That means that if you're putting the $1000 in the CD, you may be foregoing an opportunity to use the money as a good faith deposit on a home. Time value of money varies and involves an opportunity cost. The time value of your $1,000 is 2%, or $20, in exchange for letting the bank keep your money for a year. The opposite of that is a variable rate, which is an interest rate that changes depending on how much benchmark rates rise or fall in the open market.Ĭalculated simply, if you invest $1,000 in a one-year CD at a fixed 2% interest rate, the future value of your $1000 will be $1,020. Fixed rate refers to an interest rate that will not change over time. If you have money invested in a certificate of deposit (CD), chances are it pays you a fixed interest rate. In investing and borrowing, consumers often walk a delicate line of trying to maximize the time value of their money while avoiding too much risk. Note that, with compound interest, the future value is higher than it is when calculated with simple interest. So that's another $7.63 in the course of a year.
Using the same formula as above to compute the same $2,000 at 10% for one year - but this time compounding interest quarterly, or four times a year - yields: Time value of money is usually calculated with compound interest. Simple interest is illustrated in the example above - simply adding a 10% gain to $2,000 for a year yields $2,200.Ĭompound interest, however, is calculated by adding the interest accrued up until certain intervals during the life of the loan or investment in a way that can significantly increase the future value.
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