Advertisement

Time value of money

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.

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.

Advertisement - Article continues below

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%).

Watch Tim Bennett's video tutorial: What is the time value of money?

Advertisement
Advertisement

Recommended

Economic indicators
Glossary

Economic indicators

An economic indicator is any statistic that allows us to analyse how the economy is performing or is likely to perform in future.
31 Jul 2020
Modern monetary theory (MMT)
Glossary

Modern monetary theory (MMT)

Modern Monetary theory, or MMT, has become popular on the left, both in the UK and abroad. (Wags say that it stands for "magic money tree".) 
14 Jul 2020
Modern monetary theory (MMT)
Glossary

Modern monetary theory (MMT)

Modern monetary theory, or MMT, has become popular on the left, both in the UK and abroad. (Wags say that it stands for "magic money tree".) 
14 Jul 2020
Barbell strategy
Glossary

Barbell strategy

A “barbell… investment strategy means weighting a portfolio towards the two extreme ends of an asset class with nothing in the middle.
8 Jul 2020

Most Popular

Eagle Lightweight GT: the reincarnation of the E-type Jag
Toys and gadgets

Eagle Lightweight GT: the reincarnation of the E-type Jag

Jaguar’s classic E-type sports car has been reinvented for the modern age. The result – the Eagle Lightweight GT – is a thing of beauty.
7 Aug 2020
Should you take advantage of the UK’s new breed of domestic holidaymakers?
Buy to let

Should you take advantage of the UK’s new breed of domestic holidaymakers?

With Britons choosing to holiday in the UK this year, the owners of the country’s holiday cottages are cleaning up. Should you buy in, too? Merryn? So…
10 Aug 2020
The pound has been trending higher against the dollar – will it last?
Sponsored

The pound has been trending higher against the dollar – will it last?

Sterling has been rising against the dollar. Dominic Frisby sets his trend lines in the charts to see where the pound is heading next.
10 Aug 2020