Time Value of Money and Interest Rate Risk

Topic: Finance
Words: 296 Pages: 1

The time value of money concept holds that a given amount of money received today has more value than the same amount received in the future. For instance, a dollar received today is more valuable than a dollar received in one year (Shanbhag, 2019). This is because when a person receives money in the present time, they can invest it and make more money from the initial investment. On the other hand, if the payment is deferred, they will not be able to invest or earn interest payments from the investment. In the given case, it is unwise to increase tax withholdings in exchange for a larger refund on April 15th. This goes against the time value of the money concept and will result in lesser earnings. Instead, financial advisors should recommend lower withholding taxes and higher earnings today. This money can then be invested, which will lead to income from investment interest.

Interest rate risk is the risk of loss due to fluctuations in the interest rate. It is the probability of a decrease in yield due to changes in interest rate in the market. This type of risk typically affects bonds and other fixed-income securities (Akan & Tevfik, 2020). When the interest rates rise, the prices of bonds fall and vice versa. It is also essential to note that interest rate risk varies with a fixed-income security’s duration. Long-term bonds are more sensitive to interest rate changes than short-term bonds. If an investor believes that interest rates will fall, they should hold bonds with a longer maturity. This is because it will be unprofitable to redeem such bonds presently when the bond rate is higher than the interest rate. Therefore, in the given scenario, the investor should sell short-term bonds and purchase long-term bonds.


Akan, M., & Tevfik, A. T. (2020). Fundamentals of finance. In Fundamentals of Finance. De Gruyter. Web.

Shanbhag, M. (2019). Time Value of Money and Optimal Portfolio Diversification. Available at SSRN 3433093. Web.

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International Financial Reporting Standard 9