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Econ 2- Chapter 27 Notes

by: Daniel Ochs

Econ 2- Chapter 27 Notes ECON 2

Daniel Ochs

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About this Document

Chapter 27
Principles of Economics
Class Notes
25 ?




Popular in Principles of Economics

Popular in Macro Economics

This 2 page Class Notes was uploaded by Daniel Ochs on Friday October 14, 2016. The Class Notes belongs to ECON 2 at University of California - Los Angeles taught by Rojas in Fall 2016. Since its upload, it has received 7 views. For similar materials see Principles of Economics in Macro Economics at University of California - Los Angeles.


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Date Created: 10/14/16
Thursday, October 13, 2016 Chapter 27 The Basic Tools of Finance - Finance: field that studies decision making occurring in the financial system - Time Value of Money • Present Value (of a future sum): amount needed today to yield that future sum at prevailing interest rates • Future Value (of a sum): amount the sum will be worth at a future date with interest - FV = PV (1+r)^N - PV = FV / (1+r)^N - Present value helps explain why investment falls when the interest rate rises - Compounding: accumulation of a sum of money where the interested earned earns more interest - The Rule of 70: if a variable grows at rate of x%/year that variable will 2x in 70/x years • Economic growth builds on itself over time • Small annual growth rate can add up to a large change in an economy over time • GDP (Year A) = GDP (Year B) x (1+ Growth rate)^(Year A-Year B) - Risk Aversion: disliking uncertainty - Utility Function: subjective measure of well-being that depends on wealth • Diminishing marginal utility: more wealth a person has, the less extra utility he gets from an extra dollar - Managing Risk With Insurance • Insurance allows risks to be pooled, and can make risk averse better off - Two Problems in Insurance Markets • Averse selection: high-risk person benefits from insurance, so more likely to have it • Moral hazard: people with insurance have less incentive to avoid risky behavior - Measuring Risk 1 Thursday, October 13, 2016 • Standard deviation: statistic that measures a variable’s likelihood to fluctuate - Higher the standard deviation of the asset’s return, the greater the risk - Diversification: reduces risk by replacing a single risk with a large number of smaller, unrelated risks • Firm-specific risk: affects only a single company • Market risk: affects all companies in the stock market • Total Risk = Diversifiable risk + Nondiversifiable risk 2


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