Investment

Investment
- redirecting resources that you would consume now for the future

• Financial Assets
• plans on property and income of the borrower
• Financial Intermediaries
• institution that channels funds from savers to borrowers
• Relationship between the two : savers to institution to investor

Three Purposes for Financial Intermediaries :

1. Share Risks
• diversification, spreading out your investment to reduce risk
2. Providing Information
• stock broker to help you in the market
• ex : facebook, teens attracted to it because of instagram
3. Liquidity, easily converted to cash
• Returns - money an investor receives above and beyond the sum of money that was initially invested
• the higher the risk, the higher the return

Bonds

- loans or I.O.U.s that represent a debt that the government or corporation must repay to an investor

- generally low risk investment

Three Components : 

1. Coupon Rate
• interest rate that a bond issuer will pay to a bond holder
2. Maturity
• time at which payment to a bond holder is due
3. Par Value
• amount that an investor pays to purchase a bond at that will be repaid to an investor at maturity

Yield

- annual rate of return on a bond if the bonds were held at maturity

• Bonds, YOU LOAN
• Stocks, YOU OWN

Time Value of Money

• Is the dollar today worth more than the dollar tomorrow?
• Yes
• Why?
• Opportunity cost and INFLATION

Formulas :

• v = future value of $
• p = present value of $
• r = real interest rate ( nominal - inflation rate ) [a decimal]
• n = years
• k = number of times interest is credited per year
• Simple Interest Formula
• v = ( 1 + r ) ^ n * p
• Compound Interest Formula
• v = ( 1 + r / k ) ^ nk * p

-Inflation expected at 3 %, nominal on simple interest is 1 %

Example Problems :

- Future Value of $1 After 1 Year :

• 1 - 3 = 2 % ( real interest )
• v = (1 + ( - 0.02 ) ) ^ 1 * 1 = $ 0.98

- Inflation 3 % , nominal 4 %

• 4 - 3 = 1 % → 0.01
• ( 1 + .01 ) ^ 2 * 1 = $ 1.01

- Inflation 2.5 % , nominal 5 % , years = 10 , future value = $1,000 , compound monthly

• ( 1 + .025 / 12 ) ^ 10 ( 12 ) * 1000
• ( 1 + 0.002083 ) ^120 * 1000 = $ 1,283.69

Monetary Equation of Exchange :

• MV = PQ
• M = money supply ( M1 or M2 )
• V = money's velocity ( M1 or M2 )
• P = price level ( P on AS / AD )
• Q = real GDP (Y on AS / AD )

How is Money created ?

• by banks ( fractional reserve banking )
• money is loaned into existence
• when it is paid back, there is no more money