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Introduction of time_value_of_money

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Assignment Essay on Time Value of Money
Table of Contents
Time Value of Money .............................................................................................................................. 1
Time Value of Money Applications ......................................................................................................... 1
Discount and Interest Rate Components ................................................................................................ 3
Interest rate in determining future value ............................................................................................... 3
Conclusion ............................................................................................................................................... 4
Time Value of Money
One might know that time is one of the most valuable assets in our lives. In the financial world the
value of money is linked to time, primarily because investors expect progressive returns on their
cash over periods of time, and they always compare the return from certain investments with the
going or average returns in the market. Inflation on other hand erodes the purchasing power of
money causing future value of one rupee to be less than the present value of a rupee. This essay will
examine time value of money and the applications that determine successes or failures. After
defining the applications that generalize time value of money, an explanation will be offered
regarding the components of interest rates by expanding on the concept that interest rate equates
the future value of money with present value.
Time Value of Money Applications
Capital markets are markets "where people, companies, and governments with more funds than
they need (because they save some of their income) transfer those funds to people, companies, or
governments who have a shortage of funds (because they spend more than their income)". The two
major capital markets are stock and bond markets. Capital markets promote economic efficiency by
moving funds from those who do not have an immediate need for it to those who do. Individuals or
companies will put money at risk if the return on the intended investment is greater than the return
of holding risk-free assets. An example of this would be those that invest in real estate or purchase
stocks and bonds. Those that invest want the stock, bond, or real estate to grow in value or
appreciate. An example of this concept would be if an individual or company invested an amount
saved over the course of a year. While investing may be riskier, these individuals hope that the
investment will yield a greater return than leaving the money in a savings account drawing nominal
interest. In this example the companies that issue the stocks or bonds have spending needs that
exceeds their income so the company will finance their spending needs by issuing securities in the

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capital markets. This is a method of direct finance because the "companies borrowed directly by
issuing securities to investors in the capital markets".
Opposite of direct financing is indirect financing which involves a "financial intermediary between
the borrower and the investor". Banks would be an example of the intermediary because they may
loan out money that an individual or company has left in a savings account. The capital marketplace
could not exist without these intermediaries as they are what help create strong economies.
Stocks and bonds are commonly called securities "because they both represent obligations on the
part of issuers to provide purchasers with expected or stated returns on the funds invested or
loaned". In the primary market firms issue securities and sell them initially to the public. When a
company needs capital to expand a plant, develop products, acquire another firm, or pursue other
business opportunities, it may make a stock or bond offering which gives investors the opportunity
to purchase ownership shares in the firm and to take part in its future growth in exchange for
providing current capital. Netscape and Yahoo! are examples of companies that have grown because
of a stock offering in the primary market called initial public offering.
Government agencies will also use primary markets to raise funds by issuing bonds. Treasury bonds
to finance part of the budget deficit as well as state and local governments will issue municipal
bonds to finance long-term capital projects in a community. A long-term capital project might be
building a new school or park. Secondary markets consist of a "collection of places where previously
issued shares of stock and bonds are traded among owners other than the issuing firms".
A corporate security that represents the ownership or debt of a company is a stock or bond. The
basic form of ownership in a business is the common stock. Purchasers of common stock expect to
be paid dividends and/or capital gains that result from the increases in the value of the stock they
hold. The value of the stock sold on either par value or no-par value cannot be confused with two
other types of stock value, market and book value. The par value of a stock is an arbitrary value for
the stock designated by the company. Since par value is arbitrary, most companies will issue no-par
value stock. Market value of stock is the price the stock is currently selling at and book value is
determined by subtracting the company's liabilities, including the value of any preferred stock it has
issued, from its assets. The net figure is then divided by the number of shares of common stock
resulting in the book value.
Another form of stock issued by corporations is preferred stock. Preferred stock owners receive
preference in payment of dividends. Unlike common stock holders who may lose money if a
company fails, preferred stock holders will receive money if a company fails because preferred stock
holders receive payment before any claim by common stockholders.
Bonds are another way for a corporation to receive financing. In selling bonds, corporations obtain
long-term debt capital. Bondholders have a claim on corporations assets should that corporation fail
which must be satisfied prior to any claims that a preferred stockholder or common stockholder be
satisfied.
The three categories of securities that are used for the valuation and reporting on financial
statements of corporations are trading securities, available for sale securities, and held to maturity
securities. Trading securities are those securities that are "bought and held primarily for sale in the

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Assignment – Essay on Time Value of Money Table of Contents Time Value of Money 1 Time Value of Money Applications 1 Discount and Interest Rate Components 3 Interest rate in determining future value 3 Conclusion 4 Time Value of Money One might know that time is one of the most valuable assets in our lives. In the financial world the value of money is linked to time, primarily because investors expect progressive returns on their cash over periods of time, and they always compare the return from certain investments with the going or average returns in the market. Inflation on other hand erodes the purchasing power of money causing future value of one rupee to be less than the present value of a rupee. This essay will examine time value of money and the applications that determine successes or failures. After defining the applications that generalize time value of money, an explanation will be offered regarding the components of interest rates by expanding on the concept that interest rate equates the future value of money with present value. Time Value of Money Applications Capital markets are markets "where people, companies, and governments with more funds than they need ...
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