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Effects Of Annuities With Time Value Money
| Time value money is nothing but a simple idea that proclaims that a dollar is worth more today than tomorrow. Let us take an example in terms of food. If you have money today, you will be able to buy food immediately. The other alternative is that you do not use your money to buy food immediately, instead decide to wait until later to buy your food. In terms of time value of money, you lend your money to another person with a promise that the money would be returned to you at a particular time in the future. And since you are giving up the money now and not “buying” your immediate “needs”, you want the person to return a sufficient amount so that you can buy as much of your “needs” in the future as you are giving up now. |
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That is the basic principal of time value of money.
However, we do not know the future. We know that there are risks involved as the person who borrowed the money might not repay it; or the borrower might return the money but the prices increase so you cannot purchase the same amount of “needs” that you expected to be able to buy. This means that the lender, that is you, would require a higher rate of interest to accept the risks involved in lending the money.
The same holds true in terms of structure annuity settlement payment. You give money to a person who requires a lump sum in turn of his or her annuity payments. An annuity is a flow of constant money that happens at regular intervals over a fixed period of time. You can calculate the present value of an annuity by taking the cash flow and then discounting it back to present.
With regard to time value, the value of an annuity decreases if a person consumes more today, if inflation rises or if the improbability of receiving the annuity increases.
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