Question

These questions have to do with a chapter on the time value of money. The other prompt was concerning how to find the payment of a future annuity.

What effect does increasing the required return have on the present value of a future amount? Why? What effect would a decrease in the interest rate have on the future value of a deposit? Why? What effect would an increase in holding period have on future value, ceteris paribus?

Answer 1

Effect of increasing the required return on the present value of a future amount-

Other things remaining constant, Increasing the required return will reduce the Present value (They are inversely related). This is because, if the required rate of return is increased, the Present Value Annuity factor (PVAF) will also reduce which will ultimately reduce the present value of Future amount.

Effect of decreasing the Interest rate on the present value of a future amount-

Other things remaining constant, decreasing the interest rate will decrease the Present value (They are directly related). This is because, the present value is the sum total of future cash inflows. If we reduce the interest, the future inflow will also get reduced and ultimately present value will also get reduced.

Effect of increase in holding period on future value

If holding period is increased, the Present value will get reduced (other things remaining constant). This is because of Time value of money, longer the waiting period, lesser the present value.

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