Some Conventions and Terminology

Welcome, we talk about time value of money basics in this module. [COUGH] Module will last as long as it needs to, but what I'll do is I'll break it up into bite sized pieces. The other thing I want to emphasize in every module is I do a lot of problems, that's anything I do in finance is very applied. So, I do start out with problems. Having said that, I would encourage you to take advantage of technology and pause. And if I show you a problem, try to do it quickly and then we'll do it together.

But what I don't want to happen is take so many pauses that every two minutes, we are kind of taking a pause just so that. We can get synced or something like that. Remember, I'll play it along. I'll flow naturally. And hopefully, that's helpful to you. But practice, practice, practice. Second thing, do assessments and assignments. But remember, you don't have to do them right away. Do them when you are comfortable. They'll challenge you a bit and they are sink to what I do in class. In other words, as I'm doing a module, the problem sets are related, assessments are related.

On the other hand, what you could do is you could do the whole course and then do the segment still. It's entirely up to you. Sometimes I encourage you to do them as we are going along, because it's useful. But it's up to you, as I said. If you feel like you need to go to the next chapter or module to help you, do so. So, let's get started. The essence of decision-making is what this course is all about. Pitch to anyone who wants to learn from us the first time. So as I said in the introductory videos to this class, that every decision we make effects us in the future.

It's almost always the case that you'd make a decision today, it has consequences for you in the future. Please keep that in mind, because it's intimately related to decision-making, time value of money and so on. Second, I also believe that important decisions tend to effect us more significantly and potentially for longer. So, one example to think about it is I think it was a great innovation that we had the internet. It took a lot of resources to create, a lot of ingenuity, but it'll stay with us for a long time. So, important decisions. Investment is costly, but they also stay with you longer.

So understanding time value of money is actually a very, very important thing to any decision, small or big.

Therefore, just be patient and what I'll do is I'll go slowly and build the Legos you need to understand what happens with just the passage of time. I do want to emphasize one thing. In this course, I will not explicitly do risk, but risk will be everywhere as we talk about it. Why don't I do explicitly risk? Because risk is a whole topic on its own and I think it requires a lot of knowledge of statistics and so on, and so forth. Remember, I told you I've done a MOOC, which is pretty advanced for most people and part of the reason it was advanced was because risk takes a whole new set of tools to understand.

So in this course, our main thing is to focus on time value of money and you'll be surprise how far we go. We'll internalize it with the explicit goal of making good decisions. And what I'll do all the time is examples, examples, examples and the way I'll pull you in is through the examples. So, why is it for everyone? Because I guarantee you, there'll be some problem that you'll relate to very well if not most and that'll bring you in. Remember, learning happens when you want to learn not when I want to teach. So, that's another thing that's very cool about technology is you don't have to listen to me. You can fast forward and so on.

If you're sitting in my class, you're kind of suffering for two hours or so and it's kind of rude to walk out of class suddenly. But here, you are on your own. Sipping a cup of coffee, learning at the same time. I think that's wonderful. So, the first thing I would like to do before we get started on the tools is the importance of timelines and you know what? I must admit to you that I don't think my handwriting is very good, but I will write a lot and that's my way of expressing my enthusiasm and also showing what I am doing.

But remember, you always can listen to me and you can always redo stuff, but the first thing I want to do is to make sure you understand timelines and a very important convention. So, the timeline issue is the following. You make a decision.

At time 0 and for simplicity in the beginning, we'll assume the decision effects you, it will be a time 1. Of course, that's not true. So what we'll do is we'll break this timeline up into pieces that are one, two, three, four, five, six. But in the beginning, we'll start off with one and then we'll make them more. Some conventions to remember that whenever we say, be that one. It usually in finance, means end of the period. So if something is happening at the end of the period, it'll show up here. What is the point in time? 1 and 0, but the period of time is going to 0 to 1.

These simple things are very important and the reason, again is decision-making. You make a decision today and it affects you in the future. For now, I'll keep it just one period. But as we go along, you'll see, there will be multiple periods. In fact, the richness of decision-making is as I said, you want to have impact forever. That's a very human feeling that you want to change the world, but you want to change it, so that it matters forever. What I want to now talk briefly about is some terminology, which is very, very important and the terminology is some lingo of finance. The nice thing is the same terminology will be used often across different media.

So I'll talk about it now, but it'll also be prevalent in Excel and so on. The first thing, remember, timeline was today. And at point zero, which is today, we use a term called PV, Present Value. So, PV stands for? Present Value and because it's appoint in time, it's measures in some currency. It's a language of business, a language of life. So I will use dollars and I apologize for that, because I'm used to that, but you can use any currency you're used to. You can use cows, if you want. But I'm just teasing, but Present Value is a at time zero. The next term we want to use, remember, we started from timeline zero and one.

So, let's just stick with one period for the time being. So at time zero, we call it PV. At time one, we'll call it FV, future value. Remember, at both points in time, we'll measure it in dollars. So one is PV, one is FV. The third term we'll use often is n. Many times people use t, as well. What does n mean? It means the number of periods and it does measure in numbers. So, you define the period. So typically we'll say, one period. But you define whether it's a year, a month, according to the nature of the problem. And when we do problems, you'll understand what I mean. So for the time being, we're taking a very simple approach.

There is zero, there is one. PV is a time zero, FV is a time one and what is n? One. N is the number of periods. This will, of course, change very soon. Finally, there's a concept that I could teach a whole class on called Interest Rate. This also captures the value of time. So, what is Interest Rate? Interest Rate, I'll spend a little more time on it is a rate of return. It's a percentage. It's neither in dollars, nor in number of periods. It's a percentage and we will assume that there is a strong assumption, but not as strong as others assumptions is we will assume that it is positive typically.

So the Interest Rate will be positive, it's an assumption we will use throughout. There are times when interest rates have been negative. And as I said, this could be a whole topic of discussion and we can go on forever, but let's assume that Interest Rates are positive. Remember, there is no uncertainty. So we will not talk about statistics, risk and so on, but we'll talk about risk implicitly. Let me ask you this. Suppose you invest in something very risky versus something that's not so risky. So, take a bank account.

You put your money in the bank account as a deposit versus you put your money in a brand new initiative, it's also called the new venture and so on and so forth. Where is there more risk typically? Obviously, in something that's more uncertain and so on. So, how do you get attracted to it by being expecting a higher return? So high-risk, high-return tend to go together. So implicitly we'll be talking about risk, but not explicitly, because it requires a whole bunch of ammunition, statistics and so on.