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This Material Is Covered in Much More Detail in Your Finance Class (MGT 726) and Will Not Be Covered in MGT 704

The document discusses key concepts in finance including present value, compounding, risk management through diversification and insurance, asset valuation methods like fundamental analysis and the efficient markets hypothesis, and the tradeoff between risk and return. It defines important terms and concepts in finance and economics.

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15 views2 pages

This Material Is Covered in Much More Detail in Your Finance Class (MGT 726) and Will Not Be Covered in MGT 704

The document discusses key concepts in finance including present value, compounding, risk management through diversification and insurance, asset valuation methods like fundamental analysis and the efficient markets hypothesis, and the tradeoff between risk and return. It defines important terms and concepts in finance and economics.

Uploaded by

moonnlightt290805
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Chapter 27: The Basic Tools of Finance

Principles of Economics, 6th Edition


N. Gregory Mankiw
Page 1

1. Introduction
a. This material is covered in much more detail in your finance class (Mgt 726) and
will not be covered in Mgt 704.
b. Def: Finance is the field that studies how people make decisions regarding the
allocation of resources over time and the handling of risk. P. 578

2. Present Value: Measuring the Time Value of Money


a. Def: The present value is the amount of money today that would be needed to
produce, using prevailing interest rates, a given future amount of money. P. 578
b. Def: The future value is the amount of money in the future that an amount of money
today will yield, given prevailing interest rates. P. 578
c. Def: Compounding is the accumulation of a sum of money in, say, a bank account,
where the interest earned remains in the account to earn additional interest in the
future. P. 578
d. FYI: The Magic of Compounding and the Rule of 70, P. 580

3. Managing Risk
a. Risk Averse
i. Def: Risk averse is exhibiting a dislike of uncertainty. P. 581
ii. Figure 1: The Utility Function, P. 581
b. The Markets for Insurance
a. Diversification of Firm Specific Risk
i. Def: Diversification is the reduction of risk achieved by replacing a single
risk with a larger number of smaller unrelated risks. P. 582
ii. Figure 2: Diversification Reduces Risk, P. 583
iii. Def: Firm specific risk is risk that affects only a single company. P. 583
iv. Def: Market risk is the risk that affects all companies in the stock market.
P. 583
b. The Tradeoff Between Risk and Return
i. Figure 3: The Tradeoff Between Risk and Return, P. 584

4. Asset Valuation
a. Fundamental Analysis
i. Def: Fundamental analysis is the study of a company’s accounting
statements and fute prospects to determine its value. P. 585
b. The Efficient Markets Hypothesis
i. Def: The efficient markets hypothesis is the theory that asset prices reflect
all publicly available information about the value of an asset. P. 585
ii. In the News: A Cartoonist’s Guide to Stock Picking, P. 586
iii. Def: Informational efficient is reflecting all available information in a
rational way. P. 586
iv. Def: A random walk is the path of a variable whose changes are impossible
Chapter 27: The Basic Tools of Finance
Principles of Economics, 6th Edition
N. Gregory Mankiw
Page 2

to predict. P. 586
v. Case Study: Random Walks and Index Funds, P. 587
vi. In the News: Is the Efficient Markets Hypothesis Kaput? P. 588
c. Market Irrationality

5. Conclusion

6. Summary

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