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What is the future value of an investment. ?How is it related to rate of interest?
Yes, Interest is generally been treated as an expense or revenue depend upon the nature of investment or borrowing. Everybody wanted to grow and appreciate the value of his investment with regular income and compare with the current rate of bank interest to ensure that he fetch more income than bank deposit interest..
Hi!
That question is applicable only to people who borrow money from the market for either doing business or consuming - home loans, personal loans etc.
Why is interest a cost in the first place? Well, interest is a price that is paid for parting with liquidity (JM Keynes). People generally prefer to hold cash with them. If A needs cash for some activity, and does not have it, he/she would borrow this cash from B. B expects something in return (interest) because when B lends money to A, B and in doing so, sacrifices his/her consumptions in the current time and postpones to a future period. In this case B parts with his/her liquidity in this process.
In order to recover that loss of consumption in present times B expects A to pay back the principal along with a cost of borrowing - that is interest.
Where doest interest derive the actual rates? It is given that a soveriegn nation is the most credit worthy than an individual or business. So depending upon the risk associated with this borrower (credit worthiness of this borrower) interest rate is charged by adding a risk premium to the exisiting risk free rate prevalent in the country. In some cases a liquidity premium too is added - if the loan is for a long duration.
Future Value of an investment is: the principal invested today + the interest earned on that for a definite period of time. That can be written as: P (1+k)n. P = principal, k i= interest and n = years the investment stays invested.
It is related to interest rate because when someone invests there is another using that investments - by borrowing it. When you borrow you have to pay back the principal and interest along with it (refer the first paragraph for explanation on why interest rate).
Santosh Nair
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