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Summarize: Present Value/ Future Value/ Compounding SOLVE: Suppose you are depositing an amount today in an account that earns 5% interest, compounded annually. If your goal is to have $5,000 in the account at the end of six years, how much must you deposit in the account today? Solution The following information is given: • future value = $5,000 • interest rate = 5% • number of periods = 6 • We want to solve for the present value. • present value = future value / (1 + interest rate)number of periods PV = FV/ (1 + r)t or n PV = $5,000 / (1 + 0.05)6 PV = $5,000 / (1.3401) PV = $3,731 If the interest rate is 7%. What is the present value of $150 to be received in 10years. A company has an investment project that would cost $10million today and yield a payoff of $15million in 4 years. a. Should the firm undertake the project if the interest rate is 11%? 10%? 9%? 8%? b. Can you figure out the exact cutoff for the interest rate between profitability and nonprofitability. • Present value: refers to the amount of money today that would be needed to produce, using prevailing interest rates, a given future amount of money. • The concept of present value demonstrates the following: • Receiving a given sum of money in the present is preferred to receiving the same sun in the future. • In order to compare values at different points in time, compare their present values. • Firms undertake investment projects if the present value of the project exceeds the cost. • If r is the interest rate, then an amount X to be received in N or T years has present value of: X/(1 + r)N • Future Value –The amount of money in the future that an amount of money today will yield, given prevailing interest rates, is called the future value. • Money is the set of assets in an economy that people regularly use to buy goods and services from other people. • Money has three functions in the economy: –Medium of exchange –Unit of account –Store of value • Analyze each function in small group discussion. • Medium of Exchange –A medium of exchange is an item that buyers give to sellers when they want to purchase goods and services. –A medium of exchange is anything that is readily acceptable as payment. • Unit of Account –A unit of account is the yardstick people use to post prices and record debts. (EXPLAIN) • Store of Value –A store of value is an item that people can use to transfer purchasing power from the present to the future.(EXPLAIN) • Liquidity –Liquidity is the ease with which an asset can be converted into the economy’s medium of exchange. • Commodity money takes the form of a commodity with intrinsic value. –Examples: ? • Fiat money is used as money because of government decree. –It does not have intrinsic value. –Examples: ? • Commodity money takes the form of a commodity with intrinsic value. –Examples: Gold, silver, food • Fiat money is used as money because of government decree. –It does not have intrinsic value. –Examples: Coins, currency, check deposits • Analyze the following statements: 1. “This note is legal tender for all debts, public, and private.” 2. “Federal Reserve Note.” • Which of the following are money in the U.S. economy? Which are not? Explain your answers by discussing each of the three functions of money? a. A U.S. penny b. A Picasso painting c. A plastic credit card • What characteristics of an asset make it useful as a medium of exchange? A store of value? • 1. Must be widely accepted(so all transactions can be made in terms of it) • 2. Recognized easily as money(so people can perform transactions easily and quickly) • 3. Divisible (make change) • 4. Difficult to counterfeit (can’t print own money) • Make a table and evaluate how well each of the following items would perform the functions of money in today’s economy. Fulfil +, doesn’t Fulfil -, ? Not sure • 1.Medium of exchange • 2. Store of Value • 3. Standard of Value. • • • • • • • • • Salt Cattle Gold Copper Coins Beaver pelts Personal checks Debit card Credit card $1 bill and $100 bill • Characteristics of Money: Discuss these characteristics of money. 1. Portability 2. Uniformity 3. Acceptability 4. Durability 5. Stability in Value • Rate the items from the previous activity +, -, ? for each characteristic. • • • • • • • • • Salt Cattle Gold Copper Coins Beaver pelts Personal checks Debit card Credit card $1 bill and $100 bill • Free Write: Why might factors such as ease of storage, difficulty in counterfeiting and security of electronic transfer of funds also be characteristics that you might use in evaluating money? • The quantity of money circulating in the United States is sometimes called the money stock. • Included in the measure of the money supply are currency, demand deposits, and other monetary assets. Discuss the conceptual definition of money. Keep in mind, the complexity of the real world and our rapid evolving financial system prevent agreement on a single measure of money. • Define and measure the money supply into three definitions: –Label them M1, M2 and M3 Currency(coins and paper) plus Checkable deposits = M1 Savings deposits, including money market deposits accounts, plus small time deposits, plus money market mutual fund balances equals = M2 Plus large time deposits = M3 $523 $578 $1101 $1812 $1024 $890 $4827 $2026 $6853 Describe the Federal Reserve: -Who are they? -Describe their structure. -What 2 jobs do the Fed perform? • Explain the primary way in which the Fed increases and decreases the money supply. • Your uncle repays a $100 loan from Tenth National Bank by writing a $100 check from his TNB checking account. Use T-accounts to show the effect of this transaction on your uncle and on TNB. Has your uncles wealth changed? Explain.