Question

1) What is the meaning of the time value of money?

2) How are compounding and discounting related?

3) What happens to the future value of a lump sum invested the longer the time period for which it will be invested?

Answer 1

1) The worth of the money you have now is more than the same amount of money you have in future. This concept is called as time value of money.

For Example, the $1000 you have now and the $1000 you have in a years' time is not equal due to it's potential earning capacity.

2) Compounding is the method used to determine future value of an investment made at present.

Disounting is the method to determine the present value of cash flows which are due to come in future.

3) When a lump sum amount is invested at present and longer the time period, the higher the amount gets due to the compounding factor.