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Eco 202 ch 27 the basic tools of finance part 2
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Eco 202 ch 27 the basic tools of finance part 2

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Transcript

  • 1. Chapter 27The Basic Tools of Finance Part 2
  • 2. Finance Decisions aboutmoney, time, and risk
  • 3. Present ValueThe amount of money need today, using an interest rate, to produce a future amount
  • 4. Future ValueThe amount of moneyin the future, using an interest rate, that a present amount will produce
  • 5. Compounding Formula N (1+r)
  • 6. DiscountingThe process of findingthe present value of afuture sum of money
  • 7. Risk AversionA dislike of uncertainty
  • 8. Insurance Sharing riskDoes not eliminate risk Spread around risk
  • 9. Scenario Cost: 1000 Risk: 1 in 100Expected cost = cost x risk = 1000 x .01 =10
  • 10. Scenario Expected cost =10 Total Cost = 1000Get 100 people to give 10 each to fund the account 10 x 100 = 1000
  • 11. Insurance ProblemsAsymmetric Information Adverse Selection Moral Hazard
  • 12. Asymmetric Information Parties to a trade do not have the same information Not Equal
  • 13. Adverse SelectionMaking a bad choicedue to asymmetric information
  • 14. Moral HazardChanging behavior after an agreement Temptation to abuse the other party
  • 15. DiversificationReplace one large risk with lots of smaller unrelated risks
  • 16. Three Risks Firm RiskIndustry Risk Market Risk
  • 17. Firm RiskRisk that affects only a single company
  • 18. Industry RiskRisk that affects all the companies in an industry
  • 19. Market RiskRisk that affects all thecompanies in the stock market
  • 20. Valuation What is it worth? Analyze financialstatements and future prospects
  • 21. Speculative BubblePrice is greater than fundamental valueBuy because everyone else is buying