Question

1. Why does money have a time value? In other words, why, conceptually, is a dollar today worth more than a dollar tomorrow?
2. When we talk about interest rates, this is sometimes referred to as a “hurdle rate” or the “opportunity cost(s)” for the various uses of capital. What exactly is meant by this? Why do interest rates serve as a barometer for the various potential uses of an investor’s capital?
3. Suppose you won a $2 Million (after taxes) jackpot in a state lottery. Assume for the purposes of discussion, that there are no fees associated with the transfer of these funds into your own personal financial institutions, that the funds are free of any contingencies, and that you can utilize them immediately as you see fit. You look out into the marketplace for potential opportunities, where you, as the Savvy Investor, can grow your newly-acquired capital. What sorts of questions are you going to ask? Where would you look for opportunity? What kind of information would you need to make the soundest judgement? Once you have conducted your analyses, how would you ultimately come to a decision on how to deploy your capital?

Answer 1

1. Money has time value because

a. Change in Inflation rate impacts the purchasing power per dollar. That means what a dollar can buy for you now, will change over a period of time because of inflation.

b. Time utility- A businessman borrows money for his business projects and utilises for same. When the Business creates surplus funds he or she returns the money back to the lenders. It gives and opportunity for the businessman to do his business and earn money for a certain period of time.

c. Reward for the Risk taken in lending- Till the time the business generates surplus the lender should wait and there is a scope of defualt by borrower. For the risk taken lender is rewarded with Interest.

2. Dollar today worth more than dollar tomorrow, it is true only when the inflation rate is positive. If the Inflation rate turns negative then the purchasing power per dollar will increase and it will result a dollar tomorrow worth higher than dollar today.

3. Interest rate is the rate at which interest amount calculated for the amount lent by the lender to the borrower for the agreed period. Interest is the consideration for parting money with the borrower for an agreed period of time and taking default risk in lending. However hurdle rate is the required rate of return from an investment in a project. Opportunity cost is the next best benefit forgone for the current selection. Interest rate may be selected based on the opportunity cost of the amount invested.

4. Interest rate serve as barometer-

Banks and financial institutions lend money to the business people after assessing the rate of return from the projects whether it is sufficient to meet interest costs. Hence interest rate in an economy plays significant role. If an economy is increasing its interest rate then the businesses will borrow less money and there will be impact on the amount of production as well. Lower the Interest rate more money can flow into the system thereby more production and more employment.