Discounting: Difference between revisions
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{{g}}To “[[discount]]” the value of a payment due in the future is to calculate the value of that future right ''today'' (its “[[present value]]”). You do this by | {{g}}To “[[discount]]” the value of a payment due in the future is to calculate the value of that future right ''today'' (its “[[present value]]”). You do this by subtracting, rather than adding, interest. This is a kind of time travel for a dollar bill and it is amazing no-one has yet premised an art-house sci-fi on it.<ref>''Yet''.</ref> | ||
In the simplest terms, if I have a dollar today I can put it in the bank and earn [[interest]] on it. Time’s arrow running forward, in a year’s time, my dollar will be worth a dollar ten to me<ref>I have an Icelandic bank and it pays me amazing interest, okay?</ref>. So by the same token, a dollar ten in a year must be worth a dollar today. | In the simplest terms, if I have a dollar today I can put it in the bank and earn [[interest]] on it. Time’s arrow running forward, in a year’s time, my dollar will be worth a dollar ten to me<ref>I have an Icelandic bank and it pays me amazing interest, okay?</ref>. So, by the same token, a dollar ten in a year must be worth a dollar today. | ||
[[Discounting]] is just | [[Discounting]] is just that process of asking what would happen if you turned time’s arrow the other way: If I will have a dollar in a year, how much would I have today? What sum, compounded with interest over twelve months, will give me a dollar? | ||
Why | Why do we care? Well, for one thing, if I know the [[present value]] of a future [[cashflow]], I can sell it now at that discounted value — this is called “[[monetise|monetising]]”. | ||
{{sa}} | |||
*[[Mark-to-market]] | |||
*[[Valuation]] | |||
*[[Cashflow]] | |||
{{ref}} | |||
Latest revision as of 16:30, 21 October 2019
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To “discount” the value of a payment due in the future is to calculate the value of that future right today (its “present value”). You do this by subtracting, rather than adding, interest. This is a kind of time travel for a dollar bill and it is amazing no-one has yet premised an art-house sci-fi on it.[1]
In the simplest terms, if I have a dollar today I can put it in the bank and earn interest on it. Time’s arrow running forward, in a year’s time, my dollar will be worth a dollar ten to me[2]. So, by the same token, a dollar ten in a year must be worth a dollar today.
Discounting is just that process of asking what would happen if you turned time’s arrow the other way: If I will have a dollar in a year, how much would I have today? What sum, compounded with interest over twelve months, will give me a dollar?
Why do we care? Well, for one thing, if I know the present value of a future cashflow, I can sell it now at that discounted value — this is called “monetising”.