Lecture 17

Introduction to Microeconomics

Professor Norman Aitken

Second Hour Exam: Total Points• The following are total points from the

exam (maximum = 240)

• High score = 228; Low score = 76.

• Mean Score = 144

• Number of students that scored:> 200 12

160-200 87

120-159 129

< 120 70

Points Still Available

Review Sessions

Wednesdays: May 5th and May 12th

Room: Hasbrouck 228

Time: 3:30 – 5:00 pm

Mutual Fund Fraud

• “Stale Prices”

• “Late Trading”

• Bogus Loans & Payoffs for Fund Managers

New details of widespread trading abuses:

Eliot Spitzer and regulators

Mutual Funds Control $7 Trillion in Investments for 95 Million Investors

Stephen Cutler, the head of S.E.C.’s enforcement division:

“ The ‘unholy trinity’ of illegal late trading, abusive market timing and related self-dealing practices that have recently come to light are matters that affect us all…I have gathered evidence of one betrayal after another, the feeling I’m left with is one of outrage.”

Your Stock Report

• Due :Tuesday, April 20th

• Turn in printed paper copy in class.• Report should explain how and why stock

price has changed from Jan. 16 – Apr. 2• Include in report:

– Brief description of Co., comparison of price change to changes in stock market as a whole

– http://www.excite.com (GM, FBF)

Your Stock Report• You must cite references or your grade will

be zero:– If you are taking words directly from another

source, use beginning and end quotes and cite the source.

– If you paraphrase, i.e. put in your own words, information from a published source, you need to cite the source but quotation marks are not required.

Savings: $ Not Spent by Recipient of Money in a Given Time Period

• Income earned by individuals

• Profits earned by business

• Taxes collected by governments– If money is not spent then recipient can earn

more by lending it out in financial markets

Types of Investments

• Money market funds– http://www.bankrate.com

• Savings accounts• Bonds (Government and Corporate)• Stocks

– Investing in stocks means you are not loaning money but purchasing a portion of a company. Investors can earn a return either through receipt of dividends or appreciation in the value of the company.

Mobilizing Savings

Income

Spending

Productmarkets

Factormarkets

Spending Saving

Financial markets and intermediaries(such as banks and stock and bond markets.)

NATIONAL SAVINGS

Consumer saving — Business savingState and local budget surpluses

The Loanable Funds Market

Quantity of Loanable Funds (dollars per year)

Inte

rest

Rat

e (p

erce

nt p

er y

ear)

Supply ofloanable funds

Demand forloanable funds

0 qe

re

Interest Rates (Current)

• If interest rates are high, the future payoff to present savings is greater.

• Higher interest rates increase the quantity of available savings (loanable funds).

Financial Intermediaries

• By reducing search and information costs, financial intermediaries ease the task of raising start-up funds.

• A financial intermediary is an institution, (a bank or the stock market) that makes savings available to dissavers (investors).

Investing Savings Effected By:

• Time Preferences

• Interest Rates

• Risk

• Risk Management

• Risk Premiums

When You Apply for a LoanLenders check:

- current and historical employment record

- earnings

- assets

- credit history

You should:

- compare alternative lending sources

- types of loans

Time Preferences

• How much to save depends partly on time preference.

• In deciding to save rather than spend, people effectively reallocate their spending over time.

Risk

• The interest rate paid on savings is linked to the risk of future nonpayment.

• High risk attaches to high interest rates.

Risk Management

• The essence of risk management is to diversify an investment portfolio.

• By diversifying their portfolios, investors can select any degree of average risk.

Risk Premiums

• Lenders will want to be compensated for any above-average risks they take.

• The risk premium is the difference in rates of return on risky (uncertain) and safe (certain) investments.

Risk Premiums

• Risk premiums help explain why blue-chip corporations pay a low “prime” rate while ordinary consumers have to pay much higher interest rates.

The Stock Market

The three legal forms of business entities are:

1. Corporations

2. Partnerships

3. Proprietorships

Corporation• A business organization having a

continuous existence independent of its members (owners) and power and liabilities distinct from those of its members.

Corporate Stock• When people buy a share of stock, they’re

buying partial ownership of a corporation.

Dividends

• Dividend is the amount of corporate profits paid out for each share of stock.

• Annual corporate profits are divided between dividends and retained earnings.

Dividends =Corporate profits – Retained earnings

Retained Earnings• Amount of corporate profits not paid out in

dividends.

Capital Gains

• The increase in the value of a stock represents a capital gain for shareholders.

• Capital gain is the increase in the market value of an asset.

Initial Public Offering

• By going public, a corporation seeks to raise funds for investment and growth.

• The first offering of shares in a corporation to the public is known as an initial public offering (IPO).

Initial Public Offering

• initial public offering (IPO) is the first issuance (sale) to the general public of stock in a corporation.

• People who buy the newly issue stock are putting their savings directly into the corporation’s accounts.

• As new owners, they stand to profit from the corporation’s business or take their lumps if the corporation fails.

Secondary Trading

• People who buy stock are interested in the price/earnings ratio.

• price/earnings (P/E) ratio is the price of a stock share divided by earnings (profit) per share.

Video: Wall StreetBud (Buddy Fox)…………...…….CHARLIE SHEEN

Gordon Gekko.……………....MICHAEL DOUGLAS

Darien……………………...…….DARYL HANNAH

Carl Fox…………………...……….MARTIN SHEEN

Blue Star Airlines (BST)

Video: Wall StreetStory Line?

• Themes:

Greed vs. Integrity

Love vs. Money

• Stock market fraud and its impact on financial markets

• U.S. corporate fraud in recent years

Interest Rates (Future Expectations)

• If Lenders expect interest rates (R) to:

Will try and sell short-term loans.

Will try and sell long-term loans

Present Discounted Value (PDV)Time Value of Money

• PDV: The value today of future payments, adjusted for interest accrual.

• The PDV of future payments is computed as follows:

Expected Value

• A risk factor is included in present-value computations whenever an anticipated future payment is uncertain.

• This is done by calculating the expected value.

Expected Value

• Expected value is the probable value of a future payment, including the risk of nonpayment.

Expected value = (1 – risk factor) X Present discounted value