Question

• Why is interest rate important in determining the future value of money?
• What are your opportunity cost associated with buying a home vs renting?

Answer 1

Solution:

Q1) When we calculate the future value of the money then we basically factor in the interest rate impact. The formula for the calculation of future value is

Future value =Present Value * (1+ Interest rate)^period

Let's understand this with an example. Suppose a person has $100 today and the interest rate is 6% and he wants to calculate the future value of this after 1 year

Future value =100* (1+ 6%)^1 = $106

We can see that the interest rate is the major factor in determining the future value of the money.

Q2) When we buy a house then we are paying the money that is much higher than the money that is required when we go for rent option. Let us understand this with an example- Suppose buying a house costs $100,000 while renting option costs $100 per month. In buy option we are making the payment of $100,000. We could invest this money and generate some income hence we are losing the investment opportunity while buying the house.