Introduction
Money is anything or any object generally accepted as a medium of exchange for goods and services and other transactions in societies and countries. Before a money came to be , the system of trade was trade-by-barter. Here, you exchange one good for another (for instance, yam for bread).
The trade-by-barter system was faulty because the value of one good might be higher than another. And this led to a generally accepted item called money.
Money is a unit of account, which means it provides a standard to measure the value of goods and services for exchange.
Money is also a store of value for goods and services. This indicates that money must be able to hold its value over some time. Money is also liquid, meaning it can be readily available as exchange and easily transported as well.
Time Value of Money
It is essential to know that although we have described money as a store of value, the time affects money. This effect could be negative or positive because money itself has a time value added to it at every point.
For instance, if Mr Obi receives a N1000 note today and decides to invest for five years, the value will increase over time if you add the interests that will accrue over time due to the investments.
In another scenario, if Mr Obi chooses an option of receiving the N1000 note in five years, it means that he is lending the money and there are various risks involved with lending (e.g. inflation, which reduces the value of money).
Put in simpler terms, the value of money we have in the present can surely increase in the future through investments. Money can be subject to risks through lending. This may likely reduce the value of the money if there is inflation.
There are specific terms that have to be understood when talking about the time value of money, and when calculating it. They are:
It is essential to know that although we have described money as a store of value, the time affects money. This effect could be negative or positive because money itself has a time value added to it at every point.
For instance, if Mr Obi receives a N1000 note today and decides to invest for five years, the value will increase over time if you add the interests that will accrue over time due to the investments. In another scenario, if Mr Obi chooses an option of receiving the N1000 note in five years, it means that he is lending the money and there are various risks involved with lending (e.g. inflation, which reduces the value of money).
Put in simpler terms, the value of money we have in the present can surely increase in the future through investments. Money can be subject to risks through lending. This may likely reduce the value of the money if there is inflation.
Terms to Know
There are specific terms that have to be understood when talking about the time value of money, and when calculating it. They are:
- Present value (PV) – This refers to the current starting amount. It is money you have in your hand at present and your initial investment for a later time.
- Future value (FV) – This refers to the amount of money you have at a point in time. This money should be worth more than the present value, provided it has earned interest.
- The Number of Periods (N) – N represents the timeline for your investment (or debts). It is typically measured in years but could be any scale of time such as quarterly, monthly, or even daily.
- Interest rate (I) – This is the rate at which of your money over the lifetime of the investment. It is calculated in a percentage value, such as 8% or .08.
The formula for calculating the time value of money is PV=FV×(1+i) −n.
The time value of money is also used to calculate the intrinsic value of a firm, a share of common stock, bonds, or any other financial instrument; from the formula above, we can see that time is indeed money.