7-Financial Markets and Rates of Return

*T=Time in years, r=interest rate, FV=future value,

PDV=Present discounted value


  1. About
    1. Investing means: Supply of financial capital say buying stocks or demand of financial capital say selling stocks, and one must distinguish clearly
    2. Financial markets are the demand side of markets, and are more inelastic, for example buying a home when interest rates are low.
    3. Households do the saving, firms save on behalf of shareholders
  2. Supply and demand
    1. Equilibrium is where qnty supplied and qnty demanded. This happens at a certain rate of return, but there are many different capital markets, just like there are many different labor markets
    2. Each rate of return is made up of: 1. compensation for inflation 2.Compensation for level of risk 3. Time value of money
      1. With inflation at work, one must make sure he is getting a rate of return that at least covers inflation. The real interest rate or nominal interest rate is the interest rate minus inflation
      2. Part of the investment package is risk and its omnipresent, however, those that are riskier tend to pay higher interest rates
      3. Part of the package rewarding the delay in consumption(Getting money now is worth more later and giving money later is better than now)
  3. The key tradeoff in financial markets is time.
    1. Present discounted value is a formula to show what a future value is worth now
    2. FV/(1+r)T=PDV
    3. Other factors include interest rates, risk and sometimes the amount
    4. Used to declare investment expenses with things such as the lottery, mortgages, etc
  4. There are four ways a firm can get capital
    1. Retained earnings: using prior success to fund future growth
    2. Borrow money from a bank or a lender: Based mostly on risk. Based on PDV it will have a certain fee attached
    3. Sell ownership(i.e. issue stocks): usually activity for smaller companies. Gives up a portion of the company to shareholders. May also attach a dividend(A portion of the profits paid out to shareholders)
    4. Bigger companies use bonds and profits

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