Future value

Future value is the value of an asset at a specific date. It measures the nominal future sum of money that a given sum of money is "worth" at a specified time in the future assuming a certain interest rate, or more generally, rate of return; it is the present value multiplied by the accumulation function. The value does not include corrections for inflation or other factors that affect the true value of money in the future. This is used in time value of money calculations.

Money value fluctuates over time: $100 today has a different value than $100 in five years. This is because one can invest $100 today in an interest-bearing bank account or any other investment, and that money will grow/shrink due to the rate of return. Also, if $100 today allows the purchase of an item, it is possible that $100 will not be enough to purchase the same item in five years, because of inflation (increase in purchase price).

An investor who has some money has two options: to spend it right now or to invest it. The financial compensation for saving it (and not spending it) is that the money value will accrue through the interests that he will receive from a borrower (the bank account on which he has the money deposited).

Therefore, to evaluate the real worthiness of an amount of money today after a given period of time, economic agents compound the amount of money at a given interest rate. Most actuarial calculations use the risk-free interest rate which corresponds the minimum guaranteed rate provided the bank's saving account, for example. If one wants to compare their change in purchasing power, then they should use the real interest rate (nominal interest rate minus inflation rate).

The operation of evaluating a present value into the future value is called capitalization (how much will $100 today be worth in 5 years?). The reverse operation which consists in evaluating the present value of a future amount of money is called a discounting (how much $100 that will be received in 5 years- at a lottery, for example -are worth today?).

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