Warren Buffet predicts a long and painful recession in the US. Gas and food prices seem to keep going up as house prices fall. Now is as good a time as any to understand money, and to understand how banks, and companies all over the world influence the value of your wallet or purse’s contents.  Important concepts and definitions laid out below:

Time Value of Money

Economics has a simple principle; resources are finite while desires are infinite. So, as our infinite desires lead us to consume these finite resources, the law of scarcity drives prices up. This phenomenon is called inflation; over time prices increase. What this means is that the cash you have hidden under your bed will not be worth as much in the future as its worth today. So, by keeping money lying around not doing anything, you are in fact losing money. This is the time value of money; a dollar today is worth more than a dollar tomorrow.

Equity

This word signifies ownership. When you buy a stock, you are becoming an owner of the company’s equity – you are not a part owner in that company. This ownership is the reason you can buy ‘shares’ in a company. You’ve become an owner, and so your share should represent the present and future value of that company. This property is why share prices move up and down. As a company makes more profit and uses its resources more effectively, its share price goes up. Imagine a pool as a profit making venture. Buying a share is like buying a pool chair. When the pool is doing well, your chair’s value increases because more people are using it. If the pool is not doing so well, the value of your pool chair plummets. Equity equal ownage. Literally. But, remember, you are lower down on the financial ladder than creditors. Why? Creditors are people who have loaned your company money. You owe them their money back before anyone else. How does a company take on this debt? Bonds.

Bonds

This is an asset (a store of value or a source of future incoming cash) where you loan a company money, and they agree to pay you back the full value some time in the future along with (usually) semi-annual interest payments. It’s through these semi-annual payments that the company compensates you for the use of your money, and it’s time value. How much are these semi-annual (‘coupon’) payments? This value depends on another popular yet misunderstood aspect of money – interest rates.

Interest rates

Simply put, interest rates are the cost of borrowing money. If I were to borrow money from a bank, but only wanted to pay back what I had borrowed, would the bank lend me money? No. Why? Because I didn’t take into account the time value of the money I had borrowed from the bank. Banks make a business out of charging for the use of money, and get this supply of money from people looking to keep their money safe. In fact, the bank pays you when you keep money with them. They’re paying you the cost of using your money when you get paid interest on your account.

So, the time value of money concept, equity, bonds and interest rates are what you need to take from this post. It’s basic. But it lays the foundation for the value of your money.

And that’s jus’ the tip.