Money’s worth over time is closely related to time itself. Thus, it is proper to claim that the longer a period, the greater the activity of external agents or even the effect of macroeconomic variables on the purchasing power of a particular currency. Inflation contained in any system of a capitalist economy is a determining factor in the relationship between money and time, as a given amount of money in March of one year does not have the same purchasing value in March of the following year:
- There is a need to consider the inflation rates in the capital during this period. Another simplified way to understand this fact is to think that the inflation rate that occurred in the period increased the prices of goods.
- The external environment strongly influences the value of money over time, as it is an external macroeconomic factor that organizations or people cannot control.
- Interest influences the value of money.
They are applied, whether through an investment that makes it pay off, the cost of raising it, or even the opportunity cost, when not invested. Interest, simply put, is the “rent” paid for the use of money. For lenders, interest is compensation for transferring the usufruct of capital. Already stop through an investment that makes it pay off, the cost of raising it, or even the opportunity cost when it is not invested. Interest, simply put, is the “rent” paid for the use of money. For lenders, interest is compensation for transferring the usufruct of capital.
To completely comprehend personal and commercial finance, you must first understand one of the most fundamental ideas in financial mathematics: the time value of money. The primary goal of financial mathematics is to learn and use the notion of the time value of money in economic choices. Financial decisions, in turn, primarily concern the allocation of income and costs across time.
A machine acquisition, for example, entails an initial expenditure in equipment, molds, support structure, and installation, in addition to the working capital required to run the business. The income streams arising from the sale of the items produced and their related manufacturing expenses are then shown.
There may also be initial inflows in the form of financial contributions from bank financing and monthly disbursements for amortization and interest payments. However, as a result, resource disbursements and inflows are dispersed throughout time.
Explain why interest is paid or gained by saying: Interest on a bank deposit or debt compensates the depositor or creditor for the deterioration of money’s value over time.
A Practical Example of the Time Value of Money
Let’s say the price of gasoline today is $3.50 per liter. So, with $ 140.00 today, we can fill our car with 40 liters of gasoline (140.00/3.50).
If, in 1 year, gasoline costs $4.00 per liter. We have two options: fill up less fuel, 35 liters (140.00/4.00), or pay more for the same amount.
We then concluded that the expectation of an increase in fuel resulted in a loss in our purchasing power. But, again, this is inflation; in this case, we have a price increase of around 14.29% (from $3.50 to $4.00).
Also, according to this case, whether we have $140.00 today or $160.00 1 year from now, we say they are equivalent amounts because they have the same purchasing power.
But let’s assume the price of gasoline remains the same one year from now or inflation equals zero. Does it matter if I have $140.00 today, one year from now?
Of course not, as we can invest this money, which will earn interest and have a higher value in 1 year.
If we have an investment at the simple interest that yields 2% per month on top of the amount of $140.00, we could say that if my opportunity cost was 2% a month (at simple interest) and zero inflation, for us, it’s as little as $140.00 today or $173.60 a year from now.
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