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Lecture02_winter09

Lecture02_winter09 - Time Value of Money Time Value of...

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Time Value of Money
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Time Value of Money Is Money received Today worth more or less than the same received in the Future? Usually MORE Why?
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Time Value of Money We could invest the money received today in a riskless asset and have more in the future. Example: The 6-month Treasury Bill has a return of 1.56%. If $1,000 are invested in it, after 6 months you end up with $1,015.6.
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Time Value of Money The conclusion is that $1,000 today are more valuable than $1,000 six months from now.
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Time Value of Money George Washington received a salary of $25,000 in 1789 George Bush receives a salary of $400,000 to go with a $50,000 expense account. Who was better paid?
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Time Value of Money If we use the CPI Index, $25,000 in 1789 is the same as $550,000 today. If we use the GDP per-capita measure, $25,000 in 1789 is the same as $23,000,000 today.
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Future Value and Compounding If you invest C 0 today, earn a interest rate of r, how much do you have after one year? C 1 = C 0 x(1+r) C 1 is the FUTURE VALUE in one year of C 0 today
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Future Value and Compounding If you invest C 0 today, earn a interest rate of r, how much do you have after two years? After one year C 1 = C 0 x(1+r) In the second year C 2 = C 1 x(1+r)=C 0 x(1+r)x(1+r)=C 0 x(1+r) 2 C 2 is the FUTURE VALUE in two years of C 0 today
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What is Compounding? It Means that the interest you receive during the time of your investment is RE-INVESTED and will itself earn interest in the next periods You are earning interest over past interest!
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General Rule If you invest C 0 today, earn a interest rate of r, how much do you have after n years? C n = C 0 x(1+r) n C n is the FUTURE VALUE in n years of C 0 today
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Is Compounding Important?
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