TIME VALUE OF MONEY

PREETHISRI S R
PRIYADHARSHINI R
RAAJ KOUSHIK N
PONMATHI
RAJSEKHAR
Need for Money
In a varied economy, producers will specialise in
production
of certain goods, yet consume a diverse set of
goods.
There are three basic solutions-
Barter – difficult to overcome double
coincidence of wants – difficult to equate the
values of goods exchanged because of
indivisibility of goods
Government Allocation – inefficient use of
information and incentives

Money – solves all the problems of barter

system and removes inefficiency in government
allocation
Money
• Money is whatever is generally accepted in
exchange for goods and services – accepted
not as an object to be consumed but as an
object that represents a temporary room of
purchasing power to be used for buying still
other goods and services
• - Milton Friedman
TIME VALUE OF MONEY
• Money has a time value because of the following
reasons:
• Individuals generally prefer current consumption to
future consumption.
• An investor can profitability employ a rupee received
today to give him a higher value to be received
tomorrow or after a certain period.
• In a inflationary economy the money received today
has more purchasing power than money to be
received in future.
EXAMPLE
• A gives a loan of Rs 10000 to B for a period of
one year. The market value of rate of interest
is 10% p.a. Thus at the end of a year A gets
Rs.11000 for the initial loan of Rs.10000 given
by to B. In other words ,the amount of rs.
10000 of today at 10%interest is equivalent to
Rs.11000 to be received after a year.
COMPOUNDING & DISCOUNTING
• A Rupee in hand today is worth more than a dollar to
be received tomorrow. Hence interest payment is
necessary to postpone present expenditure or to
save.

• Compound interest calculations are needed to

determine future sums of money resulting from an
investment.

• Discounting or the calculation of present values, a

concept inversely related to compounding is a
technique which is used to evaluate the cash flow
associated with the valuation of financial markets.
COMPOUND VALUE
CONCEPT
• In case of the time concept the interest earned
on the principal becomes a part of the
principal at the end of a compounding period.
• Eg. If Rs.100 is invested at 105 compound
interest for 2 years ,the return for the first year
will be Rs.10 and for the second year will be
rs.11 and the total amount at the end of two
years will be (100+10+11) Rs.121.
COMPOUNDING OF INTEREST
OVER N YEARS
• The general equation used to calculate the
conmpounded value after ‘N’ years is

A= P(1+i)^n
where
A= amount at the end of period ‘n’
P= principalat the beginning of the period
i= interest rate.
n= number of years.
 Why Compound Interest?

lue (U.S. Dollars)

DISCOUNTING OR PRESENT VALUE

• The present value concept is the exact

opposite of compounding concept.
• In case of present value we calculate the
present worth of a future payment/instalments
or seriesof payments adjusted for the time
value of money.
• Eg. The value of Re.1 received after a year is
less than its present value.
FORMULA FOR PRESENT VALUE

oPV=A/(1+i)^n
Where
PV = PRESENT VALUE
i= INTEREST RATE
A= AMOUNT AT END OF THE PERIOD n
n= NUMBER OF YEARS
Value of an asset
• In general, the value of an asset is the price
that a willing and able buyer pays to a willing
and able seller.
There are three types of values.
• Book Value: The asset’s historical cost less its
accumulated depreciation.
• Market Value: The price of an asset as
determined in a competitive market place.
• Intrinsic Value: The present value of the
expected future cash flows discounted at the
decision maker's required rate of return
INTEREST RATE
• Interest rates are at the centre of the key
issues in understanding the economics of
financial markets.
• Interest rates provide investors with a gride for
allocating funds among investment
opportunities
• Investors choose investment opportunities
which have expected rates of return more
than the prevailing interest rates
• Interest rate also provides a measure of the
relative advantage of current consumption
compared to saving.
• Higher the interest rate or lower the expected
future inflation higher will be the saving
DETERMINANTS OF SAVING
• Interest rate is a price expressed as a ratio
• Interest rate is determined by demand for and supply
of money
• The sources of supply of funds are
1. Savings
2. Reduction in demand for money
3. Decrease in money supply by the central bank and
commercial bank
4. The sources of demand for funds are
5. investment demand
• Consumption demand
• Increases in demand for mone
Risk and Uncertainty
• Certainty means the probability of a value that
a variable can take is one.
• Uncertainty means the objective probability
distribution of values that a variable can take
is unknown or some subjective probability
distribution can be imputed.
• Risk is that the objective probability
distribution of values that a variable can take
is known.
Systematic and Unsystematic
Risk
• Systematic risk refers to a situation when the
variability of a security’s return is same as the
variability of the market return. The systematic
risk affects the entire market, hence it cannot
be reduced through diversification of portfolio.
The systematic risk is called non-diversifiable
risk.
• Unsystematic risk refers to a situation when
the variability of a security’s return is unrelated
to the variability of the market return.
Determinants of Intrinsic Value
1.The size and timings of the expected future
cash flows.
2.The individuals required rate of return. (This is
determined by a number of other factors such
as risk/return preferences, returns on
competiting investments, expected inflation,
etc).
BOND
1.A bond is a tradable instrument that
represents a debt owed to the owner by the
issuer. Most commonly, bonds pay interest
periodically and then return the principal at
maturity.
2.Some bonds are callable. That is, the issuers
can compel the bondholder to sell it back to
issuer. Usually there are restrictions on the
timings of the call and the amount that must
be paid.
BOND VALUES
• Bond values are discussed in one of the two
ways
1.The Rupee prices
• The yield to maturity
• These two methods are equivalent since a
price implies a yield and vice versa.
BOND YIELDS
• Types of Rate of Return on a bond
1.Coupon rate
• Current yield
• Yield to maturity
• Modified yield to maturity
• Yield to call
• Realized yield
COUPOUN RATE
• The coupon rate of bond is the rate of interest
that the bond will pay.
• The coupon rate does not normally change
during the life of the bond, instead the price of
the bond changes as the coupon rate
becomes more or less attractive relative to
other interest rates.
• The coupon rate determines the dollar amount
of the annual interest payment
Annual payment = coupon rate*FV
CURRENT YIELD
• The current yield is a measure of the current
income from owning the bond.

• CY = (Annual payment/FV)

• CY is expressed in a ratio.
YIELD TO MATURITY
• The yield to maturity is the average annual
rate of return that a bondholder will earn under
the following assumptions.
1.Bond is held to maturity
• Interest payments are reinvested at the YTM.
• The yield to maturity is the same as the
bond’s IRR.
THE REALIZED YIELD
• The realized yield is an expost measure of the
bond’s returns.
• The realized yield is simply the average
annual rate of return that was actually earned
on the investment
 ANNUITY

• An annuity is an amount of money that occurs

(received or paid) in equal amounts at equally
spaced time intervals.
• These occur so frequently in business that
special calculation methods are generally
used.
For example:

• If you make payments of $2,000 per year into

a retirement fund, it is an annuity.
• If you receive pension checks of $1,500 per
month, it is an annuity.
• If an investment provides you with a return of
$20,000 per year, it is an annuity.
Conclusion
• MONEY MUST ALWAYS FLOW FROM ONE
HAND TO ANOTHER AND SHOULD NOT
REMAIN STATIC IN ONE PLACE .

• MONEY ALWAYS POSSES MORE VALUE

AT THE PRESENT DAY RATHER THAN AT
A FUTURE DATE