"The Value of a Rupee Today is Worth More Than The Value of a Rupee Tommorow"
To understand the idea of Time Value of Money (TVM), one has to not just internalise the above statement but use it as a light to peek into the dark crevices of finance.
Once sitting in a KFC my father said that as a boy he saved two rupees, bought a full chicken, its spices and gave it to his mother. Today, two rupees buys you a Ben10 tatoo, free on two Boomers.
The how and why of this lies in a phenomena called inflation. Its a complex beast but for now, it only means rise in prices of goods and services.
So, as time moves ahead, prices rise and the change you got back on a tenner after a sutta or cigarette keeps shrinking.
Now say your'e offered a deal, either hundred rupees today or a year later with a hug and maybe a kiss. What would you choose ?
Tough choice but stay calm, the halo of TVM's holy statement shall light our path.
If a rupee today is worth more than a rupee tomorrow then obiviously a hundred today should be worth more than a hundred tomorrow. Thus, rationally you should opt for a hundred rupees today, unless you're a kiss and hug hungry person.
We now know that 'Time' has value and its passage can either create value or destroy it. Overtime as value is created its called appreciation and in the either case depreciation. The thing about money is, if you hide it under your pillow, its surely liable to be depreciated. However, if you gave it to a bank they would give it back to you after some time along with a few more rupees that's appreciation.
The passage of time alone doesn't create value, its partner in crime is - Interest rate.
The amount of money that you placed in the bank to appreciate is called 'Principal', say you've given this amount for a year. After a year your principal should have appreciated i.e. you should receive principal plus an extra amount. This extra amount is called interest. The rate/percentage of the principal which you received as the extra amount is called the 'Interest rate'.
The process of time and interest rate combining to help your money appreciate is called 'Compounding'. It informs us of the value of our investment in the future.
You have a choice, choose between a hundred today or two hundred a year later; before we make a choice we would like to know what is the value of the future two hundred as of today. This can be resolved by 'Discounting' the two hundred receivable a year later to today and evaluating if its more or less than a hundred.
Time Value of Money is a powerful idea in finance and if not understood thoroughly, one will be a babe lost in the dark woods of finance.
In my next post I shall go into the intricacies of this idea.
Thank you.
The passage of time alone doesn't create value, its partner in crime is - Interest rate.
The amount of money that you placed in the bank to appreciate is called 'Principal', say you've given this amount for a year. After a year your principal should have appreciated i.e. you should receive principal plus an extra amount. This extra amount is called interest. The rate/percentage of the principal which you received as the extra amount is called the 'Interest rate'.
The process of time and interest rate combining to help your money appreciate is called 'Compounding'. It informs us of the value of our investment in the future.
You have a choice, choose between a hundred today or two hundred a year later; before we make a choice we would like to know what is the value of the future two hundred as of today. This can be resolved by 'Discounting' the two hundred receivable a year later to today and evaluating if its more or less than a hundred.
Time Value of Money is a powerful idea in finance and if not understood thoroughly, one will be a babe lost in the dark woods of finance.
In my next post I shall go into the intricacies of this idea.
Thank you.
