In addition to being able to understand the financial statement, IAs must also have the ability to estimate the value of an investment in the future.

Future Value
When planning investment strategy, it's useful to be able to predict what an investment is likely to be worth in the future, taking the impact of compound interest into account. This formula allows you (or your calculator) to do just that:

Pn = P0(1+r)n
is future value of P0
P0 is original amount invested
r is the rate of interest
n is the number of compounding periods (years, months, etc.)

Note in the example below that when you increase the frequency of compounding, you also increase the future value of your investment.

P0 = $10,000
Pn is the future value of P0
n = 10 years
r = 9%

Example 1- If interest is compounded annually, the future value (Pn) is $23,674.
Pn = $10,000(1 + .09)10 = $23,674

Example 2 - If interest is compounded monthly, the future value (Pn) is $24,514.
Pn = $10,000(1 + .09/12)120 = $24,514

Present Value
As part of your investment planning, you might also need to calculate the present value of investments. For example, if your clients want to retire with $1 million in their investment accounts, it would be useful to know how much they need to save each year to reach that goal.

You can simply reverse the future value formula like this:

P0 = Pn
(1+ r) n

Pn = $23,674
P0 is the present value of Pn
n = 10 years
r = 9%

How much would somebody need to invest now if they wish to have $23,674 10 years from now based on a return of 9% compounded annually?

P0 = $23,674 = $10,000
(1+ .09) 10

Exam Tips and Tricks
A typical time value of money question will look something like this:

If $10,000 is invested at 6%, compounded monthly, it would be worth $18,194 in 10 years. $18,194 would be the investment's _____________.

  1. Internal rate of return
  2. Present value
  3. Expected return
  4. Future value

The correct answer is "d" - the ending value of the investment is known as the future value.
Pn = $10,000(1+.06/12)120 = $18,194

Rates of Return - Internal Rate of Return

Related Articles
  1. Investing

    Learn Simple and Compound Interest

    Interest is defined as the cost of borrowing money, and depending on how it is calculated, it can be classified as simple interest or compound interest.
  2. Investing

    The Effective Annual Interest Rate

    The effective annual interest rate is a way of restating the annual interest rate so that it takes into account the effects of compounding.
  3. Investing

    Overcoming Compounding's Dark Side

    Understanding how money is made and lost over time can help you improve your returns.
  4. Investing

    Understanding the Time Value of Money

    Find out why time really is money by learning to calculate present and future value.
  5. Investing

    How To Calculate Your Investment Return

    How much are your investments actually returning? Find out why the method of calculation matters.
  6. Personal Finance

    How Interest Rates Work on Savings Accounts

    Here's what you need to know to grow your rainy-day fund.
  7. Financial Advisor

    Compound Annual Growth Rate (CAGR)

    The compound annual growth rate is an important tool for measuring investment performance and comparing it across asset classes. Discover how it is calculated and how it can inform your investment ...
  8. Investing

    What is Present Value?

    Present value tells us how much a future sum of money is worth today, given a specified rate of return. This is an important financial concept based on the principle that money received in the ...
Frequently Asked Questions
  1. Why is social responsibility important to a business?

    Take social responsibility seriously, and your business could benefit from happier, more productive staff members while helping ...
  2. Which socially responsible retailers appeal most to ethical investors?

    Learn why ethical investors have many options in the retail sector, and discover which retail companies are most popular ...
  3. What are Some Examples of Free Market Economies?

    Learn which of the world's economies best resemble free market economies, marked by free trade, low government involvement, ...
  4. Who Decides When to Print money in India?

    Find out the role of the Reserve Bank of India, or RBI, and the amount of authority given to the government. Learn who is ...
Trading Center