Even if inflation and interest rates are zero, money has a time value. If you are owed £10, you would rather it was paid back now than in, say, one year's time. That's because the borrower is less likely to pay you back if you wait.
Now throw in interest rates. Lend someone £100 now with interest rates at 5% and if they return £100 in one year you've actually lost out. That's because you could have earned £5 of interest in the meantime. So they should be paying you £105 and that assumes you were happy to accept zero default risk when you made the loan. Equally, if you lend the £100 over two years you should expect £100 x 1.05 x 1.05 back, or £110.25.
In reverse, the "present time value" of £110.25 due in two years time but received today instead is £100 (if interest rates are a constant 5%).
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Watch Tim Bennett's video tutorial: What is the time value of money?
-
Where are ISA savers and investors putting their money?With less than three months until the end of the tax year, where are ISA savers and investors putting their money? We look at the latest ISA trends.
-
More than £53 billion held in fixed-rate cash ISAs will mature by April - where should savers move their money?If your fixed-rate cash ISA is maturing soon, we look at the options available to you
