Glossary of Time Value of Money Terms Of Time Value Terms

Actuaries: Professionals skilled in quantifying risks associated with mortality, disease, property loss.

Adjustable-rate mortgages: mortgages that allow interest rates to change after an initial fixed interest period.

Amortization: the reduction of a loan balance to zero.

Annuity: a series of payments usually monthly and usually terminating on the death of the recipient.

Arbitrage: exploiting the difference between the rate of return on invested funds and the cost of borrowing those funds.

Bonds: IOUs issued by private companies or governments.

Certificates of deposit (CDs): A form of savings accounts offered by banks.

Compound interest: a method of calculating interest in which the rate of interest is applied to the original principal invested and the previously earned interest on that principal.

Compounding period: the frequency in which interest income is earned.

Consumer Price Index (CPI): A periodic measurement of consumer price movement performed by the Bureau of Labor Statistics.

Conversion rate: also know as interest or discount rate usually represented by the letter “i” in time value formulas. It is the key variable in conversion of present dollars to future dollars and vice versa.

Coupon rate: The stated interest rate on a bond.

Defined benefit pension plan: A pension plan in which future benefits are based upon a formula usually including years of service and highest average wage.

Defined contribution plan: A pension plan where future payouts are based upon only previous contributions and earnings on those contributions.

Deflation: a period of time where prices are dropping.

Discount rate: another term for the interest rate or conversion rate in time value formulas.

Dividends: Distributions of profits to equity shareholder of a corporation.

e: Eulers’ constant used to compute continuous compounding of interest

Effective interest rate: The nominal interest rate adjusted upward to reflect the impact of the number of compounding periods.

Equities: Any non-fixed income investment in the shares of a company.

Exponential models: Time value of money formulas containing an exponent usually “n”, the number of compounding periods.

Federal Reserve Bank (aka the Fed): The government appointed central bank most responsible for setting interest rates in the economy.

Future value: In time value conversions the amount to which a present value will grow based on the interest rates and compounding periods.

Home equity: The difference between the fair market value of a home and the mortgage on that home.

“i”: The symbol for the interest, discount, or conversion rate in time value formulas.

Imputed interest rate: The unstated interest rate in an equipment or car leasing payment plan.

Inflation: An increase in price levels.

Interest in arrears: The standard for collecting interest after a borrower has had use of borrowed funds usually for a month.

Interest rate: The rate applied to borrowed or invested funds. Or the rate of conversion from present to future values and vice versa.

Internal Rate of Return (IRR): The rate of return on a series of future cash flows that brings the net present value of the cash flows to zero.

Lease vs. Buy: A choice between leasing an asset like a car or piece of equipment and buying it outright.

Life expectancy tables: Estimates based on birth and mortality data used to derive a life expectancy at a specific attained age.

Money supply: The total of currency, coin and demand deposits in circulation at a point in time.

Mortgage: A loan secured by residential or commercial real estate.

“n”: The symbol used for the number of compounding periods in a time value formula.

Nominal interest rate: The annual interest rate stated without factoring the impact of compounding.

Opportunity cost: A measurement of the next best alternative to a particular investment option. In time value contexts it is usually the rate of return on a treasury bond.

Par value: The stated redemption amount on a bond.

Perpetuity: An investment which promises to pay a set dollar amount without a term limit or redemption amount.

Present value: The value of a projected future cash amount or stream of cash amounts today.

Principal: In mortgages it is the original amount of a loan and that component of monthly payments that reduce the balance owed.

Producer Price Index (PPI): A measure of price changes in the wholesale and manufacturing sectors of the economy.

Publicly traded bonds: Bonds issued by private companies and government units that are actively traded on stock exchanges.

Rate of Return: The rate of profit on an investment.

Reserve requirements: The percentage of deposits that a bank must maintain on hand. The Fed regulates the money supply by adjusting these requirements.

Simple interest: The crediting of interest on the original invested amount only without crediting on previously earned interest.

Structured settlements: A periodic monetary payout over an extended period of time.

Usury: The charging of excessive interest rates on borrowed funds.

Weighted Average Cost of Capital: A blended rate based on the cost of borrowing and the rate of return on equity.

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