Posted: September 6th, 2013

Time and value of money

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Time and value of money

**Question 1**

The nature of this question requires calculation of simple interest. This is a fast way of calculating interest received in a certain amount after a certain period. It is called simple interest because it does not put into account effects of compounds. It can only be used if ignoring compounding will have no effect on the calculation. Simple interest is used to calculate loans with short terms and the principle amount depends how much interest will be expected. Many areas where simple interest is mainly used are in the bank when calculating interest for an individual who wants to deposit money.

The formula for simple interest is multiplying the principle with rate then the length of time. If the principle is $ 2500, the rate 0.7% and time is one year, the interest:

2500*0.007*1= $ 17.5

The formula is written as Principle*Rate*Time

**Compound interest**

Compound interest includes accumulative interest earned through out the year. It is mainly applied when an individual is getting a loan from a bank. The bank calculates the interest according to the principle amount and knows what to expect after the given time. If an individual wants to deposit money in the bank, the bank calculates compound interest and pays out to the owner of the money. It is always advisable to get loans from financiers with less interest loans and deposit money in banks offering high interest. Calculating compound interest requires principle, rate, length of time, and amount of accumulated interest.

The formula for this calculation is: A=P (1+r)^n

If the principle is $ 2235, rate is 2% and time is 4 years, the answer is:

2235(1+0.02)^4= $2419.24

The formula is written as Principle*(1 plus Rate) raised to the power of Number of years

**Total annual return**

Annual return shows the amount of money earned or lost in an investment. It can be given in percentage or actual amount of money. Returns can be calculated monthly but annual returns are calculated after one year. If an individual experiences a loss in his or her investment, it is deducted from the returns. Total returns takes into account appreciation of capital and dividends. In cases of mutual funds, returns include income received from interest, dividends or payments. Annual returns are important because they tell an investor whether he or she is benefiting from the investment.

($12-$10)/100

$2/100

The prediction of the analyst was inaccurate because the returns were less than ten percent, even before deducting the loss. The stock had appreciated by two million at the end of the year. The loss was 2.5 million and loss is usually deducted from the overall returns. When the remainder was converted into percentage form, it was less than ten percent. Therefore, the analyst was not correct.

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