Step 23: Time Value of Money

Time Value of Money

• Is the dollar today worth more than the dollar tomorrow?
• Yes
• Why?
• Opportunity cost and INFLATION

Formulas

v = future value of $

p = present value of $

r = real interest rate ( nominal - inflation rate ) [a decimal]

n = years

k = number of times interest is credited per year

• Simple Interest Formula

v = ( 1 + r ) ^ n * p

• Compound Interest Formula

v = ( 1 + r / k ) ^ nk * p

• Inflation expected at 3 %, nominal on simple interest is 1 %

Function of the Fed

1. issues currency
2. sets reserve requirements and holds reserves of banks
3. lends money to banks and charges them interest
4. a check clearing service for banks
5. acts as a personal bank for the government
6. supervises member banks
7. controls the money supply in the economy