BUS-FP3062 - Fundamentals of Finance: Time Value of Money

This assignment explores the core concepts of the time value of money within the realm of finance, addressing critical aspects such as savings accounts, compounding periods, and the comparative advantages of monthly versus annual compounding. It delves into the practical application of amortization schedules, detailing their structure and purpose in loan repayment, particularly for mortgages and car loans. The assignment further examines the tax implications of mortgage interest payments over time, highlighting the differences between early and later stages of repayment. Finally, it differentiates between ordinary annuities and annuities due, explaining their payment structures and the impact of interest rates on their values, providing a comprehensive overview of annuity cash flows.

Running head: TIME VALUE OF MONEY
TIME VALUE OF MONEY
Name of the Student
Name of the University
Author Note:

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TIME VALUE OF MONEY
Table of Contents
Answer to Question 1......................................................................................................................2
Answer to Question 2......................................................................................................................3
Answer to Question 3......................................................................................................................4
Answer to Question 4......................................................................................................................4
Reference.........................................................................................................................................6

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TIME VALUE OF MONEY
Answer to Question 1.
Saving accounts is basically a bank account that allows you to deposit money, withdraw
funds, and provides principal security, apart from giving a modest rate of interest. Such accounts
are held at a financial institution. Typically, the borrowers prefer less recurrent compounding
periods while the savers prefer more recurrent compounding periods.
In monthly compounding, the banks will calculate interest from the account only once per
month, while in yearly compounding, the bank will calculate interest once per year. To find out
which compounding method is better, let us assume that a principal payment of $5000 is
deposited into a savings account.
Again assuming that the same amount is invested in the savings account but the interest is
compounded monthly then the interest will be:

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TIME VALUE OF MONEY
There is basically no difference, but if the investment is for a longer period, say ten years, then
the monthly and annual compounding factor will play an important role in investment (Lusardi &
Tufano, 2015). Therefore, people, in general, will choose to opt for monthly compounding rather
than annual compounding.
Answer to Question 2.
An amortization schedule is a comprehensive table showing the payments of the
periodical loan, presenting the amount of principal and interest that is required to be paid at each
payment (Hull, 2017). It is a process of repayment of debt over time through regular payments.
For installment loans that have a specific settlement date known at the time when the loan is
taken, an amortization schedule is made, such as for mortgage loan or a car loan. Lenders who
use this schedule are financial institutions, to present a loan repayment list that will be based on a
specific date of maturity. It is also used to minimize the current balance on loan, through
installment payments.

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TIME VALUE OF MONEY
The purpose of the amortization schedule is to provide the small business of devising a
precise set payment amount which will comprise of both interest and principal. It will provide
better repayment and manageable schedule.
Answer to Question 3.
Mortgage payments during the initial stages of the amortization schedule comprise of
mainly interest with petite principal; therefore, the interest paid in the earlier years of home
mortgage is more obliging as it helps in reducing taxes (Lusardi & Tufano, 2015). However, the
interest payments declines at the later stages and principal payments make up more of the
mortgage payments, therefore the interest payments at the later stage are unhelpful for reducing
taxes in the later years. Thus, the tax-deductible portion is higher in the earlier years as compared
to the later years (Kim & Kim, 2016).
Answer to Question 4.
The payments of the ordinary annuity are done at the end of the covered span. These
annuity payments are generally done monthly, quarterly, semi-annually, and annually. The
payments that are covered under ordinary annuity are the payments of the home mortgage, bonds
and stock dividend. On the other hand, in annuity due payments are made at the commencement
of the term rather than at its expiration, for example, rental payment and insurance premium
(Chan & Rate, 2019).
The payment made under annuity due is done earlier than under ordinary annuity.
Considering the time value of money, the payment made under annuity due is higher than the
payment made under the ordinary annuity. So, with an increase in the interest rate, the value of

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the ordinary annuity decreases and similarly, with a decrease in the interest rate, the value of the
ordinary annuity increases.

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TIME VALUE OF MONEY
Reference
Chan, K., & Rate, E. A. I. (2019). & 6 The Time Value of Money. Financial Management.
Hull, I. (2017). Amortization requirements and household indebtedness: an application to
Swedish-style mortgages. European Economic Review, 91, 72-88.
Lu, C., Rosenberg, J., & Toder, E. (2015). Options to reform the deduction for home mortgage
interest. Tax Policy Center report, Urban Institute & Brookings Institution, December, 8.
Lusardi, A., & Tufano, P. (2015). Debt literacy, financial experiences, and overindebtedness.
Journal of Pension Economics & Finance, 14(4), 332-368.
Kim, S. H., & Kim, D. K. (2016). Mortgage Interest Tax Shield and Home Mortgage
Refinancing Decision.