Understand Present Value Versus Future Value

In this article, we will continue the financial investing series with the discussion of financial market structures known Present value and future value in macroeconomics.

The concept of present value versus future value is like the concept that a dollar today is worth more than a dollar. In fact, a dollar invested today earning interest will grow in value when the interest is paid and if the dollar plus interest is automatically reinvested for a further period of time, new interest will be earned on both the dollar of original investment and on the interest already earned. As this is repeated over a period of time, we call the result of compounding interest. It is possible to determine the future value of money by using

1. Financial tables.

a) Present value represents the original investment that we have in hand today.
b) Future value represents what that investment will grow to when interest is earned on a sequential renewal of investment, where the original investment plus all interest earned, keeps being reinvested for subsequent periods until maturity.

Here is the formula

FV = PV (1+I) where
FV is future value
PV is present value
I is annual interest rate
n is number of compounding periods

2. Present value of a single sum
In order to determine the present value, we must take the final sum and discount it by the interest factor working backwards from our known single sum. Here is a formula:
PV= FV/ (1+I)
The definitions for PV, FV, I, n are the same as 1. above.

3. Present value and the amount of the annuity payment of an annuity
There are two types of annuities
*Deferred Annuity:
Receipts on payments are made at the end of the period.
*Annuity Due:
Receipts or payments occur at the beginning of the period.
Future value of an annuity helps to calculate how much money needs to be invested today, in order to receive a certain payment in the future.

a) The present value of an annuity is calculated by the formula below
PV = (PMT/i) ยท [1 - (1 / (1 + i)n)]
Where
PV= Present value
PMT= The amount of the annuity payment
i =The annual rate of interest
n =The number of discounting periods

b) The amount of the annuity payment is calculated by this formula below
Where
PV= Present value
PMT= The amount of the annuity payment
i =The annual rate of interest
n =The number of discounting periods

I hope this information will help. If you want more information of the above subject, you can find this series of articles at my home page: