Time value of money
Also known as: TVM
The time value of money is the principle that a dollar today is worth more than a dollar in the future, because money in hand can be invested and earn a return. It underlies present value, future value, and discounted cash flow analysis.
The time value of money (TVM) is the foundational finance principle that money available now is worth more than the same amount received later. A dollar in hand can be invested to earn interest, so receiving it sooner means more wealth over time. Inflation reinforces the idea: a future dollar will typically buy less than a dollar does today.
TVM calculations move money across time in two directions. Compounding converts a present amount into a future value: $1,000 invested at 5% grows to $1,050 in one year and about $1,102.50 in two, because interest earns interest. Discounting runs the process in reverse, converting a future amount into a present value: at a 5% discount rate, $1,050 received one year from now is worth $1,000 today.
These two operations power most of financial analysis. Bond prices are the present value of future coupon and principal payments. Stock valuation models like the dividend discount model rest on discounted future cash flows. Capital budgeting tools — net present value (NPV) and internal rate of return (IRR) — compare a project's discounted future cash flows to its cost. Retirement planning, loan amortization, and annuity pricing all apply the same logic.
The time value of money appears across finance exams. The Series 65 and Series 66 test it under analytical methods, expecting you to understand present value, future value, NPV, and IRR conceptually, while the CIMA/CGMA Certificate in Business Accounting applies TVM directly in investment appraisal. Focus on the intuition: discounting future cash flows is how nearly every asset gets valued.
Key takeaways
- A dollar today is worth more than a dollar tomorrow because it can be invested to earn a return.
- Compounding converts present amounts into future values; discounting converts future amounts into present values.
- Bond pricing, stock valuation, NPV, and IRR are all applications of the time value of money.
- The Series 65, Series 66, and CIMA/CGMA exams test TVM through present value, future value, and investment appraisal questions.