Time Value of Money is one of the most important concepts when it comes to finance. Oddly enough, Time Value of Money is an ancient concept while also being one of the least understood concepts in modern society. I am guessing the concept probably predates text. At a minimum, the concept dates back to at least 500 CE in The Talmud. I am not Jewish or a religious scholar so I am not going to speak to what The Talmud says, I just wanted to point out how old the Time Value of Money concept is.
The modern version of Time Value of Money is not just a concept but we have a mathematical formula to help understand it. I have mentioned in another blog post many financial concepts are very old and cannot be patented. I have learned about these concepts with text books and using online resources. Typically the online resources are "better," in my opinion, because the online resources are more concise and usually free. This resource from investopedia.com on Time Value of Money is pretty good but a little too concise - https://www.investopedia.com/terms/t/timevalueofmoney.asp
So to start off, the concept of Time Value of Money is the idea that money is worth more today than it is worth at some point in the future. This is obviously true in modern society because of the way Fiat currency works, but currency debasement is a very different discussion that I will save for another day.
So for this discussion, assume Fiat currency is backed by something and does not lose value overtime. Let's assume $1 is backed by gold and is always worth $1.
In this instance, saying $1 today is worth more than $1 in the future sounds crazy. However, when you think about Opportunity Costs, $1 being worth more today than $1 in the future makes a lot of sense.
So what is an Opportunity Cost? Opportunity Cost as a concept is kind of confusing. Most economists assume people naturally pick the best option based on Opportunity Costs. I do not believe that is true and I am not sure how it can be proved that people naturally do this for things that are "complicated." An Opportunity Cost is what you give up when you make one decision over another decision. We could have a whole post just on Opportunity Costs. @angeluxx, you may consider writing about Opportunity Costs for the TradFi community given your interest in economics. If people want to dig more into Opportunity Costs this resource is pretty good - https://www.investopedia.com/terms/o/opportunitycost.asp
So to recap the above:
- Time Value of Money is the idea that $1 today is worth more than $1 in the future. (This is "true" even if assuming Fiat currency debasement does not exist).
- Opportunity Cost is what you give up when you make one decision over another decision.
- Time Value of Money is primarily true because Opportunity Costs are very real.
- There is a modern formula for understanding Time Value of Money.
Side Note - What is weird... you cannot even clearly credit anyone who made the current formula for Time Value of Money. You could literally write a whole book about Time Value of Money.... it would just be really boring so I doubt anyone who who has written a book about Time Value of Money ever became famous 🤣
Here is the current formula from the Investopedia article I referenced above:
https://www.investopedia.com/terms/t/timevalueofmoney.asp
So, I cannot tell you what the Time Value of Money IS, but I can tell you what my Opportunity Cost is if I give someone an interest free loan rather than investing in a government bond (investing in a government bond is basically loaning the government money).
Please assume the following for this example:
• Fiat currency debasement does not exist.
• I give someone an interest free loan of $1000 for 2 years.
• The person I loan money to will pay me back and pay me back on time.
• Rather than loaning someone $1000, I could have bought a $1000 A rated government bond that pays an interest rate of 3%.
• This A rated government bond pays monthly (there will be 12 payments in 1 year).
• Assume A rated government bonds are "risk free" (This is not a safe assumption in today's society but that is a conversation for a different day).
The formula we are using for this example is Future Value = Present Value (1 + Interest rate / Number of compounding periods per year)^(Number of compounding periods per year * Number of years)
The Future value of the interest free loan = $1000 (1 + 0/1 )^(1*2)
• (1 * 2) = 2
• 1 + 0/1 = 1
• 1^2 = 1
• $1000 * 1 = $1000
Future Value of a 2 year interest free loan = $1000
The Future Value and the Present Value are the same in this case. It is $1000.
The Future Value of the government bond is = $1000 (1 + 3%/12 )^(12*2)
• (12 * 2) = 24
• 1 + 3%/12 = 1.0025
• 1.0025^24 = 1.061757
• $1000 * 1.061757 = $1061.757
Future Value of investing $1000 into a 2 year government bond, with a 3% interest rate, and 12 payments a year = $1061.757
In summary, I will make $61.757 less if I give the $1000 loan for free rather than buying a government bond.
For the TradFi community I am going to start with "simple" concepts first before we go down how to value TradFi style investments. Some of what I will cover in the TradFi community will help in crypto but most of the models used in Traditional Finance fall short. Some context, I have been trying to figure out how to value HIVE for 2 years and I have no idea; I basically gave up 🤣.... for now 😉
Happy New Year and please consider stopping by my TradFi community here - https://peakd.com/c/hive-143901/created
You must request membership on chain and I will tell you if we have any openings based on what you want to write about. If your KE is over 2, I likely will not include you but it never hurts to ask.
If someone else wants to write about Time Value of Money to help them learn they should do it! Feel free to use the picture I made with Copilot as I made it for the TradFi community.
Good luck in life and good luck on HIVE! Cheers!
❤️
Hurt
