stock vs flow -
- stock - instantaneous amount owned by a firm
- ie. capital
- flow - variable inputs/outputs
- amount needed/used over a time period
- capital, if not used, can gain interest
- firms calculate how much capital in the future is worth today
- determines whether or not it's a good investment
- future flow of income worth less today than at that time
present discounted value (PDV)
- future dollar value = M(1+R)n
- M = amount of capital now
- R = interest rate
- n = time period (usually in years)
- present value = M / (1+R)n
- stream of payment w/ smallest present value is best
bond - contract where borrower (issuer) pays a stream of income to lender (holder)
- gov't could issue bond where they would pay $100 every year for 10 years
- results in $1000 total after 10 years
- but remember that $100 paid before 10 years can still have time to grow
- lender (bondholder) would pay less than that $1000 in the beginning
- that $1000 has present value of: 100/(1+R) + 100/(1+R)2 + ... 100/(1+R)9 + 100/(1+R)10
net present value = -C + profit1/(1+R) + ... + profitn/(1+R)n
- profit can be negative if firm is operating in a loss
- risk premium paid in form of higher yield for riskier bonds/stocks (ie. tech stocks) and lower yield for more stable/dependable bonds (ie. gov't bonds)
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