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Semelhante a Eco 202 ch 27 basic tools of finance
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Eco 202 ch 27 basic tools of finance
- 2. Survey Question 1 What would you prefer? ! A. Win 1,000 riyals ! B. Flip a coin: 50 percent chance you win 2,000 riyals 50 percent chance you win nothing.
- 3. Survey Question 2 What would you prefer? ! A. Lose 1,000 riyals ! B. Flip a coin: 50 percent chance you lose 2,000 riyals 50 percent chance you lose nothing.
- 4. Survey Most people avoid risk on gains ! but prefer to take risks to avoid loss
- 5. Key Terms finance present value future value compounding discounting risk aversion diversification firm-specific risk market risk fundamental analysis efficient market hypothesis information efficiency random walk
- 6. Key Formulas r = rate N = number of periods Compounding Discounting Future Value or FV multiplying Present Value or PV dividing N (1+r) 1 N (1+r)
- 9. Discount the future ! Today is worth more than tomorrow
- 10. Today One year Ten Years Grow in the Future
- 11. Promissory Note I.O. U. 10 SAR Dr. Gale Trading paper for paper
- 13. Linear versus Exponential Adding versus Compounding 64 64 ^ 56 48 40 32 32 24 16 16 8 0 2 1 + 4 2 8 6 8 3 4 10 5 12 6
- 15. Compounding Grow by a percentage each year, not a fixed amount
- 16. Compounding The process of finding the future value of a present sum of money ! multiplying
- 17. Discounting The process of finding the present value of a future sum of money ! dividing
- 18. compounding is the inverse of discounting discounting is the inverse of compounding
- 23. Future Value The amount of money in the future, using an interest rate, that a present amount will produce
- 24. Key Formula 1 Future Value or FV N (1+r) r = rate N = number of periods
- 25. r = 10% FV =? N (1+r) N 1 2 3 4 5 FV 1.100 1.210 1.331 1.464 1.611
- 26. Present Value The amount of money need today, using an interest rate, to produce a future amount
- 27. Key Formula 2 Present Value or PV Reciprocal 1 of the N FV formula (1+r) r = rate N = number of periods
- 28. r = 10% N = 5 PV =? 1 N (1+r) N 1 2 3 4 5 PV .909 .826 .751 .683 .621 3.791
- 29. 7% discount 1 0.935 2 0.873 3 0.816 4 0.763 5 0.713 6 0.666 7 0.623 8 0.582 9 10 0.544 0.508 Worth less and less due to time and risk
- 30. Insurance Sharing risk ! Does not eliminate risk Spread around risk
- 32. Risk Aversion A dislike of uncertainty
- 33. Scenario Cost: 1000 Risk: 1 in 100 Expected cost = cost x risk = 1000 x .01 =10
- 34. Scenario Expected cost =10 Total Cost = 1000 Get 100 people to give 10 each to fund the account 10 x 100 = 1000
- 35. Insurance Problems Asymmetric Information Adverse Selection Moral Hazard
- 36. Asymmetric Information Parties to a trade do not have the same information ! Not Equal
- 37. Adverse Selection Making a bad choice due to asymmetric information
- 38. Moral Hazard Changing behavior after an agreement ! Temptation to abuse the other party
- 39. Diversification Replace one large risk with lots of smaller unrelated risks
- 40. Three Risks Firm Risk Industry Risk Market Risk
- 41. Firm Risk Risk that affects only a single company
- 42. Industry Risk Risk that affects all the companies in an industry
- 43. Market Risk Risk that affects all the companies in the stock market
- 44. Valuation What is it worth? ! Analyze financial statements and future prospects
- 45. Speculative Bubble Price is greater than fundamental value ! Buy because everyone else is buying