Investment: Time Value of Money Essay

Investment is the use of cash for a future financial gain. Investments may come in the form of sh ars of stock, keep insurance, government bonds, or putting up a savings account. every(prenominal) enthronement decision has its underlying risks and uncertainties. Various factors quite a little modify investment decisions and outcomes much(prenominal) as annuities and stay entertain of money.Money has a flowing appreciate. A sawbuck now is worth much than than a vaulting horse to be received at any later envision. Many economical decisions involve investing money now in the hope of receiving more money later on. Various economic factors affect the time revalue of money much(prenominal)(prenominal) as risk, pompousness, opportunity address, and others. According to Robert C. Higgins (1999), time value of money exists for at least three reasons. Robert C. Higgins (1999) stated that inflation reduces the buying index finger of future dollars relative to current o nes, uncertainties surrounding 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 decline in the value of money in relation to the goods and services it arsehole buy. Inflation can affect time value of money and investment decisions. Due to inflation, borrowers usually get ahead while lenders suffer, because mortgage, personal, business, and government loans argon paid with money that loses purchasing power over time (Encarta, 2004). It is great to understand however, that borrowers only benefit when the inflation is surprising, when inflation is expected by creditors, the sideline roam they charges rises to compensate for the unexpected decline in the purchasing power of the principal loan (Encarta, 1999).luck or financial risk is defined as the possibility of prejudice in an investment. Investment decisions involve some type of risk because of the time value of money. Lenders should jam into consideration heterogeneous factors before extending credit such as the borrowers ability to pay or collaterals. Interest rate on loans can besides be based on the mark of risk involved. The higher the risk involved the higher stake rate. On the other hand, lower interest is imposed 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.Opportunity cost is defined as the expected income on the next best alternative or the income foregone if an investor chooses one trans deed 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 simulacrum in the future. Opportunity cost depends on what action is to be considered. Before making decisions, an investor must first look for and beat an understanding of all the available alternative cours es of action. After determining the various alternatives, the differential effects of each alternative should be considered to avoid voltage problems in the future.Interest is the payment made for the use of another persons money and is regarded as a payment made for bully (Encarta, 2004). Interest can be affected by economic factors such as inflation. When interest is computed based on the principal issue forth, it is called simple interest. However, when interest is computed not only on the principal amount but also on the cumulative total of past interest payments, the process of interest computation is now called compounding. Compounding is the process of determining the future value of a present sum (Higgins, 1999). The interest rate used on compounding is called the compound interest rate.            Discounting, on the other hand is the learn opposite of compounding. Discounting is the process of finding the present value of a f uture 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 given on the purchase of assignable 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 disposition of interest on the loans.An annuity is a type of investment that can provide a steady 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 mean (Encarta, 2004). At times, it is required to compute for the present value of a serial of equal amounts to be received at the end of a serial publication 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 rule of 72 is a order of estimating an investments doubling time or halving time ( ordinance of 72, 2006). The Rule of 72 estimates the number 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 evolution rate into 72 to determine the number of years it will take to double. By taking into consideration the rule of 72, investors can assess the aloofness 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 possible inherent risks and uncertainties. An legal investing decision requires a consideration of the time value of money. propagationsEncarta Reference Library 2004. Microsoft CorporationHiggins, R. (1999). Analysis for financial management. Evaluating investment opportunities (pp 231-266). Washington. Irwin McGraw Hill.Rule of 72 (2006). Wikipedia, the free encyclopedia. Retrieved December 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