The time value of money

A bird in the hand

If in an uncharacteristic fit of generosity, your accountant offered you a $100 bonus and told you that you could choose whether to take it today or in one year’s time – no strings attached – which would you choose? Obviously, you would grab it now with both hands. You do not need telling twice that money in your possession now is worth somewhat more than the promise of the same amount at some future time. There are two main reasons.

If interest rates have risen from 10% to 12% they have increased by two percentage points – or by 20%. The first is a unit, the second is a rate of change. Bankers, who often make money by taking advantage of very small changes in interest rates, refer to 1% as 100 basis ...

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