Investment: Time Value of Money Essay

enthronement is the use of money for a next fiscal gain. Investments may derive in the form of sh ares of stock, life insurance, government bonds, or putting up a savings account. Every enthronization decision has its underlying risks and uncertainties. different factors ignore affect enthronization decisions and outcomes such as annuities and term tax of money.Money has a time value. A dollar directly is cost more than a dollar to be received at either later date. Many frugal decisions involve investing money now in the hope of receiving more money later on. Various economic factors affect the time value of money such as risk, inflation, opportunity cost, and others. According to Robert C. Higgins (1999), time value of money exists for at least trey reasons. Robert C. Higgins (1999) stated that inflation reduces the purchasing king of future dollars relative to flow ones, uncertainties surrounding the receipt of dollar increases as the date of receipt get away, a nd because of the presence of opportunity cost.In economics, inflation is a filiation in the value of money in relation to the goods and services it green goddess buy. Inflation can affect time value of money and investment decisions. Due to inflation, borrowers usually benefit while lenders suffer, because mortgage, personal, business, and government loans are compensable with money that loses purchasing power over time (Encarta, 2004). It is important to determine however, that borrowers only benefit when the inflation is unexpected, when inflation is expected by creditors, the worry rate they charges rises to compensate for the unexpected decline in the purchasing power of the mavin loan (Encarta, 1999).Risk or financial risk is outlined as the possibility of loss in an investment. Investment decisions involve several(prenominal) type of risk because of the time value of money. Lenders should take into considerateness conf employ factors onwards extending credit such as the borrowers ability to succumb or collaterals. Interest rates on loans can also be based on the degree of risk manifold. The higher the risk involved the higher pursuit rate. On the other hand, lower engross is enforce on low-risk loans. As mentioned above, investment decisions has its underlying risk and uncertainties, therefore before making investment decisions it is important to understand the risks and uncertainties involved.luck cost is define as the expected income on the next best election or the income foregone if an investor chooses one action over another (Higgins, 1999). A dollar today is worth more than a dollar in the future since money today can be invested for it to double in the future. Opportunity cost depends on what action is to be considered. Before making decisions, an investor mustiness first look for and obtain an understanding of all the available pick 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 make for the use of another persons money and is regarded as a payment made for capital (Encarta, 2004). Interest can be bear on by economic factors such as inflation. When interest is computed based on the principal amount, it is called simple interest. However, when interest is computed not only on the principal amount but also on the cumulative total of quondam(prenominal) interest payments, the subprogram of interest computation is now called compounding. Compounding is the process of determining the future value of a chip in sum (Higgins, 1999). The interest rate used on compounding is called the compound interest rate. Discounting, on the other hand is the exact opposite of compounding. Discounting is the process of finding the contribute value of a future sum (Higgins, 1999). The interest rate used in discounting is called the discount rate. The amount of money to be receiv ed in a future date is usually a combination of the authoritative investment and the interest on that investment. Discounts are rewards or considerations given 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 steady blow 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 years. Annuity earnings grow tax-deferred and are usually purchased by investors who are primarily concerned with limiting their taxes (Understanding annuities, 2006).The order of 72 is a met hod of estimating an investments doubling time or halving time (Rule of 72, 2006). The Rule of 72 estimates the come up of years it takes for an investments value to double at a specific 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 taking into consideration the precept of 72, investors can assess 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 judicial decision of the possible inherent risks and uncertainties. An effective investing decision requires a consideration of the time value of money.ReferencesEncarta Reference Library 2004. Microsoft CorporationHiggins, R. (1999). Analysis for financial management. Evaluating investment opportunities (pp 23 1-266). Washington. Irwin McGraw Hill.Rule of 72 (2006). Wikipedia, the free encyclopedia. Retrieved celestial latitude 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