Hello, students!

In today's lecture, we will be diving into a crucial concept in Personal Finance called the time value of
money. Let's get started!

Imagine you have 1000 Rupees that you don't need right now. What would you do with that money?
You might choose to put it in the bank, or if it's a small amount that doesn't warrant a bank visit, you
could simply keep it in a safe. You may even forget about the money altogether. After a year passes,
and you open the safe for some other reason, you discover that the 1000 Rupees you kept there is
still intact. Naturally, this would make you happy, realizing that you still have the 1000 Rupees you
saved a year ago. However, here's the question: Even though the denomination remains 1000
Rupees, what about its value?

Undoubtedly, the value is not the same. Why? Because the things you could have purchased with
1000 Rupees a year ago cannot be bought for the same amount now. This demonstrates that the
value of money decreases over time due to inflation. Inflation is responsible for reducing the value of
money as time passes.

Now, let's move on to Slide 3.

On this slide, you will find a graph depicting the consumer price index from 2014 to 2023. The
consumer price index is an economic concept that measures the average change in prices paid by
urban consumers over time for a basket of consumer goods and services. In simpler terms, it reflects
how the prices of household goods change over time. The base year for the consumer price index on
this graph is 2013. Thus, goods that used to cost 100 Rupees in 2013 would now cost 180 Rupees in
2023.

Transitioning to Slide 4.

This slide presents a graph illustrating the change in the value of 50,000 Rupees over a 15-year
period. Suppose you have 50,000 Rupees with you and you decide to keep it in a cupboard. Let's
observe how its value changes over time due to inflation, assuming a typical inflation rate of 6% in
the Indian markets. After 1 year, the value of 50,000 Rupees decreases to 47,000 Rupees. After 5
years, it decreases further to approximately 37,000 Rupees. After 10 years, it reaches 27,000 Rupees.
Finally, at the end of 15 years, the value is approximately 20,000 Rupees, significantly less than the
initial amount. As we can see, due to inflation, the value of 50,000 Rupees becomes less than half of
its original value after 15 years. Ultimately, the 50,000 Rupees you kept in the safe dwindles to
20,000 Rupees in 2015. While the amount remains the same, the value decreases over time. This
showcases the time value of money—the change in value over time.

Let's now shift our attention to Slide 5.

Money serves as a medium of exchange. In today's world, when you want to make a purchase, you
need money. Would you prefer to receive ₹1000 now or ₹1000 after one year? Of course, we would
all prefer the money now! This illustrates that there is an inherent monetary value attached to time
Furthermore, the value of 1000 Rupees today is greater than the value of 1000 Rupees in the future.

Slide 6

The concept that money available today is worth more than the same amount of money in the future
is the time value of money.

We can say that the current value of money is higher because you can invest that money in various
investment instruments and earn interest. For instance, you can earn a 20% return by investing in the
stock market, a 15% return in a mutual fund, or a 7% return in a bank fixed deposit. By choosing
different investment instruments, you can earn returns and ultimately grow the value of your money.

Slide 7

The longer you keep your money invested, the higher the potential returns. This demonstrates that
the value of money depends on the time it remains invested and the rate of returns.

Slide 8

By knowing the tenure and return rate, you can calculate how much money you can earn. Two
important concepts in finance are the present value and the future value. The present value
represents the value of money at the current time, while the future value is its value at a specified
date in the future.

Moving on to Slide 9.

Regarding future value, it represents the value an asset will have at a specified date in the future.
Future value measures the future sum of money that the present sum of money is "worth" at a
specified time in the future, assuming a certain interest rate. When calculating future value, the
impact of inflation is not taken into account. As we have seen, inflation reduces the value of money
over time. Therefore, if your returns are at 8% and inflation is 6%, your actual returns would only be
2%. While the money grows at a rate of 8%, its value decreases at a rate of 6%, resulting in a net
effect of 2%.

Slide 10

The formula for future value is...

Let's take a look at Slide 11.

Here, we will delve into the meaning of compounding periods. Compounding periods refer to the
time intervals during which interest is added to an account. Interest can be added annually, semi-
annually, quarterly, monthly, or even daily. Consider the example of investing Rs 100 with a 12%
annual rate of return. The monthly rate of interest is calculated by dividing 12 % by 12months,
resulting in a 1% interest added each month, known as monthly compounding. If 6% interest is
added every 6 months, it is referred to as semi-annual compounding. When 3% is added after 3
months, it is called quarterly compounding. Lastly, if 12% is added once a year, it represents annual
compounding. Does the compounding rate truly make a difference? Indeed, it does. The
compounding rate significantly affects the final sum. The higher the compounding rate, the greater
the future value.

Slide 12

Let's consider an example to understand future value with different compounding rates. Suppose
Miss 'X' wants to invest Rs 500,000 at a 10% rate. The future value of her investment will be Rs
8,05,225. If she continues to invest for another 5 years, making the total investment tenure 10 years,
the value of her investment will be approximately 1.3 million Rupees. Now, if we change the
compounding period, the future value of Rs 500,000 will differ. Through annual compounding, the
future value will be Rs 805,225. If the compounding is done monthly, the future value will be Rs
822,654. If it is done quarterly, the value will be Rs 819,000. Remarkably, with daily compounding,
you can earn an additional Rs 17,000 compared to annual compounding for the same investment
amount.

Slide 13

Slide 13 presents a formula for future value in Excel, which allows for easy calculation. The formula is
=FV(rate,nper,pmt,[pv],[type]). The rate represents the interest rate, nper is the total number of
payment periods, PMT is the payment made per period, PV is the present value, and type depends
on whether the payment is made at the start or end of the period. It's important to remember that
interest rates are generally specified annually.

Slide 14
If there is monthly compounding, divide the annual interest rate by 12; for quarterly compounding,
divide by 4, and so on. To determine the total number of periods, multiply the years by the number
of periods per year.

Let's move on to Slide 15.

Here is the example of investing 5000 Rs at the interest rate of 7%. The table shows the formula used
for different compounding periods. For weekly compounding divide the interest rate i.e. 7% by 52,
number of weeks in a year. This will yield the weekly interest. Next to that, as the interest is added
per week, we have to take number of periods as 52 since interest is added 52 times in a year. Can you
try for daily compounding?

Slide 16

Now, let's explore the concept of discounting, which is the reverse of compounding. Discounting
involves translating the value back in time and is used to determine the current value of a future
sum. If you want to know the current value of a future sum, you use the discounting method. On the
other hand, if you want to know the future value of a current sum, you employ the compounding
method. Discounting is particularly useful in calculating the present value.

Slide 17

This slide focuses on the concept of present value, also known as the current value. Present value is
the process of discounting the future value to obtain its value at zero time period. It reveals the
amount of money you must invest at a given interest rate to achieve a desired future value.

Slide 18

We can determine how much we need to invest today to receive 10,000 in the future at a given
interest rate. The formula for present value is...

Slide 19
Let's consider an example shown on the slide. If you want to receive 5,000 at a discount rate of
8.25%, you need to invest 3,364 on the payment day.

Slide 20.

The concept of time value of money plays a crucial role in many important financial decisions, such
as bond valuation, stock valuation, project evaluation, and more. In personal finance, understanding
the time value of money helps investors make informed investment decisions based on the expected
returns from various investment instruments. In summary, the time value of money is a fundamental
factor considered in making business decisions.

Slide 21.

Let's discuss an example that demonstrates the time value of money. Net present value (NPV) is the
present value of cash flows at the required rate of return for a project, compared to the initial
investment. The formula involves summing the present values of all the project's cash flows over
different time intervals. If the project has a positive NPV, it is considered profitable, while a project
with negative cash flows is assumed to result in losses.

Slide 22

Let's examine an example of a machine purchase for Rs 1,000. The cash flows generated by the
machine are rs. 600 in the first year, Rs.400 in the second year, and Rs. 100 in the third year. The
discount rate is 15%. The discount rate depends on the opportunity cost. If you had invested the
money in a mutual fund instead of purchasing the machine, you would have received a 15% return.
Therefore, the business should earn a higher return than mutual fund. In this example, the NPV
comes out to be positive, indicating that the business investment is profitable.

Slide 23.

The concept of time value of money is also crucial in understanding the profitability of annuities. An
annuity refers to a series of equal payments received or made at regular intervals. For example, if Mr.
X receives 10,000 every year for the next 10 years from an initial investment of Rs. 100,000, the Rs.
10,000 payments made at regular interval represent an annuity.

Understanding annuities is essential for making investment decisions related to pensions, insurance
policies, and more. In one of our upcoming lectures, we will delve into insurance in detail and explain
why it is not advisable to purchase money-back policies. The concept of annuity will help us
understand the reasons behind this recommendation.

Slide 24
To assess the profitability of an annuity, we need to calculate its present value. The present value of
an annuity is the current value of a series of equal future payments received over a specific number
of periods. On this slide, you will find an annuity timeline. The timeline demonstrates an example
where you invest Rs 400 and receive 100 annuity payments over 5 years.

Slide 25.

To determine the profitability of the annuity, we calculate its present value. This can be achieved by
discounting each cash flow back to the present value and then summing all the present values.

Slide 26

In this case, the present value of the annuity amounts to around Rs 380. Thus, the present value of
the annuity is lower than the investment amount, suggesting that the annuity is not profitable.

Slide 27

Therefore, when assessing the profitability of an annuity, it is crucial to compare the present value
with the initial investment. If the present value is higher than the initial investment, it indicates a
profitable annuity, while a lower present value suggests potential losses. Always calculate the
present values of annuities before purchasing money-back policies or similar products from
insurance companies.

That concludes today's lecture. See you in the next one!

Thank you!