Chapter 14 Powerpoint

# Chapter 14 Powerpoint - Chapter 14 Basic Tools of Finance...

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Chapter 14: Basic Tools of Finance

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Basic Tools of Finance Economics Macroeconomics Monetary Economics Finance You will have to deal with economy’s financial system. (mortgage, savings account, retirement investment, stock, and bond etc)
Basic Tools of Finance 3 Topics of this Chapter 1. Present Value: Measuring the Time Value of Money 2. Managing Risk 3. Asset Valuation

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Present Value (PV) Example 1: Someone offers to give you \$100 today or \$100 in 10 yrs. Money today is more valuable the same amt of money in the future Example 2: Someone offers to give you \$100 today or \$200 in 10 yrs
Present Value (PV) Example 2 continues: You need some way to compare sums of money from different times. PV PV of any future sum of money is the amount today that would be needed, at current interest ( r) , to produce that future sum. With 5% of r and \$100, 1yr: (1+r)*\$100 = \$105 2yr: (1+r)*[(1+r)*\$100] = (1+r) 2 *\$100 = \$110 3yr: (1+r)*[(1+r) 2 *\$100] = (1+r) 3 *\$100 = \$115 N yr: (1+r) N *\$100

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Present Value (PV) Example 2 continues: Value of \$100 today 10yr later with r = 5% = (1+0.05) 10 * \$100 = \$163 Using the above calculation in the opposite way, what is the today’s value of \$200 10yr later? \$200/(1.05) 10 = \$123 General formula of PV If r is the interest rate then an amt x to be received in N yr has PV of x/(1+r) N .
Present Value (PV) Example 3: In example 2, if r increases to 8%, PV of \$200 in 10 yr becomes \$200/(1+0.08) 10 = \$93. (-) relationship between r and PV The concept of PV is useful in many applications. Evaluating Investment Projects GM is thinking about building a new factory. \$100 M cost today, \$200 M revenue in 10 yr, 1) r = 5% PV = \$123 M 2) r = 8% PV = \$93 M PV explains why I = I(r)

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Managing Risk Risk = Uncertainty 1. ski, 2. drive, 3. stock Do you avoid risk at any cost? We need to take it account in our decisions. Attitude on Risk 1. Risk Averse (Most people) 2. Risk Neutral 3. Risk Love
Risk Averse : People dislike bad thing more than they like comparable good things. Example

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## This note was uploaded on 11/16/2011 for the course ECON 202 taught by Professor Kim during the Fall '11 term at CSU Fullerton.

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

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