Question

how can the "time value of money" concept affect the valuation of liabilities?

For example, how can this concept be used to determine the price of bond?

In contrast, how can it be used to help us plan for a specific goal (e.g., purchase of a car, home, or retirement)?

Answer 1

Time value of money is the fundamental concept in finance. Its essence lies in saying that 1$ of today will be equal to $1.2 of next year if interest rate were 20 % for the year. Price of the bond is determined using this concept.

For example -

A bond is issued at par value of $ 1000 for 2 years with coupon rate of 4 % per annum, interest rate in the market is 6 % then price of bond can be calculated as -

Price of bond today = Coupon Amount *PVAF(6%,2) + Par value *Present value factor(6%,2)

= $ 40 * 1.833 + $1000* 0.889

= $ 73.33 + $ 889

= $ 962.33

Therefore it can be said that it is used to determine the value of the bond.

As specified above it can used in deciding whether to invest in bond or share now. Present value and future value are the two major element of the concept.