can anyone help me understand the time value of money example given in the curriculum book.
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i have a good understanding of time value of money and the concepts of present value and future value,
But this example confuses me a lot. especially the sixth line “Possibly, because a payment of $10,000 a year from now would probably be worth less to you than a payment of $10,000 today.”
Is this the explanation to why we would choose the second option which is get $9500 today and pay $10000 in one year. or is it the explanation to why both amounts could be considered equivalent.
if you received 10000 today and put it in the bank - you would definitely have more than 10000 a year later. So how does getting 10000 1 year later become better?
That is the time value of money… so given a choice between 10000 today and 10000 1 year later - you should choose 10000 TODAY.
Do you? If you had good understanding of TVM, you would have understood the curriculum example. The mathematics can be really straightforward in some cases, but that is not enough. You must understand why the money is less worth in the future from the point of view of today.
The factor that leads us to choose a money today or a money tomorrow is the implied interest rate of that deal. 5.26% is good for you for a 1-year saving? For me not, but for other people perhaps. I would recommend you to forget about this text, you will find out what TVM really is when go further in the Curriculum.
I don’t think you are confusing about the concept of TVM, you are just confusing about the wording of this paragraph. This paragraph simply tells you that, “$10000 today worth more than $10000 in the future”, that’s it. But it explains the concept in a very theoretical way and makes reader confused. If you know “$10000 today worth more than $10000 in the future”, you should be good.
exactly, i have been studying finance from past three years. i have firm understanding of how time value of money works and i do acknowledge that $10000 today are worth more than $10000 after one year. but what does the writer imply with this statement, is he trying to convince us that second scenario is better than first one because we pay $10000 after one year which is probably worth less than $10000 today.
if i stick to this than where is the explanation for the amounts being equivalent, that is what confuses me, because both of the questions are written together, the first question asks “but what if we recieve $9500 today and pay $10000 a year after?” suddenly after this question ends the writer asks another question which says “can these amounts be considered equivalent?” so which question does this line answers the first one or the second one.?
The example talks about the payment of $10000, not the amount that we will recieve.
in both scenarios we receive $9500 today. but in the first one we pay $10000 today and in the second one we pay $10000 after one year.
if we compare the present values of both the PAYMENTS $10000 today has present value of $10000 but $10000 after one year has present value of less than $10000 so we are better of paying it after one year rather than now.
It is likely that you are over thinking about this. The writer just want to express that inter temporal cash flows are linked by the implied interest rate in the deal. He/she/helicopter even use the word “probably” when talking about if that deal would be accepted or not. This is because the implied interest rate is not necessarily attractive to every investor.
Further in the curriculum of the CFA Program (I mean L2 and L3), you will find out that risk-adjusted returns on investments not only depends on facts or numbers. This is because investors are human beings and can even reject an optimized portfolio (hence optimal return) due to subjectivity factors like fear, beliefs, boredom, etc.
TVM is the first rock in understanding investments, simply because investments suppose future cash flows which must be discounted to present in order to know their values (price).