Macroeconomics Lecture 11 Basic Tools of Finance
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Macroeconomics
Lecture 11
Basic Tools of Finance
Questions
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
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
Cultural Capital
EthicsInstitutions
EthicsHow people treat each other
Beliefs, Values, & Preferences
Informed by Worldview
Institutions
Organizations that people create to implement their
ethics.
Common Propertyvs.
Private Property
Different IncentivesDifferent Behaviors
Common Property
If everybody owns it, no one takes care of it.
Private Property
If one party owns it, they will tend to care for it
because they receive the value
Insurance Problems
Asymmetric InformationAdverse Selection
Moral Hazard
Asymmetric Information
Parties to a trade do not have the same
information
Not Equal
Asymmetric Information
0
25
50
75
100
Salesman Buyer
Asymmetric Information
How to make the information equal on
both sides
Asymmetric Information
Asymmetric Information
0
25
50
75
100
Salesman Buyer
Asymmetric Information
Adverse Selection
Making a bad choice due to asymmetric
information
Moral Hazard
Changing behavior after an agreement
Temptation to abuse the other party
Diversification
Replace one large risk with lots of smaller
unrelated risks
Three Risks
Firm RiskIndustry RiskMarket Risk
Firm Risk
Risk that affects only a single company
Industry Risk
Risk that affects all the companies in an
industry
Market Risk
Risk that affects all the companies in the stock
market
Valuation
What is it worth?
Analyze financial statements and future
prospects
Speculative Bubble
Price is greater than fundamental value
Buy because everyone else is buying
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