Question

DB 1- What is the time value of money?

DB 2- What is the nature of interest? Distinguish between “simple interest” and “compound interest.”

DB 3- What are the primary characteristics of an annuity? Differentiate between an “ordinary annuity” and an “annuity due.

Answer 1

DB 1 )Time value of money : The concept of time value of money states that money has interest earning potential. A dollar today worths less than a dollar tomarrow. Time value of money states that its better to get money today than after some time because

1) Money can be invested today and interest can be earned on it

2) By this one can eliminate risk of not getting money after words

DB 2) Interest is nothing but reward investor gets by investing his money. There are two types of interest

1) simple interest : It is calculated on principal amount only. For eg if 10% is rate of interest and principal is 100$ than interest = 100*10% = 10$ for first year as well as for 2nd year

2) Compound interest - It is calculated on principal as well as on interest that is earned on principal. For eg if 10% is rate of interest and principal is 100$ than interest = 100*10% = 10$ for first year and interest for second year = (100+10)*10% = 11$

DB 3) annuity is uniform stream of cashflow occuring at regular interval. When annuity occurs at end of period than it is called ordinary annuity and if annuity occurs at begining of year than it is called annuity due