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ECON 252 CH 9 NOTES - number of smaller risks o Eliminates...

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ECON 252 CH 9 NOTES Present value (PV): the amount of money today that would be needed, using prevailing interest rates, to produce a given future amount of money Future value (FV): the amount of money in the future that an amount today will yield, given a prevailing interest rates Compounding: the accumulation of a sum of money in an account, where the interest earned remains in the account to earn additional interest in the future o FV = (1+r)^N *PV where r = interest rate, and N = # of years Risk adverse: dislike of uncertainty Adverse selection: A high-risk person is more likely to apply for insurance because they will benefit more than a low-risk person Moral hazard: after people buy insurance, they have less incentive to be careful about their risky behavior because they are covered for any losses Diversification: he reduction of risk achieved by replacing a single risk with a large
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Unformatted text preview: number of smaller risks o Eliminates firm specific risk o But not market risk • Tradeoff between risk and return: riskier assets pay higher return, on average to compensate for the extra risk of holding them Asset valuation • Fundamental analysis: detailed analysis of a company’s accounting statements and future prospects to determine its value • Efficiency market hypothesis (EMH): the theory that each asset price reflects all publicly available information about value of an asset o Stock market is informally efficient o Stock prices follow a random walk o It’s impossible to systematically beat the market • Index vs. Manages funds o Index funds are mutual funds that buy all the stocks in a given stock index o An actively managed fun aims to buy only the best stocks (higher expenses than index) o EMH implies that actively managed funds return no more than index funds...
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