Security Variation: Present and Future Values, and Expected Returns

Present and future values and security valuation

Money accumulates value within a given period but also can lose value as well. The gain in value is measured by the amount of interest earned while the loss of value is measured by the inflation accrued over a given amount of time (Hickman, Byrd, and McPherson, 2013). The underlying principle is the fact that an amount of money will have a different buying power in the future compared to its current trading strength. In finance, the value of money keeps on changing as inflation pushes prices up hence changing the value of money. The forces of demand and supply also have a role to play in determining the value of money. An increase in demand for a product will increase its price consequently changing the value for money in relation to the purchase of that product. Security variation is a process that is used to determine the value of security mostly the value of tangible assets or the level of debts (Hickman, Byrd, and McPherson, 2013).

Importance of Present and Future values and potential application of these concepts

Understanding the concept of Present and Future Values is critical in finance because it helps in financial planning and investment. The following example shows how it works if an individual invested $100 today and the amount earns a 5% interest per annum, by the end of the year their money will be worth $105. Hence, the future value of $100 at a 5% interest will be $105 (Hickman, Byrd, and McPherson, 2013). The process of determining the future value of money is referred to in finance as capitalization. On the other hand, determining the present value of money is referred to as discounting. With a constant amount of time and a constant interest rate, the increase of the PV causes the increase of the FV and vice versa (Hickman, Byrd, and McPherson, 2013).

Factors to consider in calculating PV and FV

When calculating the PV and FV, there are factors that must be considered. One of the basic factors that have to be considered in measuring the present and future value of money is time. The value of money changes in a given amount of time due to its ability to attract or gain interest. Therefore, to determine the value of money using the present value or the future value approach time must be considered. The other factors that influence the value of money include the interest and inflation rate. The interest rate determines how much the invested amount will have accumulated in a specific period of time while the inflation rate measures the worth of the invested amount in the future in terms of buying power.

Other qualitative factors in making PV and FV decisions

Other factors to consider in making present and future values decisions include the future value of a single payment and the present value of the same. This helps in showing the disparities in the value of money over time. An investor can also consider the future and the present value of an annuity.

Interest rates in relation to bonds

When the interest rates go up, bond prices reduce and vice versa. This inverse relationship between the two is based on market attractiveness. With high-interest rates, investors will not be interested in buying bonds hence affecting the demand for the same. With low-interest rates, bonds will attract investors creating demand hence the increase in their price.

Reference

Hickman, K., A, Byrd, J., W. and McPherson, M. (2013).Essentials of Finance. New York, NY: Sage.

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