Picture the financial markets as a place for dollars are traded across time the rates returning the financial markets move dollars across time to establish their values at various points in time let’s look at moving dollars across time to establish their future values and present values will begin with future value compounding is a process by which future values are created compounding moves the present value in the future periods to determine its future value it answers the following.

Practical question if i invest to fix some today how much will have at some future date let’s look at the process of creating future value through compounding suppose we invest one dollar at an annual compound rate of interest of our percent interest is received at the end of the year at time we invest one dollar and earn a return one year later at time the future value at time consists of the original principal and interest earned on the principal interest on principle is called simple interest the one-dollar.

Principle is common and can be factored out to give this equation the future value of one dollar invested for one year at an annual rate of our percent is equal to one dollar plush now let’s reinvest this entire sum we have at the end of time one for another year the year won some has invested again to earn a $PERCENT rate of re turnover your to the future value of one dollar invested at an annual rate of our percent for two years is equal to one dollar plus R squared let’s multiply this out we obtain the component parts the process that created this future value in your to owe had the original principal we invested for two years.