TIME VALUE OF MONEY:
AN INTRODUCTION TO
PRESENT VALUE
Cezary Podkul |@Cezary
3/11/2016 1NICAR 2016 | Denver
Link to Class Materials
• Everything you need is in Dropbox:
2
bit.ly/1XiGytY
3/11/2016 NICAR 2016 | Denver
Roadmap
• What we hope to cover today:
1. Sales Pitch: Why is it useful for you to
know present value?
2. Example: We’ll m...
Why Learn PV?
Part 1
43/11/2016 NICAR 2016 | Denver
Why Learn PV?
• What is it?
– A way to put a value today on a stream of
payments owed in the future, such as:
• Pension pa...
Why Learn PV?
• Can lead to some great reporting
63/11/2016 NICAR 2016 | Denver
- The Washington Post, August 25, 2015
- T...
Why Learn PV?
• If you understand PV,
you can make sense of
documents like this
– Sample structured
settlement sale from T...
Why Learn PV?
• And documents like this
– Bond disclosure from NJ
saying that their pension
liability increased to $82.8
b...
Why Learn PV?
• Better understand
headlines like these
– Why is Michael Dell willing
to pay $67 billion for EMC?
– Depends...
Why Learn PV?
• Plus, the math makes for great visuals
103/11/2016 NICAR 2016 | Denver
Why Learn PV?
• And these concepts are coming to a
state legislature near you!
– Anyone here from Alaska? This one’s yours...
Why Learn PV?
• So it’s worth knowing the mechanics of
these calculations
123/11/2016 NICAR 2016 | Denver
Simple Example
Part 2
133/11/2016 NICAR 2016 | Denver
Simple Example
• Formula for calculating present value
143/11/2016 NICAR 2016 | Denver
Present Value
Future Value
Discount...
Simple Example
153/11/2016 NICAR 2016 | Denver
Let’s test drive it!
Open a blank Excel worksheet and
let’s pencil out an e...
$-
$10
$20
$30
$40
$50
$60
$70
$80
$90
$100
0 1 2 3 4 5 6 7 8 9 10
Present value Cumulative annual payments
Simple Example...
$-
$20
$40
$60
$80
$100
$120
0 1 2 3 4 5 6 7 8 9 10
Present value Cumulative annual payments Reinvested value
Simple Examp...
Simple Example
• A related formula that is worth knowing
183/11/2016 NICAR 2016 | Denver
Net Present
Value
Future Value
Di...
Application: CalSTRS
Part 3
193/11/2016 NICAR 2016 | Denver
Application: CalSTRS
• Let’s apply what we just learned to a
public pension plan
– CalSTRS: The 2nd largest U.S. public pe...
Application: CalSTRS
• Projected cumulative pension payments of
$1.7 trillion due over the next 100 years
Present value of...
Application: CalSTRS
• First a bit of pension accounting
– The accrued liability (AAL) is the present
value of future paym...
Simple Example
233/11/2016 NICAR 2016 | Denver
Goal: Calculate the AAL and
use it to estimate the UAAL
Let’s walk through ...
Application: CalSTRS
• So how do we know if we’re right?
– Check the Comprehensive Annual Financial Report
– ‘Schedule of ...
Application: CalSTRS
253/11/2016 NICAR 2016 | Denver
- The Los Angeles Times, November 18, 2015
• The assumed rate of retu...
Application: CalSTRS
3/11/2016 NICAR 2016 | Denver 26
(See CalPERS’
response to Crane)
• Once you fall behind, catching up...
Application: CalSTRS
• Homework: CalPERS
- CalPERS also provided us data for this exercise BUT:
- Projections only for 30 ...
Questions?
28
cezary.podkul@propublica.org
@Cezary
3/11/2016 NICAR 2016 | Denver
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Time Value of Money And How It Applies To Pensions

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This is my presentation at Nicar 2016 in Denver about the time value of money and how it applies to CalSTRS.

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Time Value of Money And How It Applies To Pensions

  1. 1. TIME VALUE OF MONEY: AN INTRODUCTION TO PRESENT VALUE Cezary Podkul |@Cezary 3/11/2016 1NICAR 2016 | Denver
  2. 2. Link to Class Materials • Everything you need is in Dropbox: 2 bit.ly/1XiGytY 3/11/2016 NICAR 2016 | Denver
  3. 3. Roadmap • What we hope to cover today: 1. Sales Pitch: Why is it useful for you to know present value? 2. Example: We’ll model out a simple example together 3. Application:We’ll apply what we learned to a real-life example – CalSTRS 33/11/2016 NICAR 2016 | Denver
  4. 4. Why Learn PV? Part 1 43/11/2016 NICAR 2016 | Denver
  5. 5. Why Learn PV? • What is it? – A way to put a value today on a stream of payments owed in the future, such as: • Pension payments • Lottery winnings • That Social Security check you’ll be getting in 40 years • Any flow of money – All you need to know is the amounts, the time when they’ll be paid, and the interest rate – Answers the question, “What is that flow of money worth to me today?” 53/11/2016 NICAR 2016 | Denver
  6. 6. Why Learn PV? • Can lead to some great reporting 63/11/2016 NICAR 2016 | Denver - The Washington Post, August 25, 2015 - The Wall Street Journal, October 19, 2012 - Bloomberg News, August 13, 2015 - ProPublica and The Washington Post, July 10, 2015
  7. 7. Why Learn PV? • If you understand PV, you can make sense of documents like this – Sample structured settlement sale from Terry McCoy’s reporting – Sells $1.6 million in nominal payments worth $844,00 for $40,000, or 5 cents on the present dollar – Clearly a ripoff 73/11/2016 NICAR 2016 | Denver
  8. 8. Why Learn PV? • And documents like this – Bond disclosure from NJ saying that their pension liability increased to $82.8 billion from $37.3 billion – Fine print that made local and national headlines – The culprit? Discount rate used in PV analysis: 4.29% vs. 7.9% makes a big impact; see our explainer here. 83/11/2016 NICAR 2016 | Denver
  9. 9. Why Learn PV? • Better understand headlines like these – Why is Michael Dell willing to pay $67 billion for EMC? – Depends on how much EMC’s business is worth to him today – How do you find out? Present value of future earnings – plus takeover premium 93/11/2016 NICAR 2016 | Denver - Forbes, October 12, 2015
  10. 10. Why Learn PV? • Plus, the math makes for great visuals 103/11/2016 NICAR 2016 | Denver
  11. 11. Why Learn PV? • And these concepts are coming to a state legislature near you! – Anyone here from Alaska? This one’s yours: 113/11/2016 NICAR 2016 | Denver
  12. 12. Why Learn PV? • So it’s worth knowing the mechanics of these calculations 123/11/2016 NICAR 2016 | Denver
  13. 13. Simple Example Part 2 133/11/2016 NICAR 2016 | Denver
  14. 14. Simple Example • Formula for calculating present value 143/11/2016 NICAR 2016 | Denver Present Value Future Value Discount Factor = Where: Discount Factor = (1+ i)n i = expected rate of return n = number of time periods
  15. 15. Simple Example 153/11/2016 NICAR 2016 | Denver Let’s test drive it! Open a blank Excel worksheet and let’s pencil out an example together
  16. 16. $- $10 $20 $30 $40 $50 $60 $70 $80 $90 $100 0 1 2 3 4 5 6 7 8 9 10 Present value Cumulative annual payments Simple Example • Mathematically, this is always true – why? 163/11/2016 NICAR 2016 | Denver Year Amount
  17. 17. $- $20 $40 $60 $80 $100 $120 0 1 2 3 4 5 6 7 8 9 10 Present value Cumulative annual payments Reinvested value Simple Example • Mathematically, this is always true – why? 173/11/2016 NICAR 2016 | Denver Year Amount Because of this
  18. 18. Simple Example • A related formula that is worth knowing 183/11/2016 NICAR 2016 | Denver Net Present Value Future Value Discount Factor = Where: Discount Factor = (1+ i)n i = expected rate of return n = number of time periods – C + – C = Initial investment (negative because spending money)
  19. 19. Application: CalSTRS Part 3 193/11/2016 NICAR 2016 | Denver
  20. 20. Application: CalSTRS • Let’s apply what we just learned to a public pension plan – CalSTRS: The 2nd largest U.S. public pension • Has $179.4bn in assets • Pays $1bn+ in monthly benefits • Covers 896,000 members and beneficiaries – What’s the liability today? • Depends on future payments due to retirees 203/11/2016 NICAR 2016 | Denver
  21. 21. Application: CalSTRS • Projected cumulative pension payments of $1.7 trillion due over the next 100 years Present value of those payments = liability today 213/11/2016 NICAR 2016 | Denver $0 $200 $400 $600 $800 $1,000 $1,200 $1,400 $1,600 $1,800 2015 2019 2023 2027 2031 2035 2039 2043 2047 2051 2055 2059 2063 2067 2071 2075 2079 2083 2087 2091 2095 2099 2103 2107 2111 Billions Cumulative Benefits Due $1.7 trillion of pension benefit payments
  22. 22. Application: CalSTRS • First a bit of pension accounting – The accrued liability (AAL) is the present value of future payments to retirees – The pension asset value (AVA) is what’s available today to pay future liabilities – If pension liabilities exceed assets, then there is an unfunded liability (UAAL) – The size of the funding gap is measured using the funded ratio (AVA/AAL) . . . More key terms available here 223/11/2016 NICAR 2016 | Denver
  23. 23. Simple Example 233/11/2016 NICAR 2016 | Denver Goal: Calculate the AAL and use it to estimate the UAAL Let’s walk through it together
  24. 24. Application: CalSTRS • So how do we know if we’re right? – Check the Comprehensive Annual Financial Report – ‘Schedule of Funding Progress’ is your best friend 243/11/2016 NICAR 2016 | Denver
  25. 25. Application: CalSTRS 253/11/2016 NICAR 2016 | Denver - The Los Angeles Times, November 18, 2015 • The assumed rate of return matters – a lot! – CalPERS, the other big California pension, shows why:
  26. 26. Application: CalSTRS 3/11/2016 NICAR 2016 | Denver 26 (See CalPERS’ response to Crane) • Once you fall behind, catching up is hard – Taxpayers or markets have to pick up the tab – Even if markets do their part, it may not be enough
  27. 27. Application: CalSTRS • Homework: CalPERS - CalPERS also provided us data for this exercise BUT: - Projections only for 30 years - ‘True-up’ based on partial data . . . So take it with a grain of salt - Benefit projections include future normal cost - Discount rate is same as CalSTRS, 7.5% - PV the benefits and see how sensitive they are to the discount rate assumption 3/11/2016 NICAR 2016 | Denver 27
  28. 28. Questions? 28 cezary.podkul@propublica.org @Cezary 3/11/2016 NICAR 2016 | Denver

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