Time value of money

:A separate article treats the time value of an option.

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

The time value of money (TVM) or the present discounted value is one of the basic concepts of finance, developed by Leonardo Fibonacci in 1202.

Related Topics:
Finance - Leonardo Fibonacci

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

If one deposits money in a bank account we will earn interest. Because of this, we prefer to receive money today rather than the same amount in the future. Money received today is more valuable than money received in the future by the amount of interest we can earn with the money. If $90 today will accumulate to $100 a year from now, then the present value of $100 to be received one year from now is $90.

Related Topics:
Bank account - Interest

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

TVM also takes into account risk aversion - both default risk and inflation risk. 100 monetary units today is a sure thing and can be enjoyed now. In 5 years that money could be worthless or not returned to the investor. It is important to remember, however, that there is a residual time value of money beyond compensation for default and inflation risk that represents simply the preference for money now versus later. Inflation-linked U.S. Treasury bonds notably carry neither inflation nor default risk, but pay interest.

Related Topics:
Inflation - Investor - Bond

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

To adjust for this time value, we use two simple formulae. The present value formula is used to discount future money streams: that is, to convert future amounts to their equivalent present day amounts. The future value formula is used to convert today's money into the equivalent amount at some time in the future (i.e., to compound money...either a lump sum or streams of payments).

Related Topics:
Present value - Future value

~ ~ ~ ~ ~ ~ ~ ~ ~ ~