Lecture 11 basic tools of finance
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Transcript of Lecture 11 basic tools of finance
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Macroeconomics
Lecture 11
Basic Tools of Finance
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Questions
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1. What is an Index Fund?
2. What is the basic equation for finance?
3. What is the Future Value of $100 invested at a 13% growth rate for 7 years?
4. What is the Present Value of $800 in 12 years at 4%?
5. What is the Future Value of $700 invested at a 7% growth rate for 13 years?
6. What is the Present Value of $500 in 4 years at 12%?
7. What does insurance allow you do do?
8. What is the difference between an index fund and a mutual fund?
9. What is compounding?
10. What is discounting?
A stock that consists of stocks from a stock market group
(1 + r)N
$100 x (1 + r)N = $100 x (1 +.13)7 = $100 x 2.353 = $235.30
$800 ÷ (1 + r)N = $800 ÷ (1 +.04)12 = $800 ÷ 1.60 = $500.00
$1,686.89
$317.75
Take more risks
management, fees, diversity
multiplying to find a future value
dividing to find a present value
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Intellectual
Financial Physical
Human
Culture
Entrepreneur
trust knowledge skills personality health relationships
natural resources time buildings equipmentthings than make things
money and risksavers and borrowers time is money
(1+r)n
insurance limited liability corporations
ideas technologymethods
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Cultural Capital
EthicsInstitutions
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EthicsHow people treat each other
Beliefs, Values, & Preferences
Informed by Worldview
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Institutions
Organizations that people create to implement their
ethics.
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Common Propertyvs.
Private Property
Different IncentivesDifferent Behaviors
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Common Property
If everybody owns it, no one takes care of it.
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Private Property
If one party owns it, they will tend to care for it
because they receive the value
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Insurance Problems
Asymmetric InformationAdverse Selection
Moral Hazard
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Asymmetric Information
Parties to a trade do not have the same
information
Not Equal
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Asymmetric Information
0
25
50
75
100
Salesman Buyer
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Asymmetric Information
How to make the information equal on
both sides
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Asymmetric Information
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Asymmetric Information
0
25
50
75
100
Salesman Buyer
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Asymmetric Information
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Adverse Selection
Making a bad choice due to asymmetric
information
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Moral Hazard
Changing behavior after an agreement
Temptation to abuse the other party
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Diversification
Replace one large risk with lots of smaller
unrelated risks
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Three Risks
Firm RiskIndustry RiskMarket Risk
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Firm Risk
Risk that affects only a single company
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Industry Risk
Risk that affects all the companies in an
industry
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Market Risk
Risk that affects all the companies in the stock
market
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Valuation
What is it worth?
Analyze financial statements and future
prospects
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Speculative Bubble
Price is greater than fundamental value
Buy because everyone else is buying