Investment: Time Value of Money Essay

Investment is the use of money for a future financial gain. Investments may come in the form of shares of stock, life insurance, political science bonds, or putting up a savings account. Every enthronization funds decision has its profound risks and uncertainties. Various factors give the axe affect investment decisions and outcomes such as annuities and metre value of money.Money has a time value. A dollar sign sign now is charge more than a dollar to be received at any later date. Many economic 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 three reasons. Robert C. Higgins (1999) stated that inflation reduces the purchasing power of future dollars relative to current ones, uncertainties surrounding the receipt of dollar increases as the date of receip t 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 can 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 paid with money that loses purchasing power over time (Encarta, 2004). It is important to understand however, that borrowers only benefit when the inflation is unexpected, when inflation is expected by creditors, the affair rate they charges rises to compensate for the unexpected decline in the purchasing power of the principal loan (Encarta, 1999).Risk or financial risk is define as the possibility of loss in an investment. Investment decisions involve some suit of risk because of the time value of money. Lenders should take into consideration various factors forwards extending credit such as the borrowers ability to p ay or collaterals. Interest rates on loans can also be based on the degree of risk involved. The higher the risk involved the higher pursuit 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 do investment decisions it is important to understand the risks and uncertainties involved.Opportunity cost is defined as the expected income on the following best substitute(a) 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 must first look for and obtain an understanding of all the available alternative 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 compensation made for the use of another persons money and is regarded as a payment made for capital (Encarta, 2004). Interest can be affected by economic factors such as inflation. When interest is computed based on the principal amount, it is called guileless 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 combine. 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 exact opposite of compounding. Discounting is the process of finding the present value of a future 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 ju nto of the original 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 stream of income over along period of time (Understanding annuities, 2006). Annuity is an annual allowance, payment, or income derived from funds curiously designated for the purpose (Encarta, 2004). At times, it is required to compute for the present value of a serial publication 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 rule of 72 is a method of estimating an investments dou bling time or halving time ( observe 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 growth rate into 72 to memorize the number of years it will take to double. By taking into consideration the rule 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 assessment of the accomplishable 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 231-266). Washington. Irwin McGraw Hill.R ule 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