Chapter 27

Basic Toolsof

Finance

SurveyQuestion 1

What would you prefer?

A. Win 1,000 riyals

B. Flip a coin: 50 percent chance you win 2,000 riyals50 percent chance you win nothing.

SurveyQuestion 2

What would you prefer?

A. Lose 1,000 riyals

B. Flip a coin: 50 percent chance you lose 2,000 riyals50 percent chance you lose nothing.

Payback?

One year?

Five years?

Ten years?

Promissory Note

Trading paper for paper

I.O. U.

10 SARDr. Gale

Finance

Time and Risk

Key Formula 1

(1+r)N

r = rate N = number of periods

Future Value or FV

(1+r)N

r = 7% N = 3FV =?

1 1.0702 1.1453 1.225

N FV

(1+r)N

r = 10% N = 5FV =?

1 1.1002 1.2103 1.3314 1.4645 1.611

N FV

(1+r)N

r = 15% N = 3FV =?

1 1.1502 1.3233 1.521

N FV

(1+r)N

r = 15% N = 3FV =?

1 1.1502 1.3233 1.521

N FV

Key Formula 2

(1+r)N

r = rate N = number of periods

Present Value or PV1 Reciprocal

of the FV formula

(1+r)N

r = 7% N = 3PV =?

1 .9352 .8733 .816

N PV

1

(1+r)N

r = 10% N = 5PV =?

1 .9092 .8263 .7514 .6835 .621

N PV

1