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Understanding Time Value Of Money

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If you are one of the aspiring investors, one of the major basic topics of Finance that you need to understand before going into any other complex topics like investing on stocks and bonds or assets, decision making, etc. is the Time Value of Money (TVM).

In non-scientific term, time is the measure we experience our life on- what the clocks show and what the calendars read. On the other hand, money is what we use as the source of payment in exchange for goods and services. Value of Time, being a universal concept applies to almost everything, including money.  Let’s keep it very simple. Leave behind the financial jargons for a while and try to understand the connection between the value of time, and then the value it provides to money.

Time provides value to money in a sense a dollar today is always worth more than a dollar tomorrow. This is where the whole concept revolves around.

To understand it better, let’s break it down into three major parameters that it depends upon:

1) Inflation

Inflation in simple terms is the increase in price of goods and services over the course of time. It decreases the purchasing power of your money.

Let’s say you have 100000$ right now from which you want to buy a piece of land. However, you decided that you want to shift the purchase to next year. In that one year duration, the price of land increased by 25000$ and now you cannot buy the same land for same amount of money that you had a year ago. You have to add more cash. Had you bought that land in first year, you wouldn’t have to add more money. Basically, 100000$ you had in the first year had more purchasing power and hence worth more than 100000$ at the year end.

For inflation, you can also take example of the difference cost of goods 50 years ago and today. You could buy whole lot of things with a few dollars which probably costs way more now. This shows that value of money simply erodes with time. Due to this very reason, value of a dollar today will always be worth more than tomorrow or any time in the future.

2) Opportunity Cost

According to Investopedia,”Opportunity costs represent the benefits an individual, investor or business misses out on when choosing one alternative over another.”

Let’s clarify it with a famous example that people use in case of smokers. Suppose a person has been smoking from last 10 years. Had the person not spent the money on cigarettes and used all the money that he spent on cigarettes over the years to invest in something else, the returns would have been more rewarding. That can be taken as an opportunity cost lost.

In business world, different projects keep coming up but one may not be able to invest in all of them due to the limitation in capital. In such case, the difference between the option forgone and the chosen option is basically the opportunity cost. While analyzing the opportunity cost, the future revenue should be discounted to present value in order to determine which one of the project is really profitable.

Now, coming back to the time value of money, suppose you lent some money to your friend and he will only return it after one year. Had you not lent that money, you could have invested it somewhere more profitable and earned some decent interest than having to wait a whole year just to get your money back without any returns. This supports the basic lesson of time value of money in our day to day life.

3) Risk

Risk lies in the uncertainty that the money you invested may not always yield good returns or even be lost. There is no guarantee that the person who owes money to you will always pay you. There is always some underlying risk factor. If your debtor offers you to pay 100$ today  or 110$ a year after (given that there is no inflation and the general rate of interest is 10% p.a., you would always choose the first option by which you eliminate the default risk of not getting it paid next year. So it shows how money today is always worth more than the same amount of money tomorrow.

 

Formula of Time Value Of Money:

The general formula for time value of money is:

FV = PV x [ 1 + (i / n) ] (n x t)

where,

FV = Future Value Of Money ( Value of money at future time period ‘n’)
PV = Present value Of Money ( Value of money today )
i = interest rate (compounding/discounting rate)
n= number of periods per year
t= number of years

 

Difference between Inflation/Deflation rate and Compounding/ Discounting Rate

Not to be confused, the rate of compounding and discounting determines the time value of money whereas the rate of Inflation/Deflation determines the price of commodity. Both are not same.

For example, if the compounding rate of interest is 10% p.a. and rate of inflation is 5% p.a., then the cost of goods that cost 100$ today will cost 105$ in a year, but the value of your 100$ actually compounded to 110$, hence you still have surplus of 5$.

 

The author is a CA student.  If you want to add more information on the given post, please comment below and your comment will be incorporated in the article.


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Knowledge & Infos

What’s Special Today: November 10

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Chhath:

Historically native to the Indian states of Bihar, eastern Uttar Pradesh and Jharkhand and the southern part of Nepal, Chhath is one of those festivals that transcends the caste system that exists in the society. According to the Hindu calendar, it is celebrated on the sixth day of the lunar month of Kartik. The Chhath Puja is a 4-day long ritual specially offered to the solar deity, Surya, to show thankfulness for good health, good life and to request the granting of some certain wishes.

Day 1: On the first day, the devotees after bathing clean their house and eat the food that is offered to the god to protect the mind from the vengeful tendency.

Day 2: On the second day, the devotees are not allowed to drink even a single drop of water but, in the evening, they eat kheer made up of jaggery, fruits.

Day 3: The evening of the third day which is also known as sandhya ‘arghya’ day where a bamboo basket is decorated with various puja materials, fruits, thekuwa, and laddus which are offered as an ‘argya’ to the Sun. Also, the Chhathi Maiya is worshipped.

Day 4: On the last day of Chhath puja again an arghya is offered to the Sun God but this time in the morning. The devotees go to the riverbank to offer arghya to the rising sun and break their fast and conclude their four-day long worship.

Happy Chhath to everyone! Don’t forget to enjoy some thekuwas!!

World Keratoconus Day:

Every year on November 10, World Keratoconus Day is celebrated to focus global attention on keratoconus and ectatic corneal disorders. The day was first celebrated by National Keratoconus Foundation.

Keratoconus is a disease that causes the cornea to become weak, leading to the thinning and stretching of the cornea, which may result in the loss of vision. Keratoconus is degeneration of the structure of the cornea. The shape of the cornea slowly changes from the normal round shape to a cone shape which affects the vision. The keratoconus mainly develops in teenagers and young adults and the disease keeps on growing, if not diagnosed in time.  

The disease has no prevention and no treatment. With early diagnosis, the disease can be managed and further damage can be protected. In Nepal, the prevalence of Keratoconus is 1 in 2000 according to the recent journal. So, this world keratoconus day, make a commitment to visit an eye doctor once a year for the early diagnosis of keratoconus as well as other eye diseases.

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Knowledge & Infos

Best and Worst Bank in Nepal as per our survey

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We had conducted an online survey to find out how banking services in Nepal are being used and perceived by their users. This article is entirely based on those responses. Thank you Muktinath Bikash Bank for supporting us in conducting this survey.  

Over the years, Banks have become an integral part of our daily life and economy. With the shift to digitalization and modernization of the economy, banks have definitely made life easier for people to manage their cash and transactions. With these shifts and increasing dependency on banks more than ever, the use of banking services and users’ banking experience is one of the topics with the minimal amount of research done. Out of curiosity, we conducted an online survey to find out how people have been feeling about the banking services provided by the respective banks.

About Respondents

Respondents were mostly urban educated youth with access to the internet, in the age bracket of 18-40, mostly being from 22-26 age group. The data was collected through social media users, primarily from page followers of KMAG. In total, we got 219 responses out of which 160 were males and 59 were females. 

In the list of questionnaires, one of the questions was “which is your favorite bank from Nepal as per your own experience,” and another being “which bank do you think is the worst.” Among 219, 27 respondents were undecided and 192 casted their votes for “best” and the “worst.” To build the conclusion on more strong foundation, we wanted to make sure respondents voice their opinion per their experience for which we had also asked them to reveal their primary bank.

Out of the total participants, a majority of 89.6% have multiple bank accounts though 19.5% of them just use one of those accounts. The remaining 10.4% claimed to have an only bank account. Out of all those banks, Nabil Bank is the primary bank for 36 participants (which was the highest no. of primary account holders in a particular bank). After Nabil, most of them were primary users of NIC Asia, Global IME, and Siddhartha Bank.

Nabil is voted as “Favorite Bank”

Nabil Bank seems to be the most favorite and popular among the respondents. With a total of 45 votes, it was voted the “most liked” bank. Among them, 29 were the primary account holders of the bank. Under “least liked,” it only got 4 votes.

To briefly talk about Nabil Bank, Nabil Bank is an ‘A’ class commercial bank which was founded in 1984 A.D. (2041 B.S.). It was established as Nepal’s first private sector bank incepted by multinational investors with the objective of providing modern, international-standard financial services. It was first established as Nepal Arab Bank Limited. In 1995, Dubai-government owned the majority of shares was bought by Binod Chaudhary.

NIC Asia is “least favourite”

With 76 votes for “worst bank,” NIC Asia seems like the “least liked” bank from Nepal as per the responses. Interestingly though, it has also been voted as “favorite bank” by 17 respondents.

After NIC Asia, Nepal Investment Bank seems like the second “least favorite” bank from Nepal with 23 votes against the bank.

On being asked the reason for disliking the bank, most of the participants seem to agree on the same point and that is “terrible” customer service of the bank. Similarly, other reasons were bad internet/mobile banking facilities, fraud-like business practices, and lack of important banking services/products being provided by the. Not to forget few were unhappy about the lack of branch/ATM services.

The detailed data are presented in the table below:

BanksPrimary AccountLikedDisliked
Nabil Bank36454
Global IME Bank251710
NIC Asia Bank291776
Siddhartha Bank16147
Sanima Bank13112
Laxmi Bank12101
Mega Bank10102
Standard Chartered Bank982
NMB Bank677
Bank of Kathmandu561
Machhapuchchhre Bank765
Himalayan Bank759
Sunrise Bank752
Muktinath Bikash Bank442
Century Commercial Bank330
Civil Bank433
Everest bank2310
Kamana Sewa Bikas Bank 131
Prabhu Bank Limited838
Rastriya Banijya Bank339
Agriculture Development Bank222
Citizens Bank 521
Kumari Bank321
Nepal Bangladesh Bank222
Nepal Bank325
Nepal Investment Bank15223
Garima Bikash Bank210
Nepal SBI Bank 2111
NCC Bank112
Prime Commercial Bank712
Manakamana Development Bank001
Shangri-la Development Bank100

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Knowledge & Infos

How to design a survey questionnaire

This article was originally designed for KMAG Online Writing Workshop and made available to public for knowledge-sharing purpose.

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A survey is a list of questions aimed at extracting specific data from a particular group of people so that the surveyor can gain knowledge and insights into various topics of interest and then mostly generalize the result. How to design a survey questionnaire completely depends upon the purpose behind the survey. Depending on the purpose, questions are framed.

Let’s understand this way, surveyor seeks to know anything based on either of the following grounds:

  1. They don’t know anything, they are curious to find out, and they seek for answers. Example: I don’t know many people smoke and I want to find out by asking everyone out there.
  2. They think they know but they are not sure and they want to find out if what they think they know is actually true or false. Example: I think 50% of Nepalese do smoke but I am not sure yet and I want to validate my assumption by surveying.
  3. They strongly believe that what they know is the facts and now they want to interpret the world based on the “facts” they live by. Example: I strongly believe that smoking is bad and raising tax and making it expensive is the way to discourage people to smoke. I want to survey to find out how many Nepalese believe the same and agree with raising taxes and making it expensive would discouarge people to smoke.

Whatever grounds you are holding, you must frame your questionnaire according to that. So before working on the questionnaire ask yourself if you are trying to know the unknown or are you trying to validate or crosscheck what you think you know or you are trying to pass judgment or views based on your preset theory/hypothesis that your understanding is based upon.

This is how it goes:

You already have a theory and you want to analyze people based on the theory.

Let’s take for example “Job satisfaction Survey.” In this case, as per your theory/hypothesis, to be called “satisfied” one must be displaying so and so traits and views; if not, the person is not satisfied in his/her job. Based on that, you will be designing a questionnaire and see how many people meet the criteria to pass your judgment. If your theory says, highly satisfied people have flexible working hours, one of your questions will be something like “Can you come to your office at whatever time you want and can leave per your own wish as long as you are doing what you are paid for? Yes/No/Depends.” Likewise, there will be other questions set in a fashion to funnel your judgment regarding what percentage of people are satisfied with their job and work.

You have a theory or hypothesis that you want to validate or crosscheck

In this case, you have an assumption but you are not sure of and you want to crosscheck or validate by testing it on people. For example let’s say you think “Most arranged marriage people are unhappy,” and you want to validate your claim or crosscheck the truth in it by surveying among arranged marriage couples. Your questions will be something like “If you have to rate your marriage in terms of joy and happiness in it, how much will you rate on a 1 to 10 scale?” followed by questions like “if you have a time machine, would you go back right before the marriage and take your time to find out someone to have a love marriage? Yes/No/Maybe”

You don’t have any theory or hypothesis and you are only to find out unseen/unknown reality

In this case, you don’t have any preconceived thoughts or assumptions and you are plainly trying to learn or find out in an open-minded fashion.  Like for example, You don’t know how many educated youth from Nepal actually do smoke, nor you know why they smoke despite its negative effect and you are set out to find out the answer by surveying. In such surveys, your questions will be like “do you smoke? Yes/No. “If you smoke, how many cigarettes do you smoke per day?” “despite its negative effect, why do you still smoke?”etc.

Sometimes, you can have a mixed approach, wherein the topic of your interest that you are surveying on, part of it is something you strongly believe being fact, part of it is something you are unsure about, and part of it is something you don’t know a thing about and you are willing to learn.  Like for example, you strongly believe happy couples display so and so traits, and you think couples from love marriages are happier but you are not sure of, and you don’t know at all if personal happiness is valued more in marriage or responsibilities and social factors in the context of Nepal. So part of your questionnaires will be driven by your theory that you consider as being fact, part of it will be intended to cross-verify your assumption, and part of it will be purely seeking truth as it is without any deliberate attempt to frame your assumption.

Bottom line, you should know your ground, the purpose of surveying, what you intend to do afterward, based on which you should be working on your questionnaires.  Your questionnaires will be designed according to your intention, so there is no hard and fast rule but make sure, in the end, you gather all the relevant information so put together to build a conclusion and for that, you need to think about what all needs to be asked to fill up the blocks and connect the dots.

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