time horizon

Examples of time horizon in the following topics:

• Measuring and Managing Risk

  • Assets can have varying maturity dates and potential for default, the attribution of time to maturity and timely payments involve an assessment of risk.
  • Time is a component of risk for varying reasons; however, the two most common are related to the increase in general uncertainty rising with the time horizon and reinvestment risk.
  • In our everyday lives, we are faced with momentary uncertainties that become increasingly harder to predict as we move from a five minute horizon to a five day, five month, or even five year period.
  • Another aspect of time horizon is reinvestment risk.
  • Given that at the time that the investment is called prevailing rates may be lower than at the purchase of the asset, the holder is taking a reinvestment risk at the time of purchase.

• Present Value and the Time Value of Money

  • The time value of money is the principle that a certain amount of money today has a different buying power (value) than in the future.
  • The value of money at a future point of time would take account of interest earned or inflation accrued over a given period of time.
  • The return of $5 represents the time value of money over the one year interval .
  • Alternatively, if an investment is valued at $125 and this value includes the 7% return generated over a one year time horizon, the original value of the investment or its present value is equal to (125)/(1.07) or 117.
  • The time value of money is the central concept in finance theory.

• Sources and Determinants of Profit

  • Whether economic profit exists or not depends how competitive the market is, and the time horizon that is being considered.
  • The amount of economic profit a firm earns is largely dependent on the degree of market competition and the time span under consideration.

• Cost-Benefit Analysis

  • Benefits and costs are expressed in monetary terms, and are adjusted for the time value of money, so that all flows of benefits and costs over time are expressed on a common basis in terms of their net present value.
  • For example, it is very difficult to place a dollar value on human life, consumers' time, or environmental impact.
  • The benefits side of the analysis might include time savings for passengers who can now avoid traffic, an increase in the number of passenger trips (as more people could now use the road), and lives saved by dint of fewer car accidents.
  • Estimate all costs and benefits to society associated with the project(s) over a relevant time horizon.
  • The benefits of a highway expansion project might include time savings for passengers, additional passenger trips, and saved lives.

• How to Compare Economies Throughout History

  • Both of these perspectives shed light as to the overall patterns of economic growth over time.
  • For the sake of this discussion, four general time frames are useful to highlight:
  • Over time, countries can change significantly, and these changes must be considered in order to make accurate comparisons.
  • Inflation, for example, changes the value of one unit of currency across time, so comparisons across time should be made using Real GDP, a GDP index, or another measure that accounts for changes in price.
  • As you can imagine, it is difficult to compare countries across large time horizons, but, after controlling for as many of these effects as you can, comparisons are possible.

• Difficulty in Getting the Timing Right

  • Discretionary fiscal policy relies on getting the timing right, but this can be difficult to determine at the time decisions must be made.
  • With regards to automatic stabilizers, timing is not an issue.
  • With discretionary fiscal policy, timing plays a very significant role.
  • This cannot be done without economic data that is complete, accurate and timely.
  • Explain the effect of timing on the use of fiscal policy tools

• Long Run Growth

  • Long run growth is the increase in the market value of the goods and services produced by an economy over time.
  • Long run growth is the increase in the market value of the goods and services produced by an economy over time.
  • Over long periods of time even small rates of growth, like a 2% annual increase, have large effects.
  • For example, at a 10%, divide 72 by 10 to get a doubling time of 7.2 years.
  • The actual doubling time is 7.27 years, so the rule of 72 is a good rough approximation.

• Defining Fiscal Policy

  • In times of recession, Keynesian economics suggests that increasing government spending and decreasing tax rates is the best way to stimulate aggregate demand.
  • Keynesians argue that this approach should be used in times of recession or low economic activity as an essential tool for building the foundation for strong economic growth and working towards full employment .
  • In times of economic boom, Keynesian theory posits that removing spending from the economy will reduce levels of aggregate demand and contract the economy, thus stabilizing prices when inflation is too high.
  • In times of recession, the government uses expansionary fiscal policy to increase the level of economic activity and increase employment.

• The budget constraint: balancing income, consumption, and saving across time

  • Most choices require decision-makers to trade-off costs and benefits at different points in time, which greatly influences how agents make decisions.
  • However, most choices require decision-makers to trade-off costs and benefits at different points in time .
  • Fisher's model is also defined in part by the agent's time preference in relation to consumption.
  • Foresight, self-control, habit, expectation of life, and or concern for the lives of others are the five personal factors that determine a person's impatience which in turn determines his time preference.
  • This model suggests that in an individuals seeks to maximize their consumption over time, subject to the factors stated above.

• The Money Multiplier in Theory

  • The above equation states that the total supply of commercial bank money is, at most, the amount of reserves times the reciprocal of the reserve ratio (the money multiplier) .
  • If banks lend out close to the maximum allowed by their reserves, then the inequality becomes an approximate equality, and commercial bank money is central bank money times the multiplier.
  • If banks instead lend less than the maximum, accumulating excess reserves, then commercial bank money will be less than central bank money times the theoretical multiplier.
  • A 10% reserve requirement creates a total money supply equal to 10 times the amount of reserves in the economy; a 20% reserve requirement creates a total money supply equal to five times the amount of reserves in the economy.