Present value: Difference between revisions

From The Jolly Contrarian
Jump to navigation Jump to search
Created page with "The value of something now. Of particular interest when that “something” is a financial obligation that falls due in the future. The present value of my promise to pay..."
 
No edit summary
 
(2 intermediate revisions by the same user not shown)
Line 1: Line 1:
The value of something now. Of particular interest when that “something” is a financial obligation that falls due in the [[future]]. The present value of my promise to pay you £10 in a year’s time is something less than £10.  
{{g}}The value of something now. Of particular interest when that “something” is a payment obligation that falls due in the [[future]]: for example, the repayment of a [[loan]]: The [[present value]] of my promise to pay you £10 in a year’s time is something less than £10.  


Why? For one thing, because you have to wait for a year without that money. If you wanted to replace that money, by borrowing it, you would have to pay interest on it. Call this the “funding cost”. For another, until I actually pony up the cash, you are my creditor, and if I go bust, you may not ever get that £100. Call this the “[[credit risk]]”.  
Why?  
 
*For one thing, because you have to wait a year for that money. If you wanted it now, you'd have to borrow it, and you would have to pay interest on it. Call this the “funding cost”. Deduct that funding cost from the value of the £10.
Think of it another way: imagine you loaned me £10, for a year, without interest. You would never do that, right? This is why a [[zero-coupon bond]] issues at a discount. it doesn’t pay interest, so instead you buy at a discounted price which implies the interest rate you would be prepared to pay.
*For another, until I actually pony up the cash, you are my creditor, and if I go bust, you may not ever get that £100. Call this the “[[credit risk]]”.  
*For a third, inflation. what £10 buys today is likely to be more than what £10 buys in a year.


Think of it another way: imagine you loaned me £10, for a year, without interest. You would never do that, right? This is why a [[zero-coupon bond]] issues at a [[discount]]. it doesn’t pay interest, so instead you buy at a discounted price which implies the interest rate you would be prepared to pay.


Careful book-keepers therefore ''[[discount]]'' the value of [[future cashflow]]s back, by reference to an implied interest rate, to find their [[present value]].
Careful book-keepers therefore ''[[discount]]'' the value of [[future cashflow]]s back, by reference to an implied interest rate, to find their [[present value]].


{{seealso}}
{{sa}}
*[http://www.quantopia.net/the-discount-curve-zcbs-and-the-time-value-of-money/ Good arrticle on the time value of money]
*[[Zero-coupon bond]]
*[[Zero-coupon bond]]
*[[Time value]]

Latest revision as of 15:08, 18 June 2019

The Jolly Contrarian’s Glossary
The snippy guide to financial services lingo.™
Index — Click the ᐅ to expand:
Tell me more
Sign up for our newsletter — or just get in touch: for ½ a weekly 🍺 you get to consult JC. Ask about it here.

The value of something now. Of particular interest when that “something” is a payment obligation that falls due in the future: for example, the repayment of a loan: The present value of my promise to pay you £10 in a year’s time is something less than £10.

Why?

  • For one thing, because you have to wait a year for that money. If you wanted it now, you'd have to borrow it, and you would have to pay interest on it. Call this the “funding cost”. Deduct that funding cost from the value of the £10.
  • For another, until I actually pony up the cash, you are my creditor, and if I go bust, you may not ever get that £100. Call this the “credit risk”.
  • For a third, inflation. what £10 buys today is likely to be more than what £10 buys in a year.

Think of it another way: imagine you loaned me £10, for a year, without interest. You would never do that, right? This is why a zero-coupon bond issues at a discount. it doesn’t pay interest, so instead you buy at a discounted price which implies the interest rate you would be prepared to pay.

Careful book-keepers therefore discount the value of future cashflows back, by reference to an implied interest rate, to find their present value.

See also