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Lecture Economics (18th edition): Chapter 34 - McConnell, Brue, Flynn's

Chapter 34 - Financial economics. After studying this chapter you will be able to understand: Describe the idea of present value and explain why it is critical in making financial decisions; identify and distinguish between the most common financial investments: stocks, bonds, and mutual funds; discuss how investment returns compensate for being patient and for bearing risk;. | Financial Economics Chapter 34 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Objectives Present value and making financial decisions Stocks, bonds, and mutual funds Investment returns, patience, and risk Portfolio diversification: nondiversifiable risk and rates of return Beating the market 34- Financial Investment Economic investment New additions or replacements to the capital stock Financial investment Broader than economic investment Buying or building an asset for financial gain New or old asset Financial or real asset 34- Present Value Present day value of future returns or costs Compound interest Earn interest on the interest X dollars today=(1+i)tX dollars in t years $100 today at 8% is worth: $108 in one year $116.64 in two years $125.97 in three years 34- Present Value Model Calculate what you should pay for an asset today Asset yields future payments Asset’s price should equal total present value of future payments The formula: dollars today = X dollars in t years X ( 1 + i)t 34- Applications Take the money and run Lottery jackpot paid over a number of years Calculating the lump sum value Salary caps and deferred compensation Calculating the value of deferred salary payments 34- Popular Investments Three features Pay to acquire Chance to receive future payment Some risk Stocks Bankruptcy Limited liability rule Capital gains Dividends 34- Applications Bonds More predictable than stocks Mutual funds Portfolio Index funds Actively or passively managed Calculating investment returns Asset prices and rates of return Arbitrage 34- Risk Future payments are uncertain Diversification Diversifiable risk Specific to a given investment Nondiversifiable risk Business cycle effects Comparing risky investments Average expected rate of return Beta 34- Risk Risk and average expected rates of return Positively related The risk-free rate of return Short-term U.S. government bonds Greater . | Financial Economics Chapter 34 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Objectives Present value and making financial decisions Stocks, bonds, and mutual funds Investment returns, patience, and risk Portfolio diversification: nondiversifiable risk and rates of return Beating the market 34- Financial Investment Economic investment New additions or replacements to the capital stock Financial investment Broader than economic investment Buying or building an asset for financial gain New or old asset Financial or real asset 34- Present Value Present day value of future returns or costs Compound interest Earn interest on the interest X dollars today=(1+i)tX dollars in t years $100 today at 8% is worth: $108 in one year $116.64 in two years $125.97 in three years 34- Present Value Model Calculate what you should pay for an asset today Asset yields future payments Asset’s price should equal total present value of future .