Lecture 11 basic tools of finance

1. Macroeconomics
Lecture 11
Basic Tools of Finance

2. Questions

3. 1.What is an Index Fund?
2.What is the basic equation for finance?
3.What is the FutureValue of $100 invested at a 13% growth rate for 7 years?
4.What is the PresentValue of $800 in 12 years at 4%?
5.What is the FutureValue of $700 invested at a 7% growth rate for 13 years?
6.What is the PresentValue 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

6. Intellectual
Financial Physical
Human
Culture
Entrepreneur
trust
knowledge
skills
personality
health
relationships
natural resources
time
buildings
equipment
things than make things
money and risk
savers and borrowers
time is money
(1+r)n
insurance
limited liability corporations
ideas
technology
methods

7. Cultural Capital
Ethics
Institutions

8. Ethics
How people treat each other
Beliefs,Values, & Preferences
Informed by Worldview

9. Institutions
Organizations that people
create to implement their
ethics.

10. Common Property
vs.
Private Property
Different Incentives
Different Behaviors

11. Common Property
If everybody owns it, no
one takes care of it.

15. Private Property
If one party owns it, they
will tend to care for it
because they receive the
value

16. Insurance Problems
Asymmetric Information
Adverse Selection
Moral Hazard

17. Asymmetric Information
Parties to a trade do
not have the same
information
Not Equal

18. Asymmetric Information
0
25
50
75
100
Salesman Buyer

20. Asymmetric Information
How to make the
information equal on
both sides

21. Asymmetric Information

22. Asymmetric Information
0
25
50
75
100
Salesman Buyer

23. Asymmetric Information

24. Adverse Selection
Making a bad choice
due to asymmetric
information

25. Moral Hazard
Changing behavior after
an agreement
Temptation to abuse
the other party

26. Diversification
Replace one large risk
with lots of smaller
unrelated risks

27. Three Risks
Firm Risk
Industry Risk
Market Risk

28. Firm Risk
Risk that affects only a
single company

29. Industry Risk
Risk that affects all the
companies in an
industry

30. Market Risk
Risk that affects all the
companies in the stock
market

31. Valuation
What is it worth?
Analyze financial
statements and future
prospects

32. Speculative Bubble
Price is greater than
fundamental value
Buy because everyone
else is buying