Chapter 14 Basic Tools of Finance

Chapter 14 Basic Tools of Finance - Chapter 14 The Basic...

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Chapter 14 The Basic Tools of Finance Present Value: Measuring the Time Value of Money Future Value: The amount of money in the future that an amount of money today will yield, giv- en prevailing interest rates P(1+r)ˆn Present Value: The amount of money today that would be needed,using prevailing interest rates, to produce a given future amount of money. P/(1+r)ˆn Discounting: the process of finding a present value of a future sum of money Compounding: the accumulation of a sum of money in, say, a bank account, where the interest earned remains in the account to earn additional interest in the future Investment and the quantity of loanable funds demanded declines when the interest rate rises. The Magic of Compounding and the Rule of 70 If some variable grows at a rate of x percent per year, then that variable doubles in approximately 70/x years. Managing Task Risk Aversion - a dislike of uncertainty The Utility Function- shows how utility, a subjective measure of satisfaction, depends on wealth. As wealth rises, the utility function becomes flatter, reflecting the property of diminishing mar - ginal utility . Because of the diminishing marginal utility, a $1000 loss decreases the utility by more than a $1000 gain increases it. The richer people are the less utility they get from an addi- tional dollar. The Markets for Insurance
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This note was uploaded on 07/03/2010 for the course ECON 201 taught by Professor Salehie during the Spring '08 term at University of Washington.

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Chapter 14 Basic Tools of Finance - Chapter 14 The Basic...

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