17,623 (b) Rs. 18,167 (c) Rs. 18,105 (d) Rs. 19,133
10. The value of money to be received in the future is _______the value of the same amount of money in hand today?
(a) Higher than (b) Lower than (c) The same as (d) None of the above
11. Interest has 3 types?
(a) Fixed rate, current rate, market rate (b) Market rate, combination rate, fixed rate
(c) Fixed rate, floating rate, current rate (d) Fixed rate, floating rate, combination rate
12. With continuous compounding at 8 percent for 20 years, what is the approximate future value of a Rs. 20,000 initial
investment?
(a) Rs. 52,000 (b) Rs. 93,219 (c) Rs. 99,061 (d) Rs. 915,240
13. The concept of compound interest refers to?
(a) The process of gradually retiring a debt through periodic payments of principal and interest
(b) The process of servicing a debt with regular interest payments, followed lump sumpayment of principal and
interest at the end of the loan term
(c) The process of converting future lump sums and annuities into present values at a stated interest rate
(d) The process of earning interest on an original amount, plus interest on interest previously earned
Finance


Work Book Foundation Level 31 Time Value of Money
Unit 2

14. If compounding more times outcome will be greater value, it is choice of?
(a) Borrower (b) Lender (c) Liabilities holder (d) None
15. If bank giving 12% interest rate per year, then per month it will be?
(a) 1% (b) 12% (c) 5% (d) 6%
16. Which of the following expresses 6.5%?
(a) 0.0065 (b) 6.50 (c) 0.650 (d) 0.0650
17. You invest Rs. 500,000 today at the rate of 8% per year. After 6 years fromtoday you withdraw Rs. 300,000. After
10 years fromtoday you receive the remaining owed. How much will you receive after 10 years fromtoday?
(a) Rs. 591,289 (b) Rs. 602,437 (c) Rs. 671,316 (d) None
18. You invest Rs. 300,000 today at the rate of 10% per year (for the entire length of this investment of Rs. 300,000
fromtoday to year 8). After 5 years fromtoday you invest Rs. 200,000 more at the rate of 12% per year (for the 3
years of this investment of Rs. 200,000 fromyears 5 to 8). After 8 years fromtoday all your investments are returned
to you. How much will you receive after 8 years fromtoday?
(a) Rs. 901,055 (b) Rs. 924,063 (c) Rs. 947,853 (d) Rs. 969,810
19. You just purchased a piece of land for Rs. 10,000. If you expect a 12% annual rate of return on your investment,
how much will you sell the land for in 10 years?
(a) Rs. 25,000 (b) Rs. 38,720 (c) Rs. 31,058 (d) Rs. 34,310
20. The Time value of money must be considered in total outlay decision because?
(a) Cash inflows and out flows occur at different point (b) Inflation greatly reduce the outflows
(c) A dollar received in future is more value able than a dollar today
(d) Cash flows are not known with certainty
21. Money has time value because?
(a) Individuals prefer future consumption to present consumption
(b) Money today is worth more than money tomorrow in terms of purchasing power
(c) There is a possibility of earning risk free return on money invested today (d) B and C above
22. Given an investment of Rs. 10,000 to be invested for one year?
(a) It is better to invest in a scheme that pays 10% simple interest
(b) It is better to invest in a scheme that pays 10% annual compound interest
(c) Both (a) and (b) provide the same return (d) Dont invest
23. You invest Rs. 100,000 today at the rate of 8% per year. After 5 years you deposit Rs. 150,000 more. After 7 years
all your investments are returned to you. How much will you receive after 7 years?
(a) Rs. 346,342 (b) Rs. 250,000 (c) Rs. 397,348 (d) Rs. 451,259
24. The real rate of interest reflects compensation for?
(a) Present value (b) Future value (c) Time value of money (d) None of above
25. With continuous compounding at 8 percent for 20 years, what is the approximate future value of a Rs. 20,000 initial
investment?
(a) Rs. 52,000 (b) Rs. 93,219 (c) Rs. 99,061 (d) Rs. 915,240
Finance


Work Book Foundation Level 32 Time Value of Money
Unit 2

26. Which of the following formulas is the correct way to express a future value two years into the future based on a present
value and an interest rate? FV
2
=
(a) PV (1 +i) +PV (1 +i) (b) PV (1 +i) (1 +i)
(c) PV (1 +i)
2
(d) B and C
27. The basic rule of the time value of money is
(a) Investments will always be worth more tomorrow than they are today
(b) Its always wiser to save a dollar for tomorrow than to spend it today
(c) A dollar in hand today is worth more than a dollar promised at some time in the future
(d) All of the above express an aspect of the basic rule of time value of money
28. You invest Rs. 100,000 at the rate of 8% per year for 5 years. How much will you receive after 5 years?
(a) Rs. 146,933 (b) Rs. 147,249 (c) Rs. 148,381 (d) Rs. 141,084
29. You invest Rs. 18,000,000 today for 6 years time and the rate of return is 10%. How much do you get in 6 years?
(a) Rs. 29,989,188 (b) Rs. 30,435,151 (c) Rs. 30,423,147 (d) Rs. 31,888,098
30. You invest Rs. 10,000 over 12 years at 5%. What is the amount you receive at the end?
(a) Rs. 17,959 (b) Rs. 18,153 (c) Rs. 18,299 (d) Rs. 18,977
31. A decrease in the demand for loanable funds, holding supply constant, will cause interest rates to?
(a) Increase (b) Decrease (c) Stay the same (d) Not enough information to tell
32. Find the compound amount for the deposit, Rs. 1,900 at 10% compounded quarterly for 4 years?
(a) 2,097.24 (b) 2,781.79 (c) 2,660.00 (d) 2,820.56
33. In which case will an investor receive the most interest?
(a) 10%, compounded monthly (b) 10%, compounded annually
(c) 10%, compounded daily (d) 10%, compounded continuously
34. Treasury bills are?
(a) Issued on a premiumbasis and pay a fixed annual interest rate
(b) Issued on a discount basis and mature at par (c) Issued on a premiumbasis and mature at par
(d) Issued on a discount basis and pay a fixed annual interest rate
35. Nominal Interest Rate is also known as?
(a) Annual percentage rate (b) Effective interest Rate
(c) Periodic interest rate (d) Coupon rate
36. How much will accumulate in an account with an initial deposit of Rs. 100, and which earns 10% interest
compounded quarterly for three years?
(a) Rs. 107.69 (b) Rs. 133.10 (c) Rs. 134.49 (d) Rs. 313.84
37. The nominal interest rate can be expressed as?
(a) i =MR +IF +DR +MRP (b) i =RR +IF +GRP +MR
(c) i =RR +IF +DRP +TRP (d) i = RR + IP + DR + MR
38. What is the value of Rs. 750 invested at 7.5% compounded quarterly for 4.5 years (round to nearest Rs. 1)?
(a) Rs. 1,048 (b) Rs. 1,010 (c) Rs. 1,038 (d) Rs. 808
Finance


Work Book Foundation Level 33 Time Value of Money
Unit 2

39. With discrete compounding at 8 percent for 20 years, what is the approximate future value of a Rs. 20,000 initial
investment?
(a) Rs. 52, 000 (b) Rs. 93, 219 (c) Rs. 99, 061 (d) Rs. 915, 240
40. If you place Rs. 50 in a savings account with an interest rate of 7% compounded weekly, what will the investment be
worth at the end of five years (round to nearest dollar)?
(a) Rs. 72 (b) Rs. 70 (c) Rs. 71 (d) Rs. 57
41. If you put Rs. 600 in a savings account that yields an 8% rate of interest compounded weekly, what will the
investment be worth in 37 weeks (round to the nearest rupee)?
(a) Rs. 648 (b) Rs. 635 (c) Rs. 634 (d) Rs. 645
42. If Rs. 1,000 were invested now at a 12% interest rate compounded annually, what would be the value of the
investment in two years?
(a) Rs. 1,188 (b) Rs. 1,210 (c) Rs. 1,254 (d) Rs. 1,160
43. If you put Rs. 900 in a savings account that yields 10% compounded semi-annually, how much money will you have
in the account in three years (round to nearest rupee)?
(a) Rs. 1,340 (b) Rs. 1,170 (c) Rs. 1,227 (d) Rs. 1,206
44. Rs. 20,625 at 12% compounded continuously for 5 years, find the compound interest earned by the deposit (Round
to the nearest paisa)?
(a) Rs. 37,581.20 (b) Rs. 37,577.49 (c) Rs. 13,377.58 (d) Rs. 14,353.97
45. Rs. 5,000 at 7% compounded semiannually for 8 years, find the compound amount for the deposit (Round to the
nearest paisa)?
(a) Rs. 7,800.00 (b) Rs. 6,584.05 (c) Rs. 8,669.93 (d) Rs. 8,590.93
46. Assume that you purchase a 6-year, 8 percent savings certificate for Rs. 1,000. If interest is compounded annually,
what will be the value of the certificate when it matures?
(a) Rs. 630.17 (b) Rs. 1,469.33 (c) Rs. 1,677.10 (d) Rs. 1,586.90
47. Rs. 1,000 invested today at 6% interest would be worth ________________ one year fromnow?
(a) Rs. 1,600 (b) Rs. 1,060 (c) Rs. 1,160 (d) Rs. 1,006
48. A decrease in the supply for loanable funds, holding demand constant, will cause interest rates to?
(a) Increase (b) Decrease (c) Stay the same (d) Not enough information to tell
49. The value of money results from?
(a) Its backing (b) Rates set by the State Bank (c) Its purchasing power (d) None of the above
50. The basic price that equates the demand for and supply of loanable funds in the financial markets is the _______?
(a) Interest rate (b) yield curve (c) Termstructure (d) Cash price
51. If the interest rate is greater than 0%, then a dollar today is worth?
(a) Less than a dollar tomorrow (b) The same as a dollar tomorrow
(c) More than a dollar tomorrow (d) There is not sufficient information to tell
52. In an inflationary period, interest rates have a tendency to?
(a) Fall (b) Rise (c) Stay the same (d) Act erratically
Finance


Work Book Foundation Level 34 Time Value of Money
Unit 2

53. The liquidity preference theory holds that interest rates are determined by the?
(a) Supply of and demand for money (b) Supply of and demand for loanable funds
(c) Flow of funds over time (d) Flow of bank credit over time
54. The basic motives for holding money rather than investments are?
(a) Transactions motive and the precautionary motive (b) Transactions motive and liquidity preference motive
(c) Transactions motive, the precautionary motive, and the speculative motive
(d) Transactions motive, the precautionary motive, and the liquidity preference motive
55. As the economy begins moving out of a recessionary period, the yield curve is generally?
(a) Upward sloping (b) Flattened out (c) Downward sloping (d) Discontinuous
56. An unexpected increase in inflation should?
(a) Increase the demand for loanable funds (b) Decrease the interest rate on loans
(c) Increase the interest rate on loans (d) None of the above
57. An increase in the supply for loanable funds, holding demand constant, will cause interest rates to?
(a) Decrease (b) Increase (c) Stay the same (d) Not enough information to tell
58. If you expect the inflation premium to be 2%, the default risk premium to be 1% and the real interest rate to be 4%,
what interest would you expect to observe in the marketplace under the simplest formof market interest rates?
(a) 4% (b) 7% (c) 2% (d) 1%
59. Which of the following factors directly impact the level of interest rates?
(a) Risk (b) Marketability (c) Maturity (d) All of the above
60. An increase in the demand for loanable funds, holding supply constant, will cause interest rates to?
(a) Increase (b) Decrease (c) Stay the same (d) Not enough information to tell
61. If the interest rate is less than 0%, then a dollar today is worth?
(a) More than a dollar tomorrow (b) The same as a dollar tomorrow
(c) Less than a dollar tomorrow (d) There is not sufficient information to tell
62. Assume that these current yields exist: long-termgovernment securities yield 9 percent, five-year Treasury securities
yield 8.5 percent, and one-year Treasury bills yield 8 percent. What type of yield curve is depicted?
(a) Downward sloping (b) Flat or level (c) Upward sloping (d) U shaped
63. The future value of Rs. 100 received today and deposited at 6 percent for four years is?
(a) Rs. 126 (b) Rs. 79 (c) Rs. 124 (d) Rs. 116
64. If the nominal interest rate is 8% and the risk-free rate is 3%, the expected inflation rate?
(a) 3% (b) 5% (c) 11% (d) Cannot be determined without additional information
65. Which of the following is not true of Treasury bills?
(a) Long-lived (b) Sold at a discount (c) Mature at par (d) All the above are false
66. The future value of Rs. 200 received today and deposited at 8 percent for three years is?
(a) Rs. 248 (b) Rs. 252 (c) Rs. 158 (d) 200

Finance


Work Book Foundation Level 35 Time Value of Money
Unit 2

67. Which of the following is not a determinant of market interest rates?
(a) The inflation premium (b) The maturity risk premium
(c) The volatility risk premium (d) The real rate of interest
68. What is the real rate of interest if the nominal rate of interest is 15%, the IF is 3%, the DRP is 3%, the MRP is 3%,
and the LP is 2%?
(a) 3% (b) 4% (c) 5% (d) None of the above
69. The risk-free interest rate is composed of?
(a) An inflation premiumand a default risk premium (b) A default risk premiumand a maturity risk premium
(c) A real rate of interest and a liquidity premium (d) A real rate of interest and an inflation premium
70. When investors expect __________ inflation rates they will require __________ nominal interest rates so that a real
rate of return will remain after the inflation?
(a) Higher, lower (b) Higher, higher (c) Lower, higher (d) None of the above
71. With continuous compounding at 8 percent for 20 years, what is the approximate future value of a Rs. 2,000?
(a) Rs. 152,000.4 (b) Rs. 199,061.2 (c) Rs. 191,270.5 (d) Rs. 91,524.8
72. If the nominal rate of interest is 10%, the real rate of interest is 3%, the default premiumis 3%, the liquidity
premium is 0.5%, and the maturity premiumis 1.5%, then the inflation premiummust be ______?
(a) 2.0% (b) 2.5% (c) 3.0% (d) None of the above
73. ___________________ states that interest rates are a function of the supply and demand for loanable funds?
(a) The expectations theory (b) The loanable funds theory
(c) The liquidity preference theory (d) The market segmentation theory
74. If the nominal rate of interest is 10%, the risk-free rate of interest is 3%, the default premium is 3%, the liquidity
premium is 0.5%, and the maturity premiumis 1.5%, then the inflation premiummust be ______?
(a) 2.0% (b) 2.5% (c) 3.0% (d) None of the above
75. The relationship between interest rates or yields and the time to maturity for debt instruments quality is called?
(a) The yield to maturity (b) The term structure of interest rates
(c) The maturity risk premium (d) The expectations hypothesis
76. Three theories commonly used to explain the termstructure of interest rates include all of the following except?
(a) The default risk theory (b) The expectations theory
(c) The market segmentation theory (d) The liquidity preference theory
77. ______________ occurs during economic expansions when demand for goods and services is greater than supply?
(a) Administrative inflation (b) Speculative inflation
(c) Cost-push inflation (d) Demand-pull inflation
78. If the stated or nominal interest rate is 10 percent and the inflation rate is 5 percent, the differential compounding
rate would be ________ percent?
(a) Ten (b) Five (c) Two (d) Fifteen
79. The future value of Rs. 2,000 invested at 6% in 3 years would result in a value of?
(a) Rs. 2,000 (b) Rs. 6,362 (c) Rs. 2,382 (d) None of the above
Finance


Work Book Foundation Level 36 Time Value of Money
Unit 2

80. An increase in the supply for loanable funds accompanied by a decrease in demand will cause interest rates to?
(a) Decrease (b) Increase (c) Stay the same (d) Not enough information to tell
81. Ali puts Rs. 1,000 in a savings passbook that pays 4% compounded quarterly. How much will he has in his account
after five years?
(a) Rs. 1,200.50 (b) Rs. 1,220.20 (c) Rs. 1,174.80 (d) Rs. 1,217.50
82. You put Rs. 2,000 in an IRA account at Northern Trust. This account pays a fixed interest rate of 8% compounded
quarterly. How much money do you have in five years?
(a) Rs. 2,914 (b) Rs. 2,938 (c) Rs. 2,972 (d) Rs. 2,999
83. Mr. Noman deposits Rs. 5,000 in a five-year certificate of deposit paying 6% compounded semi-annually. How
much will he has at the end of the five-year period?
(a) Rs. 6,720 (b) Rs. 6,690 (c) Rs. 6,596 (d) Rs. 6,910
84. For positive interest rates, the future value interest factor is
(a) Sometimes negative (b) Always greater than 1.0
(c) Always less than 0 (d) Never greater than 25
85. Inflation caused by an increase in the money supply is called?
(a) Demand-pull inflation (b) Cost-push inflation
(c) Administrative inflation (d) A combination of administrative and speculative inflation
86. Suppose you were going to save Rs. 1,000 per year for three years at a 10% interest rate compounded annually, with
the first investment occurring today. What would be the future value of this investment?
(a) Rs. 2,124 (b) Rs. 2,310 (c) Rs. 3,641 (d) Rs. 3,812
87. What would be the future value of a loan of Rs. 1,000 for two years if the bank offered a 10% interest rate
compounded semiannually?
(a) Rs. 1,720 (b) Rs. 1,960 (c) Rs. 1,200 (d) Rs. 1,216
88. When the amount earned on a deposit has become part of the principal at the end of a specified time period the
concept is called?
(a) Discount interest (b) Compound interest (c) Primary interest (d) Multi interest
89. If the interest rate is zero, the future value interest factor equals ________?
(a) -1.0 (b) 0.0 (c) 1.0 (d) 2.0
90. Rs. 100 is received at the beginning of year 1, Rs. 200 is received at the beginning of year 2, and Rs. 300 is received
at the beginning of year 3. If these cash flows are deposited at 12 percent, their combined future value at the end of
year 3 is ________?
(a) Rs. 1,536 (b) Rs. 727 (c) Rs. 672 (d) Rs. 1,245
91. The future value of Rs. 200 received today and deposited for three years in an account which pays semiannual
interest of 8 percent is ________?
(a) Rs. 253 (b) Rs. 252 (c) Rs. 158 (d) Rs. 135