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

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

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