![]() ![]() Up the money, the higher an interest rate you get. That you defer your money, or the longer you lock To be the case, although it's not always the case- the longer We get to keep your money, we'll give you 12%. So let me give you the money for 10 years. You know, I actually don't even need my money for 10 years, ![]() We'll give you 7%, because we get to keep your moneyįor two years. Give you a little bit more interest, because we have If we give you the money for two years? So you can keep our money, But we know if you go to theīank and you say, hey, bank, I want to essentially invest inĪ one-year CD, they'll say, oh, OK, one-year CD How long of a period we're talking about. The discount rate is the same thing, no matter For another answer to your question watch the video on Fractional Reserve Banking. So it makes sense for them to offer you an incentive to keep that in the bank longer. However if it issues a bunch of 5 year CD’s and keeps selling those year after year they can increase the number of auto loans they are able to sell. If the bank issues a bunch of 1 year CD’s it’s not in a very good position to make those auto loans. CD’s are similar to bonds in that they are a way consumers and institutions can lend banks money. One of the ways they might raise the money needed to make these loans is to sell CD’s. This will require the bank to make loans with terms of 3 -5 years. A bank may wish to improve its balance sheet by increasing the volume of car loans it offers. Bonds storyboard for a second and think of a bank. When a lending institution is planning its cash flows putting the flexibility in their control as opposed to yours is beneficial to them so they offer you a benefit (higher interest rate) to entice you to give them that flexibility. So I'll check back in a few days to see if I need to re explain anything. But in year two because of inflation $108 dollars will only buy as much $105 dollars bought when you made the investment. You really will go from having $100 to $108. But the was 1% inflation in year one and 2% inflation in year two! Your REAL interest rate is 5% that is the 8% adjusted for inflation. Although the bank advertises 2%, and you will receive 2%! Your money will be able to only purchase 1% more, because the average prices will rise as well. You would use the 1.01 discount rate in the denominator. Instead of offering 1% the bank offered you 2%. This is the REAL interest rate (Gross adjusted for inflation, gives you the real buying power of the currency). If you were going to make 5% a year on the deal, you will now be making 3%. All you have to do is adjust your discount rate (the gross interest rate). Let's assume that in Country A, inflation is always rising by a steady 2%. While it is not directly involved, it can easily be understood and inferred. Now what I think you're really trying to get at is inflation and the physical value of money. That sort of emotional/societal value is not included. In some cases in life, it is more worth while to have $150 dollars today than $20,000 in 10 years. If by value of money, you mean value of liquid assets, no. ![]() The exercise does NOT include those figures, sort of. Inflation basically is the value of money, domestically at least. Clearly more than the $110.25 in option 1. Using the FV interest calculation given in a previous video we have (1.05)^2 multiplied by $101.25 (the present value of the investment) which gives us $111.63. ![]() And the same goes for $35 in two years at 2%.Īnother way to think about it is that the present value as Sal calculated is $101.25. That is exactly the formula Sal gave ($50/1.01). The correct logic is to ask the question: How much money would I need today to have $50 in a year at a 1% interest rate. This conundrum is the entire reason for using the discounting method. Similarly, $35 is what the value WILL BE in 2 years time. Therefore you can't use addition to simply sum $20, $50*1.01, and $35*(1.02^2) because $50 isn't the present value it's the FUTURE VALUE in one year's time. You won't have access to the $50 for a whole year and the $35 for a whole two years. I will invest $35 at a 0% interest rate STARTING NOWĭo you see the error? You are assuming a timeline that starts all of your investments at the current time. I will invest $50 at a 1% interest rate STARTING NOW I will invest $20 at a 5% interest rate STARTING NOW Think about what you are really saying in your example: HankyUSA, this is a great question, but your (and the rest of the responders') logic is slightly off. ![]()
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