Econ1102_Week_2 (2) - Week 2 Lectures 3 & 4 Saving and...

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W e e k 2 L e c t u r e s 3 4 Saving and Wealth Reference: Bernanke, Olekalns and Frank - Chapter 4 Key Issues Definition and Measures of Saving Saving and Wealth Motives for Saving Investment and Capital Accumulation Saving, Investment and the Real Interest Rate
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2 Saving Saving = current income – current spending Saving rate = Income Saving Saving is a flow variable If saving is positive then assets are being accumulated If saving is negative then assets are being de- cumulated or liabilities (debts) accumulated
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3 Wealth Net Wealth = Value of Assets – Value of Liabilities Balance Sheet Assets $ Liabilities $ House (m.v.) 700,000 Mortgage 450,000 Car (m.v.) 10,000 Credit Card 3,500 Bank Account 3,500 Shares (m.v.) 25,000 Furniture (m.v.) 15,000 Total 753,500 Total 453,500 Net Wealth = 300,000 m.v. = market value
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4 Capital Gains and Losses Fluctuations in the market value of assets – capital gains or capital losses have can have an important effect on net wealth Change in Wealth = Saving + Capital gains – Capital losses Change in Wealth = W = W – W(-1) W = W(-1) + S + Net Capital Gains Assets, liabilities and wealth are stock variables
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5 Asset Pricing How can we determine the price of a financial asset? Characteristics of Financial Assets have monetary payoffs ($ X) payoffs arrive in the future (need to discount) payoffs can be uncertain (risky) Simple Example: What is the value today of a (certain) $100 in the next period?
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6 Present-Value Formula Suppose the interest rate (r) is 5 percent 24 . 95 $ ) 5 . 0 1 ( 100 = + = PV Some Notation PV = Price of asset (today) 100 = payoff of asset ) 5 . 0 1 ( 1 + = discount factor
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7 Asset Pricing Formula X r r X P × + = + = 1 1 ) 1 ( Price of Asset (today) = Discount Factor × Payoff (tomorrow) With Uncertainty Price of Asset (today) = Expected Value of [Discount Factor × Payoff (tomorrow)] Very general formula, but can be specialized to particular assets.
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8 Example: Share Price Assume (for simplicity) complete certainty Payoff for a share Pays a dividend 1 D in the next period Resale price in the next period is 1 P Payoff = 1 1 1 D P X + =
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Discount Factor Let r be the certain return on an alternative asset (e.g. a bank deposit) r D P P + + = 1 1 1 0 Simple model for share price Complications Payoff on share is uncertain
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This note was uploaded on 09/16/2011 for the course ACCT 1501 taught by Professor Helen during the Three '09 term at University of New South Wales.

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Econ1102_Week_2 (2) - Week 2 Lectures 3 & 4 Saving and...

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