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COMM 121 (16)
Chapter 4

Chapter 4

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Queen's University
COMM 121
Blair Robertson

Chapter 4: Financial Markets and Net Present Value: First Principles of Finance The Financial Market Economy  Interest rate: The annual percentage return made/owed on a loan  Principle: The initial value of the loan that must be paid back at maturity  Bearer Instruments: A financial instrument that entitles whoever possesses it to get paid The Anonymous Market  Financial Intermediaries are institutions that provide the market function of matching borrowers and lenders (for a fee)  these two people never have to meet Market Clearing  If lenders want to lend out more than borrowers want, the interest rate is likely too high o This will lead people to create side deals at a slightly lower interest rate so that they can invest all of their money o Eventually interest rates will drop until the equilibrium rate of interest is hit  The Equilibrium rate of interest is the interest rates that clears the market  lenders are willing and able to lend out and all that borrowers are willing and able to borrow Making Consumption Choices over Time Refer to in slides in class  math based examples about spending all money now taking into account the current interest rate or saving everything and spending it next year and earning the interest rate Remember that a bigger interest rate leads to more spending in the future and less spending now where are a lower interest rate leads to spending more now and spending less in the future The Competitive Market  In a huge market, no one single investor has the power to change the eql’m interest rate o In the rest of analysis we assume that the financial market is perfectly competitive  Perfectly competitive financial markets (above definition) have these characteristics o Trading is costless  access to financial markets is free o Info about borrowing and lending opportunities is readily available o There are many traders, and no single trader significantly impacts market prices How Many Interest Rates Are There in a
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