Upgrade to remove ads
Only $2.99/month

Chap 14: Basic Tools of Finance

Terms in this set (18)

present value
amount of money today that would be needed, using prevailing interest rates, to produce a given future amount of money
future value
amt of money in the future that an amt of money today will yield, given prevailing interest rates
compounding
the accumulation of a sum of money in a bank acc, where the interest earned remains in the amount to earn additional interest in the future

T = (1 +r)^N * T(0)
- r = interest rate
- T(o) = principal
Present value formula
If r is the interest rate, then an amt X to be received in N years, has a present value (X/(1+r)^N)
discounting
process of finding a present value of a future sum of money
risk averse
a dislike of uncertainty
utility
each person's subjective measure of well being or satisfaction. most people are risk averse
insurance
does not eliminate risk, but instead spreads the risk around more efficiently
adverse selection
high risk person is more likely to apply for insurance than a low risk person bc a low risk person would benefit more
moral hazard
after ppl buy insurance, they have less incentive to be careful about their risky behavior bc the insurance company will cover much of the resulting losses
diversification
the reduction of risk achieved by replacing a single risk with a number of smaller unrelated risks
firm-specific risk
risk that only affects a single company
market risk
the uncertainty associated with the entire company. diversification does not help with this
fund. analysis
the study of a company's accounting statements and future prospects to determine its value
Company's profitability depends on:
- demand for its products
- competition
- capital company has in place
- unionization of workers
- loyalty of customers
- gov't regulations
- taxes
- ETC.
Efficient markets hypothesis
theory that asset prices reflect all public available information about the value of an asset

- money managers constantly analyze stocks to buy a stock when it falls below its fund. value and sell a stock when it rises above its fund. value

- equilibrium of supply and demand sets the market price. Those who believe the stock is undervalued are countered exactly by those who believe the stock is overvalued
informational efficiency
the description of asset prices that rationally reflect all available information
speculative bubble
when the price of an asset rises above what appears to be its fundamental value
THIS SET IS OFTEN IN FOLDERS WITH...