What is the value of money?

The value of money is an economic concept based on the assertion that capital must constantly bring income to its owner. Therefore, today the value of money is much greater than in the distant future will be estimated the same amount. "Father" of this concept can be considered as Leonardo Fibonacci, who developed this concept back in 1202. However, a scientist who lived in the Middle Ages still did not take into account the possibility of depreciation of bills under the influence of external factors, since in his time there were only coins made of precious metals and copper coins for small settlements.

And the value of money in time, which is a fundamental concept of the theory of finance, depends on two main factors - risk and inflation. Moreover, the most susceptible to depreciation paper notes, the rate of which is not tied to the "troy ounce", in contrast to credit banknotes, subject to exchange for gold. Therefore, the time value of money is now an indicator used by economists of all modern states, which is especially evident in the development of credit programs.

At the same time, the value of money is conditioned by the premise that a person will prefer to receive a certain amount right now than the same number of denominations of this denomination in the distant future. When citizens or entrepreneurs make deposits to the bank, each of them wants to earn money on this and receive income in the form of interest. Therefore, in the conduct of financial transactions, it is necessary to take into account the time factor, and when analyzing long-term transactions, it is simply incorrect to summarize the quantities related to different periods.

Calculations

The cost of money, like other economic indicators, is calculated by special formulas. So, in financial management, when executing work with monetary values in different time frames, such amounts are first reduced to one period. To do this, all the flow of payments should be recalculated at the discount rate, which is the percentage used to calculate the flow of future income at a certain amount of current value. In addition to inflation, this indicator includes the level of profitability that the depositor wants to receive for using the bank's savings.

Banking system

In the financial sphere, the value of money is necessarily calculated at the time of drawing up a loan or deposit agreement, since the document specifies the size of the interest rate. For example, if the depositor decided to invest $ 5,000 for five years at 12%, then by the end of the term he will receive $ 8,000. This means that the time value of money for this period has increased by $ 3,000. And it is increasing precisely because owning these funds now, a person gets the opportunity to profitfully invest their savings, make them work for themselves, as a result, increasing their own savings and making a profit.

Influence of inflation

However, after a certain number of years, the increased value, consisting of the deposit amount and the profit, which in our example was $ 8000, will have a lower purchasing power than a similar amount of money five years ago. This is explained by inflation, which led to a depreciation of the contribution, the real income will be much less than $ 3000.

Therefore, not only the risk premium is included in the interest rate, but also the inflation factor, which is calculated in advance in view of the rate of depreciation of the currency. And in the period of unpredictable hyperinflation, the increased value can remain only nominal, since for this amount it will be possible to buy the same quantity of goods as before the deposit. For example, such situations often occur in developing countries, where the contribution is made not in dollars, but in unstable national currency.