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4751 - Financial Economics Spring 2011 1-1 4751 - Financial Economics • Name: Rene Schwengber • Today: – Syllabus – Introduction / Review 1-2 Syllabus • Grade from 4 sources • • • • 20% average homework 25% Midterm (March 4th) 25% group presentation (during the term) 30% Final (May 12th) • Homework’s typed and stapled • otherwise cap maximum grade at 75% 1-3 Our Book. • We will cover material from other sources too. • We will generally cover material on the whiteboard Investments, 8th edition Bodie, Kane and Marcus Slides by Susan Hine McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. Activity • Part of your grade is based on group work. • Knowing your group and knowing to work together in your group is essential. • Take the next few minutes to introduce yourself to your classmates. • Talk about classes you’ve taken, major/minor. 1-5 Intro • Investment current commitment of money or other resources in the expectation of reaping future benefits – Intertemporal allocation of resources • Time (for “risk-free” investments) • Uncertainty (Risky) • Examples of risky investment? – College • Example of risk-free investment? – Treasury Bills, Vatican Bonds? – Bond Market Says U.S. Debt Is Riskier Than Warren Buffett's Berkshire Hathaway – The Da Vinci Code (airplane scene) 1-6 Real Assets Versus Financial Assets • Essential nature of investment – Reduced current consumption – Planned later consumption • Real Assets – Assets used to produce goods and services • Financial Assets – Claims on real assets 1-7 Example • Consider the Dutch East India Company – Fist company to issue Stock (financial asset) • What is stock? • (Common) Stock or equity is a claim of ownership on a firm. • Payoff of exploration was potentially very big (high productivity) but so was its risk (e.g. loss ship) • Idea: Spread risk by financing more than one expedition (at once or in a given time-frame) • Many claim this was one of the major forces of growth at this time 1-8 Investment Example • The goal of investing in simple: – Maximize utility • Assume agents have utility over stream of daily consumption – (c1, c2, c3, ….cT ) gives Utility U(c1, c2, c3, …,cT) • E.g.: Consumption: of (1,1,1,96,1) or (20,20,20,20,20) – Most would prefer the 2nd stream of comsumption 1-9 General problem • A well-developed economy with financial markets provides: • intertemporal allocation of resources • Insurance – against bad shocks – decreased volatility 1-10 Next Class • Review basic concepts from basic probability theory, linear algebra, etc. 1-11