Understanding our Economy through Investment
The present value is that sum of money that would be needed today, and by using certain reigning interest rate would give rise to a given future amount of money (Mankiw, 2014). Every investor has to gestate this concept in mind if s/he wants to obtain a higher return for the future. The formula can be expressed as;
PV = K
Where; K – represents the discounted future amount, i – the interest rate (represented as a percentage and but expressed as decimal in the formula) to be compounded either annually, semiannually, quarterly, monthly or yearly basis and t – is the number of period between the current date and the date where the present amount will worth the future forecast, e.g. a lecturer who has a high school daughter would want to save sum of money in his account today for his child’s future education in the next 2 years. The total sum he expects in the next 2 years is $500, 000 and he’s certain of getting a 25% interest per annum for his savings account. How much should he start depositing to his account? This is calculated as below;
PV = K
PV = 500, 000 = $320, 000
For him to be in a position to get $500, 000 in the future, the present value that he’ll have to deposit in his account at the moment will be $320, 000.
With regards to the above illustration, as the interest rate increases, high chances of opportunity cost for the future amount also increases thus the present value of the amount to be obtained in the future decreases. On the other hand, when there’s a decrease of the interest rate, the opportunity cost of the future fund also decreases hence the present value for the above payment will raise. Before an investor consider either of the options, s(he) has to evaluate investment real rate that will be determined through getting the difference of inflation rate from the market rate. This will help in choosing one of the best investment options to garner a good return in the future. Both the corporate bonds and long term investments are considered to be more risky to short term investments and government bonds thus interest rates are usually higher.
The Federal Reserve being described as independent within the government has a mandate to ascertain that the regulation of the circulation of money is isolated from the political pressure that may arise in U.S. Fed has two parts structure: Board of Governor which is the central authority situated in Washington, D.C, 12 Federal Reserve Banks who are appointed across the country in a decentralized network, and Federal Open Market Committee (FOMC) that is responsible for formulating monetary policy.
The Board of Governor – also known as Federal Reserve Board, is appointed by the president and consists of 7 Board of Governors members who are later confirmed by the senate before resuming their role. To shield the state from political crisis that may arise, they serve a 14 year term. The chairman and his deputy are approved by the senate to serve a 4 year term which can be renewed after their appointment by the president.
Federal Reserve Banks – includes 12 Federal Reserve Banks. These are nongovernmental organizations that are set up in the same manner as the private corporations, to operate in the interest of the public. The reserve Banks have their own board of directors that comprises of commercial banks representatives who are also members of Federal Reserve System. Their presidents are appointed by the board of directors and approved by Board of Governors.
Federal Open Market Committee – this in the body that is responsible for the monetary policy making and constitutes of 12 voting members. Seven of them are members of the Board of Governors and five members are Reserve Bank presidents who usually circumvolve. Even though the Federal Open Market Committee is entitled to make its own decisions and pass them to the Congress, the head of Federal Reserve System is expected to report to the Congress on a regular basis.
Money market is that place at which the amount demanded and supplied meet to determine the nominal interest rate. The demand curve represents the quantity of money that is in demand for a certain interest rate. People would rather hold less money and have higher interest rates on bonds and other investments therefore the demand curve will have a downward sloping. On the other hand, the supply curve represents the quantity of money that can be supplied at a given interest rate. The curve for money is vertical because it does not depend on interest rates but rather the ultimate decision made by the central bank. The point at which money demanded equals the quantity supplied is referred to as equilibrium point (Boyes & Melvin, 2012). The factors that would influence the demand for a product are categorized into two; first, household determinants such as income, the price of other goods, ones taste and the necessity for the product and secondly the market demand. This is influenced by the price of the product. An increase in the price will lead to the decrease in the product demanded and vice versa. Though there could be exception to this where there are inferior goods, at times of conspicuous consumption and when there is speculative demand within the market. An increase in price of the complement products will lead to a decrease in the demand, and an increase in price of one substitute good would lead to a fall of its demand thus the demand of the other substitute.
Mankiw, N. (2014). Brief Principles of Macroeconomics: Present Value: Measuring the Time Value of Money. P. 178-184
William, B., & Michael, M. (2012). Macroeconomics: Foreign Exchange Market Intervention. P. 303-306