Discounting

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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.

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. 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”.

See also

• Mark-to-market
• Valuation
• Cashflow