RE: Time Value of Money

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RE: Time Value of Money

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diegoloco in TradFi • 6 days ago

The concept of the time value of money, as you say, is based on the idea that a dollar today is worth more than a dollar in the future. The reason is that that dollar can generate a return until we reach that future point in time we're valuing.

I think that to talk about the time value of money, a risk-free rate should be used. Otherwise, we'd be considering the risks of the business in addition to the time value of money.

In the example of the 2-year interest-free loan, at least that time value of money is being lost. Remember that we're not considering inflation or other factors (including the possibility of default).

That's because we're only looking at the time value of money. When we value using discounted cash flows, risks and inflation will be considered in the model, and the calculation will become more complex.

6 days ago in TradFi by diegoloco

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hurtlocker 6 days ago

You are right the “risk-free rate” is the best metric for understanding time value of money.

I think the “risk-free rate” today is more risky than it used to be so I have a hard time calling it risk free. That’s probably a me problem more than anything 🤣

I will have to use the risk free rate when we go through a DCF. I am not looking forward to it because calling any government bond risk free may not go over well in crypto world 😆

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diegoloco 5 days ago

US bonds are often considered risk-free. Although they also carry risk, the US is the most indebted country in the world. Other countries have a country risk premium, which is the difference in interest rates they pay compared to the US.

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hurtlocker 5 days ago

I would argue US bonds are used as the risk free rate for lack of a better metric.

In theory you could adjust US bonds for the level of default risk but that adjustment itself would be very subjective.

People have tried to come up with better metrics like "swap rates" but they all fall short IMO.

A risk free rate is not real but neither are the models that use risk free rates. These things are only us trying to apply logic to reality which is often not logical.

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diegoloco 5 days ago (edited)

In Argentina, the only thing that can be considered risk-free is investing in stock market guarantees. They've always paid out, even during times of economic collapse.

And those rates tend to fluctuate wildly.