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Unformatted text preview: Chapter 3: Asset Prices and Interest Rates 3.1: Valuing Income Streams o Future value value of a dollar today in terms of dollars at some future time. The future value of a dollar is how many dollars it can produce in some future year. $1 Today = $(1+ i) n ; if i= 6%, then $1 today in terms of 1 yr later = $(1 + .06) 1 o Present value value of a future dollar in terms of todays dollars. Shows how much a future dollar is worth today. $1 in n years= $1/(1+i) n today interest rate (i) = PV B/C the saver can trade a dollar today for more future dollars(higher int. rates mean that in future it will be so its less now) o A Series of Payments Example 1: to find the PV of 2 different payments: $3 in 2 yrs, and $5 in 4 yrs, the PV is: PV = $3/(1 + i) 2 + $5/(1 + i) 4 Example 2: to find the PV of a series of given payments continuing given years up to $X T , PV is: PV = $X 1 /(1 + i) 1 + $X 2 /(1+i) 2 + +$X T /(1 + i) T o Payments Forever Perpetuity infinite income stream To calculate the PV of a perpetuity that doesnt have a constant growth rate forever, PV: PV = $Z/i $Z is just a variable, like $X ($Z is the initial payment) To calculate the PV of a perpetuity with a constant growth rate forever, PV: PV = $Z/(i g) 3.2: The Classical Theory of Asset Prices o Classical theory of asset prices the price of an asset equals the PV of expected income from the asset Asset Price = PV of asset (income) PV of an asset tells us how much were willing to pay now No one really knows the price of an asset (For Ex: stocks), but classical theory says the asset prices depend on peoples expectations/best guesses of asset income o Safe interest rate (i safe ) interest rate that savers can receive for sure; also known as the risk free rate PV with i safe is: PV = $1/(1 + i safe ) o...
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This note was uploaded on 07/10/2011 for the course ECON 2035 taught by Professor Stahl during the Summer '08 term at LSU.
 Summer '08
 STAHL
 Interest Rates

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