ECON 4410 Lecture Notes - Lecture 10: Net Present Value, Arbitrage, Intertemporal Consumption
18 Oct 2016
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Chapter 4: financial markets and net present value: first principles of finance. In order to consume ,000 this year jack will borrow ,000 and pay ,500 (,000 principal and. ,500 interest) next year, leaving him ,500 potential consumption next year. Rachel will earn ,150 interest on the ,000 she lends out this year, which will increase her potential consumption by ,150 to ,150 next year. Ben"s consumption next year = (,000 ,000) (1+ r) += ,150. Solving these equations gives r = 0. 15 or 15% Ben is better off than before the interest rises. Financial markets arise to facilitate borrowing and lending between individuals. By borrowing and lending, people can adjust their patterns of consumption over time to fit their particular preferences. This allows corporations to accept all positive npv projects, regardless of the inter temporal consumption preferences of the shareholders. There would be too much borrowing and there would be insufficient lending at 4%.
