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Unformatted text preview: Lecture 20 Interest Rates, Investments, and Capital Markets Key issues 1. comparing money today to money in the future: interest rates 2. choices over time: invest in a project if return from investment > return on best alternative Capital and durable goods • durable goods : products that are usable for years • if durable good or capital is rented, rent up to the point where the marginal benefit = MC • if bought or built rather than rented, firm compares current cost of capital to future higher profits it will make from using capital Interest rates • assume no inflation: consuming $1 worth of candy today is better than consuming $1 worth in 10 years • how much more you must pay in future to repay a loan today is specified by an interest rate : percentage more that must be repaid to borrow money for a fixed period of time General compounding formula Frequency of compounding • for a given i , more frequent compounding, greater payment at end of a year • annual interest rate is i = 4% • if bank pays interest 2 times a year, • half a year's interest, i /2 = 2%, after six month: $(1 + i /2) = $1.02 • at end of year, bank owes: $(1 + i/2) × (1 + i/2) = $(1 + i/2) 2 =$(1.02) 2 = $1.0404 Interest rates connect present and future • future value ( FV ) depends on the present value ( PV ), the interest rate, and the number of years • put PV dollars in bank today and allow interest to compound for t years: FV = PV n (1 + i ) t Present value • 2 equivalent questions: • how much is $1 in the future worth today? • how much money, PV , must we put in bank today at i to get a specific FV at some future time?...
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This note was uploaded on 08/01/2008 for the course ECON 100A taught by Professor Woroch during the Spring '08 term at Berkeley.
 Spring '08
 Woroch
 Microeconomics, Interest Rates

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