Value and returns

Money has a time value: a rupee today is worth more than a rupee next year, because today's rupee can be invested, and because inflation and risk eat future rupees. Two tools follow: compounding (future value = present value x (1 + rate)^years) and discounting (present value = future value / (1 + rate)^years). Worked example: Rs 10,000 invested at 10% for 2 years grows to 10,000 x 1.10 x 1.10 = Rs 12,100 — the second year's interest is earned on 11,000, not 10,000, which is the whole point of compounding. Valuation applies the same idea to assets: a bond or share is worth the present value of the cash it will pay, and risk means those cash flows are uncertain, so investors demand a return that compensates for time, inflation and risk.