time value

1. The time value of money is the simple concept that money in your hand now is worth more than money in a year's time, because you can earn a return on money by lending it out. If, for instance, you are able to earn 10% interest on money, and you are offered £100 now or £109 in a year's time, you should take the £100 now because in a year's time you can have £110 (£100 + £10 interest). If you are offered £111 in a year's time, you should take that option.

   In valuing companies, stock analysts use the concept of the time value of money to discount back the estimated future earnings of a company to their present value. This is meant to enable comparison of different companies whose future earnings may come at different times. By discounting, the value of those earnings is assessed on their present value, so like can be compared with like.

2. In options, the time value is the amount by which an option's price exceeds its intrinsic value. Suppose the shares of XYZ are trading at 60p. There is an option to buy XYZ's shares before 1st December at 55p, and the price of that option is 8p.
   • The intrinsic value of this option is the difference between the exercise price (55p) and the share price (60p) = 5p
   • The time value is the difference between the option price (8p) and the intrinsic value (5p) = 3p

   Options have a time value to reflect the fact that, in the time until expiry (1st December) the option holder has the opportunity to make profits if the underlying share price moves in his favour. As that expiry date approaches, the time value will decrease until it reaches zero.