Introduction to Finance

218
CHAPTER 
9
Time Value of Money
L E A R N I N G O B J E C T I V E S
After studying this chapter you should be able to do the following:
LO 9.1
Explain what is meant by the “time value of money” and the concept of simple 
interest.
LO 9.2
Describe the process of compounding to determine future values.
LO 9.3
Describe the process of discounting to determine present values.
LO 9.4
Explain how to fi nd interest rates and time requirements for problems involving 
compounding or discounting.
LO 9.5
Defi ne an 
annuity
and describe how to fi nd the future value of an ordinary annuity.
LO 9.6
Explain how to calculate the present value of an ordinary annuity.
LO 9.7
Describe how to fi nd interest rates and time requirements for problems involving 
ordinary annuities.
LO 9.8
Explain how to determine periodic ordinary annuity payments.
LO 9.9
Explain how to calculate future and present values when time intervals are less than 
one year, and describe how to estimate the cost of consumer credit.
W H E R E W E H A V E B E E N . . .
In Chapter 8, you learned how interest rates are determined in the fi nancial markets. The supply 
of and demand for loanable funds were discussed along with the determinants of market, or 
“nominal,” interest rates. You should recall that the determinants are the real rate of interest, an 
infl ation premium, and a default risk premium for risky debt. A maturity risk premium adjusts 
for diff erences in lives, or maturities, and there also may be a liquidity premium. You also 
learned about the characteristics of U.S. government debt securities and the term, or maturity 
structure, of interest rates. You now should know how infl ation premiums and price movements 
aff ect interest rates, as well as why default risk premiums exist and how they are measured.