In our last post, you were introduced to how same "amount of money" can differ in "value" depending on "when" and "how frequently" they are given. This sentence basically covers everything we will be dealing with in the 【Time Value of Money】 series.
【Quantitative Methods】Time Value of Money (1)
In our last post, you were introduced to how same "amount of money" can differ in "value" depending on "when" and "how frequently" they are given. This sentence basically covers everything we will b..
quant-curiosity.tistory.com
In today's post, we discuss the concept of future value.
Future Value is the value of an asset at a specified date. To calculate future value, one needs to have specific information about timeline and other factors that could contribute to the change in value.
At a high-level, Future Value is calculated as sum of all future cash flows and thereby obtaining how much everything will be "worth" on the specified date.
To achieve this, we need to clarify how these cash flows are determined.
I. Payment (Cashflow)
There are two types of payments: (1) regular or predetermined cashflow and (2) irregular cashflow.
(1) Regular or Predetermined Cash Flow includes incomes from:
-
Savings Account
-
Corporate Bonds
(2) Irregular Cash Flow includes incomes from:
-
Dividends
-
Copyrights
-
Businesses
For irregular cash flow, we can only determine the future value once we have a solid projection of earnings for each period or expected cash flow. Hence, our focus will primarily be on the "regular or predetermined cash flow" category.
First step to calculating Future Value is obtaining the payments at each period starting from today, until the specified future date.
1. Nominal Amount, Single Payment
Some payments are made at once in the future.
Alex purchased Kim's TV with a promise to pay $\$$600 after 6 months with $60
Payments
At times, payment is pre-specified at a nominal rate, meaning on a dollar scale.
Example.
Alex purchased Kim's TV wide a promise to pay $\$$100 per month for the next 6 months.
We can then assume that he will pay $\$$100 at the end of each month. By the end of 6 months term, he would have paid $\$$600.
2. Percent of Principal
Sometimes, payment is stated as percent of principal (starting amount or borrowed/owed amount).
Example.
