Lecture notes
FL03 - Compounding and Discounting, Annuities and Perpetuities
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- Kings College London (KCL)
FL03 - Compounding and Discounting, Annuities and Perpetuities
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FL03 – Time Value of Money 9/10/15 Prof. Michael ShilligTIME VALUE OF MONEY: COMPOUNDING AND DISCOUNTING/ANNUITIES
AND PERPETUITIES
WHAT IS MONEY?
An asset that is generally accepted as payment for goods and services or
repayment of debt
o Means of payment
o Unit of account used to compare goods and services
o Store of value
Commodity monies
o Things of intrinsic value (e.g. gold, silk, etc.)
Fiat monies
o Value of money due to government decree (i.e. state or government
assigns value to currency)
Where is money from?
o Central Bank issues money
o M0 = monetary base or high powered money (narrow aggregate)
currency in circulation + reserves held for commercial banks
Through this base, central bank controls supply of money
through manipulation of monetary base
E.g. buys securities held by commercial banks (assets
go up, and money paid to commercial bank is credited
to deposits of the bank) balance sheet expanded,
monetary base increases supply of money increases
in economy
Central Bank has monopoly on issuing bank notes
o M1 = M0 + overnight deposits (highly liquid financial products)
o M2/M3 = includes time deposits, repurchase agreements
o Central bank = 2 roles
government’s banker
Banker for commercial banks
CENTRAL BANK BS Assets Liabilities
Government’s banker Treasury bonds, Currency (since it is
securities, foreign issued to public in
currencies (i.e. securities circulation), government
issued by foreign accounts (i.e. money
governments) that government has
deposited)
Banker for commercial Loans Reserves = 1. The
banks deposits that banks have
with central bank + 2.
Cash that banks hold
themselves
TIME VALUE OF MONEY
‘A dollar today is worth more than a dollar tomorrow’
o Why?
Opportunity cost of lending interest as compensation for lost
opportunities during the time the loan was outstanding
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