What Does Money Cost in Time?Table of Contents
What Does Money Cost in Time?
By CoinUnited.io Research Team
3 min read
But first, let's figure out the current worth of money and the future value of money so we can go on to the main event. The present value of money is the amount of money you would get in the future, discounted at the market rate, that would be equivalent to that amount of cash today. Using our example, you may be curious in the present value of $1,000 that you will get from a buddy in a year. Value in the future is the inverse of present value. It takes into account the current value of a sum of money and projects its future value based on the current market price. In other words, $1,000 in a year would be worth $1,001 after factoring in interest for that time period.
It is easy to determine the future value (FV) of money. Let's take a look at the interest rate (2%) as the potential investment opportunity at hand, and then revisit the first sample. If you invest the $1,000 you will get today, its value to you in a year will be: FV = $1,000 * 1.02 = $1,020. Let's assume your pal just told you their vacation will last two years. To calculate how much your $1,000 will be worth in the future, multiply it by 1.02 and then add 40 cents. Please take note that compound interest has been assumed in both of these examples. The universal formula for calculating future value is FV = I * (1 + r)n, where I is the initial investment, r is the interest rate, and n is the total number of periods. The present value of money, which we will discuss in more detail later, can be used in place of I. It aids in planning and estimating the potential future value of money invested now. The decision of whether to take some amount of money now or some amount of money later is simplified by this.
It's quite similar to our computation of future value to get the present value (PV) of some money. What we're really doing is just making an educated guess about how much a sum of money in the future would be worth right now. As such, we must do a backwards discounting of future value. Imagine that your buddy offers to give you $1,030 instead of $1,000 after a year has passed. You'll have to do some math to see whether or not that's a decent offer. To do so, we need just determine the PV (using the same 2% interest rate). PV = $1,030 / 1.02 = 1,009.80 In this case, your friend is actually making a generous offer. If you were to get this from your friend right now, the exchange would be worth $9.80 less than its present value. A year of waiting will likely yield better results here. Here is the standard formula for determining PV: PV = FV / (1 + r)n As can be seen, the TVM formula may be created by rearranging FV for PV and vice versa.
We touched on the idea of compounding before; now let's examine how inflation factors into those equations.
When compound interest is applied, even a tiny initial sum of money can grow significantly. Yearly compounding analysis was performed in our long-standing model. You might, however, compound more frequently, maybe once per quarter. We can slightly modify our model to incorporate this. FV = PV * (1 + r/t) n * t PV = Present Value, r = Annual Interest Rate, and t = Compounding Frequency Let's plug in our $1,000 annual compound interest rate of 2%. FV = $1,000 * (1 + 0.02/1)^1*1 = $1,020 Naturally, this matches our prior calculations exactly. But if you have the ability to compound your earnings four times a year, the effect is even better. FV = $1,000 * (1 + 0.02/4)^1*4 = $1020.15 A 15-cent hike may not seem like much, but it may add up to a significant amount when applied to greater amounts or stretched out over longer time frames.
We have not yet included inflation in our estimates. In times of high inflation, the inflation rate may be a better indicator to use than the market interest rate. But it's considerably more difficult to gauge inflation. First of all, you can pick from a variety of indices that measure the price of living to determine the rate of inflation. As opposed to interest rates on the market, inflation is difficult to forecast. In short, there is nothing we can do to combat inflation. As was previously indicated, inflation can be highly unexpected in the future, therefore we can build a discounting component into our model.
There are several situations in cryptocurrency when you might select between receiving a certain amount of cryptocurrency now or in the future. A single ether (ETH) may be yours right now, but there's also a chance you'll have to make a choice between locking it and retrieving it in six months at a 2% interest rate. In fact, you may discover an alternative staking opportunity that gives you a higher yield. BTC is often referred to be a deflationary currency, however its supply actually grows gradually up to a certain point. Because of this, it is currently defined as having an inflating supply. The former is what TVM would advise, but the reality is more complicated because of the BTC price's volatility.
You've probably already been using TVM intuitively even though we gave it a formal definition. All of us often encounter interest rates, yield, and inflation in the context of our economic lives. Large corporations, investors, and lenders all benefit greatly from the codified versions we worked on today. A change of even one percent in their bottom line might have a significant impact on them.
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