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transcript
Llad Phillips 1
Introduction to EconomicsIntroduction to Economics
Elements of Personal FinanceElements of Personal Finance
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Econ 109 Class PageEcon 109 Class Page
Econ Home Page:Econ Home Page: http://www.http://www.econecon..ucsbucsb..eduedu
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Labs(sections)12617 F 9:00-9:50 AM Jalama Lab, Phelps 1517
MCL 12625 M 2:00-2:50 PM Miramar Lab, Phelps 152612633 M 7:00-7:50 PM Miramar Lab, Phelps 152612641 W 8:00-8:50 AM Miramar Lab, Phelps 1526
12658 T 6:30- 7:20 PM Miramar Lab, Phelps 152612666 F 1:00-1:50 PM Ledbetter Lab, Phelps 1530
http://www.ic.ucsb.edu/faculty/labs/
Checking Instructional Computing Lab Scedules
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AnnouncementsAnnouncements
E-mail addressesE-mail addresses Llad Phillips <llad@econ.ucsb.edu>Llad Phillips <llad@econ.ucsb.edu> Donghun Cho<cho@econ.ucsb.edu>Donghun Cho<cho@econ.ucsb.edu> Taeil Kang<kang@econ.ucsb.edu>Taeil Kang<kang@econ.ucsb.edu> Kirk Lesh<lesh@econ.ucsb.edu>Kirk Lesh<lesh@econ.ucsb.edu>
Course GradingCourse Grading
Quiz 40Midterm 80Final 169Course 289
If you complete over 70 % of both the text Problems and Lab Exercises, then your course grade is increased by 1/3 grade point
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Economics in the NewsEconomics in the News
What can we learn from the newspaper?What can we learn from the newspaper?
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Bond MarketBond Market
Quantity of Funds, $
Supply of Funds
InterestRate On Bonds
Demand for Funds
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Bond MarketBond Market
Quantity of Funds, $
Shift in the Supply of FundsInterest
Rate On Bonds
Demand for Funds
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Background on US Labor ForceDefinitions
Background on US Labor ForceDefinitions
Civilian non-institutional population: those Civilian non-institutional population: those not in hospitals, jails etc.not in hospitals, jails etc.
civilian non-institutional population is civilian non-institutional population is either in the labor force (working or looking either in the labor force (working or looking for work) or not in the labor forcefor work) or not in the labor force
civilian labor force participation rate is the civilian labor force participation rate is the proportion of the civilian noninstitutional proportion of the civilian noninstitutional population in the labor forcepopulation in the labor force
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Total US Population, 1999
Armed Forces
Institutional Population
Civilian NoninstitutionalPopulation
U S Statistical Abstracthttp://www.census.gov/prod/www/statistical-abstract-us.html
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Civilian Noninstitutional Population, 2002 Third Quarter
Employment 63%
Unemployment4%
Not in the labor force33%
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Background on the US Labor MarketCivilian Labor Force Participation RateBackground on the US Labor MarketCivilian Labor Force Participation Rate
http://stats.bls.gov/
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MaleCivilian Labor Force Participation Rate
MaleCivilian Labor Force Participation Rate
http://stats.bls.gov/
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FemaleCivilian Labor Force Participation Rate
FemaleCivilian Labor Force Participation Rate
http://stats.bls.gov/
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16-19 Years OldCivilian Labor Force Participation Rate
16-19 Years OldCivilian Labor Force Participation Rate
http://stats.bls.gov/
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Current Economic EventsCurrent Economic Events
% of Civilian Labor Force That Is Unemployed
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Lecture FourLecture Four
Some people in class do not work, but studySome people in class do not work, but study Some people in class work and studySome people in class work and study Some of your friends may work full time Some of your friends may work full time
and not studyand not study
What is the story?
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4. Tuesday, Oct 8, Lecture Four: "Markowitz Efficiency Portfolio Analysis"
Wall Street Journal Video, Guide to Money and Markets ( on reserve in Kerr Hall)
Markowitz Efficient Portfolio Analysis
Reading Assignment:Money 101 “Basics of Investing”O’Sullivan and Sheffrin: Ch. 4, “Supply, Demand and Market Equilibrium”
emphasis: the law of demand and market supply
Problems O & S Textpp. 90-91: 1, 2, 3, 4, 5, 6, 7
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Outline: Lecture FourOutline: Lecture Four
Determinants of Personal Income (cont.)Determinants of Personal Income (cont.) Markowitz Efficient Portfolio AnalysisMarkowitz Efficient Portfolio Analysis Interest rate, % per year, APRInterest rate, % per year, APR Video Guide to Money and MarketsVideo Guide to Money and Markets
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Determinants of Personal IncomeDeterminants of Personal Income
Life Cycle ModelLife Cycle Model Learning and EarningLearning and Earning Your Market Wage Depends onYour Market Wage Depends on
your human capitalyour human capital Allocating your time between Learning and Allocating your time between Learning and
Earning Earning 24 hour endowment24 hour endowment your tastes for learning versus earningyour tastes for learning versus earning
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Explaining Differences in BehaviorExplaining Differences in Behavior
Different OpportunitiesDifferent Opportunities Different TastesDifferent Tastes Possibly BothPossibly Both
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24 hours0 hoursLeisure(learning)
Earnings
$480
Opportunities for trading leisurefor earnings (income) at a rate,$20 per hour, the market wage,determined by your stock of human capital(step one of the paradigm: describing the alternatives for choice)
$ 0
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24 hours0 hours
$480
$ 0
Savings,$ from home
24 hours0 hours
Leisure(learning)
Earnings
$480
$ 0
$240
dropout
college grad
Comparative market wages as determined by accumulated knowledge
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Choosing Between Learning and EarningChoosing Between Learning and Earning How much time for learning?How much time for learning? How much time for earning?How much time for earning? This choice, like all choices depends on This choice, like all choices depends on
your tastesyour tastes Do you want to earn and consume now?Do you want to earn and consume now? Do you want to learn, earn more in the future, Do you want to learn, earn more in the future,
and consume more in the future?and consume more in the future?
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Economists Assume You Can make ComparisonsEconomists Assume You Can make Comparisons example: more leisure and less income example: more leisure and less income
versus less leisure and more incomeversus less leisure and more income recall Lecture One: an Altima Vs. a Taurusrecall Lecture One: an Altima Vs. a Taurus
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Economists Assume You Can Make TradeoffsEconomists Assume You Can Make Tradeoffs How much income will you demand to give How much income will you demand to give
up your leisure?up your leisure?
24 hours0 hoursLeisure(learning)
Earnings
$480
$ 0
Iso-Preference Curves:You value all points on a curve equally(step two of the paradigm: valuing thealternatives for choice)
Depicting your tastes graphically: iso-preference or indifference curves
24 hours0 hoursLeisure(learning)
Earnings
$480
$ 0
Iso-Preference Curves:You value all points on a curve equally
high
low value
high value
Depicting your tastes graphically
24 hours0 hoursLeisure(learning)
Earnings
$480
$ 0
Iso-Preference Curves:You value all points on a curve equally
high
low value
high value
The choice between leisure and earning now:picking the best alternative
alternatives
24 hours0 hours
Leisure(learning)
Earnings
$480
$ 0
high
low value
high value
Optimum
15 hoursof leisure
$180for 9 hrsof work
Individual’s Supply of Labor
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24 hours0 hours
$480
$ 0
high
low value
Savings,$ from home
Higher value
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24 hours0 hours
$480
$ 0
high
low value
Savings,$ from home
Higher value
24 hours0 hoursLeisure(learning)
Earnings
$480
$ 0
high
low value
slope of the iso-preference curve through the 24 hour endowment is the lowest wage at which you are willing to work
$96
dropout is unwilling to work for $4/hr
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Poverty in the United StatesPoverty in the United States
Attributable to differences in earning powerAttributable to differences in earning power Policy: equal opportunity for educationPolicy: equal opportunity for education
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Personal InvestingPersonal Investing
Power of Compound InterestPower of Compound Interest exponential growthexponential growth
Based on Doubling Your Money Every Based on Doubling Your Money Every Four YearsFour Years rate of growth: 17% per yearrate of growth: 17% per year
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Growing Wealth at 17% per YearGrowing Wealth at 17% per Year
Year Wealth
0 $31,250
4 $62,500
8 $125,000
12 $250,000
16 $500,000
20 $1,000,000
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Growth of $31,250 at Two Different Rates
0
200000
400000
600000
800000
1000000
1200000
0 5 10 15 20 25
Year
Am
ou
nt
seventeenplusthree
$57,000
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Personal InvestingPersonal Investing
How do you choose between stocks or How do you choose between stocks or bonds as a personal investment?bonds as a personal investment?
How do you choose between mutual funds?How do you choose between mutual funds? Are stocks and bonds too risky? Should you Are stocks and bonds too risky? Should you
keep your money in cash or gold?keep your money in cash or gold?
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Creed For SuccessCreed For Success Ben Franklin: “A penny saved is a penny earned”Ben Franklin: “A penny saved is a penny earned”
mind those pennies, budget and be frugalmind those pennies, budget and be frugal save, I.e. tithe yourselfsave, I.e. tithe yourself
Diversify Your investmentsDiversify Your investments cashcash housinghousing bonds bonds stocksstocks
Invest in a Stock Index FundInvest in a Stock Index Fund
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Dow Jones Industrials IndexDow Jones Industrials Index
http://www.quicken.com
Weekly Closings of the Dow Jones Indistrials
September 28 2001
3-Jan-86
y = 1540.8e0.0025x
R2 = 0.9552
0
2000
4000
6000
8000
10000
12000
14000
0 100 200 300 400 500 600 700 800 900
Week
Ind
ex
Growth Rate 13% per Year
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Example: UC FundsExample: UC Funds Suppose you invest up to $10,000 per year in a tax sheltered 403(b) Suppose you invest up to $10,000 per year in a tax sheltered 403(b)
planplan you have to save $10,000, but you would have to pay income taxes if you you have to save $10,000, but you would have to pay income taxes if you
took it as income took it as income UC investment alternativesUC investment alternatives
guaranteed insurance contract(GIC)guaranteed insurance contract(GIC) savings fundsavings fund money market fundmoney market fund bond fundbond fund stock index fundstock index fund multi-asset fundmulti-asset fund
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Investment ConceptsInvestment Concepts monthly return for June 2001 on an assetmonthly return for June 2001 on an asset
price(June) - price(May) + dividendsprice(June) - price(May) + dividends price(June) - price(May): capital gain(loss)price(June) - price(May): capital gain(loss) dividends(interest): income from stocks(bonds)dividends(interest): income from stocks(bonds)
monthly rate of return for June 2001monthly rate of return for June 2001 [price(June) - price(May) + [price(June) - price(May) +
dividends]/price(May)dividends]/price(May) in %, multiply by 100in %, multiply by 100
• annual rate: multiply by 12annual rate: multiply by 12
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Example: UC Funds/Mutual FundsExample: UC Funds/Mutual Funds Sources of information on UC fundsSources of information on UC funds
monthly, quarterly, annual, etc. rates of returnmonthly, quarterly, annual, etc. rates of return internet: internet:
http://www.ucop.edu/bencom/rs/perform.htmlhttp://www.ucop.edu/bencom/rs/perform.html Notice, Notice, a publication of the UC Academic Senatea publication of the UC Academic Senate
Source of Information on Mutual FundsSource of Information on Mutual Funds quarterlyquarterly
The Wall Street JournalThe Wall Street Journal, Mutual Funds Quarterly , Mutual Funds Quarterly Review, e.g. extra section in July 3, 1997 Review, e.g. extra section in July 3, 1997 JournalJournal
Two UC Funds: Monthly Rate of Return, Sept 95 - Aug 01
-15
-10
-5
0
5
10S
ep
-95
De
c-9
5
Ma
r-9
6
Jun
-96
Se
p-9
6
De
c-9
6
Ma
r-9
7
Jun
-97
Se
p-9
7
De
c-9
7
Ma
r-9
8
Jun
-98
Se
p-9
8
De
c-9
8
Ma
r-9
9
Jun
-99
Se
p-9
9
De
c-9
9
Ma
r-0
0
Jun
-00
Se
p-0
0
De
c-0
0
Ma
r-0
1
Jun
-01
Year:Month
Ra
te
Equity Fund
Insurance Contract
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UC Funds: Equity Vs. InsuranceUC Funds: Equity Vs. Insurance InsuranceInsurance
steady at a rate of steady at a rate of return of about 0.6 return of about 0.6 per month or 7.2% per month or 7.2% per yearper year
does not vary muchdoes not vary much never negativenever negative
EquityEquity rate of return varies rate of return varies
a lot from month to a lot from month to monthmonth
range of rates of range of rates of return from about return from about plus 9% in Mar. ‘00 plus 9% in Mar. ‘00 to minus 13% in to minus 13% in Aug ‘98Aug ‘98
can turn negative: can turn negative: 29 months out of 72 29 months out of 72
Three "Safe" UC Funds :M onthly Rates of Return
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70S
ep
-95
De
c-9
5
Ma
r-9
6
Jun
-96
Se
p-9
6
De
c-9
6
Ma
r-9
7
Jun
-97
Se
p-9
7
De
c-9
7
Ma
r-9
8
Jun
-98
Se
p-9
8
De
c-9
8
Ma
r-9
9
Jun
-99
Se
p-9
9
De
c-9
9
Ma
r-0
0
Jun
-00
Se
p-0
0
De
c-0
0
Ma
r-0
1
Jun
-01
Year:Month
Ra
te
Insurance Contract
Money Market Fund
Savings Fund
Three "Volatile" UC Funds, Monthly Rates of Return
-15
-10
-5
0
5
10S
ep
-95
De
c-9
5
Ma
r-9
6
Jun
-96
Se
p-9
6
De
c-9
6
Ma
r-9
7
Jun
-97
Se
p-9
7
De
c-9
7
Ma
r-9
8
Jun
-98
Se
p-9
8
De
c-9
8
Ma
r-9
9
Jun
-99
Se
p-9
9
De
c-9
9
Ma
r-0
0
Jun
-00
Se
p-0
0
De
c-0
0
Ma
r-0
1
Jun
-01
Year:Month
Ra
te
Bond Fund
Equity Fund
Multi Asset (Mix) Fund
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Two Kinds of AssetsTwo Kinds of Assets low rate of return-low low rate of return-low
variabilityvariability want high rate of want high rate of
return return on return return on averageaverage
want low variabilitywant low variability predictable average predictable average
returnreturn
high return-high high return-high variabilityvariability
want high rate of want high rate of return on averagereturn on average
want low variabilitywant low variability
Dilemma: which kind of asset to hold?
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Investment Principles or MaximsInvestment Principles or Maxims Don’t put all of your eggs in one basketDon’t put all of your eggs in one basket
hold a diversified portfoliohold a diversified portfolio cashcash bondsbonds stocksstocks real estatereal estate
advantage of a mutual fundadvantage of a mutual fund instead of holding one stock, e.g. Coca-Cola, you instead of holding one stock, e.g. Coca-Cola, you
hold a bundle of stockshold a bundle of stocks
Choose the asset with the highest reward Choose the asset with the highest reward for a given level of riskfor a given level of risk
Date Bond Equity Insurance Money Market Multi-Asset Savings95.09 2.66 4 0.64 0.49 2.09 0.52
95.1 2.4 -0.26 0.66 0.49 0.64 0.5395.11 3.9 4.07 0.64 0.47 2.39 0.5195.12 2.83 -0.13 0.66 0.48 0.78 0.5296.01 -0.51 3.32 0.64 0.47 1.23 0.5296.02 -5.42 2.35 0.6 0.43 -0.12 0.4996.03 -0.63 -0.24 0.64 0.45 0.02 0.5296.04 -0.75 1.6 0.61 0.43 0.62 0.596.05 0.78 2.56 0.63 0.44 1.27 0.5196.06 1.68 -0.12 0.61 0.44 0.5 0.596.07 0.34 -5.01 0.63 0.46 -1.43 0.5196.08 0.35 2.33 0.63 0.46 1.08 0.5196.09 4.21 4.59 0.61 0.45 2.6 0.49
96.1 7 0.39 0.63 0.46 1.77 0.5296.11 5.56 7.69 0.61 0.45 3.97 0.4996.12 -4.16 -1.25 0.62 0.47 -1.1 0.5197.01 0.04 4.59 0.62 0.46 1.82 0.5297.02 1.35 0.42 0.56 0.41 0.62 0.4697.03 -3.59 -2.33 0.64 0.45 -1.31 0.5497.04 2.23 4.09 0.6 0.45 2.08 0.597.05 2.59 6.16 0.62 0.47 2.91 0.5197.06 2.75 3.5 0.6 0.46 2.02 0.5
mean 1.16 1.92 0.62 0.46 1.11 0.51standard deviation 3.00 2.95 0.02 0.02 1.38 0.02
Measures of Average Rate of Return and Variability: Mean & Std. Dev.
Return Versus Risk for Six UC Funds Sept 95-Aug 01
Money Market
Savings
Insurance
Multi-Asset
Bond
Equity
0.00
0.20
0.40
0.60
0.80
1.00
1.20
0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00
Risk: Volatility
Av
era
ge
Re
turn
Mean Returns & Standard Deviations
Return Versus Risk for Six UC Funds Sept 95-Aug 01
Money Market
Savings
Insurance
Multi-Asset
Bond
Equity
0.00
0.20
0.40
0.60
0.80
1.00
1.20
0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00
Risk: Volatility
Av
era
ge
Re
turn
Efficient Portfolio: Most Return for Given Risk
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Your portfolio should be on the efficient frontier
Your portfolio should be on the efficient frontier
But where on the frontier?But where on the frontier? depends on your taste for reward and riskdepends on your taste for reward and risk
reward, i.e. the mean rate of return is a reward, i.e. the mean rate of return is a goodgood risk is a risk is a badbad
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Economic Paradigm: Valuation of Mean Return and Risk
Assumption: Mean Return is Good, Risk is Bad: U =U(M,R)
MeanReturn,M
Risk, R
better
worse
Iso - Preference CurvesA
B
C
Prefer B to A; Prefer B to C
Return Versus Risk for Six UC Funds Sept 95-Aug 01
Money Market
Savings
Insurance
Multi-Asset
Bond
Equity
0.00
0.20
0.40
0.60
0.80
1.00
1.20
0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00
Risk: Volatility
Av
era
ge
Re
turn
Efficient Portfolio: Most Return for Given Risk
Investor A: very risk averse
Return Versus Risk for Six UC Funds Sept 95-Aug 01
Money Market
Savings
Insurance
Multi-Asset
Bond
Equity
0.00
0.20
0.40
0.60
0.80
1.00
1.20
0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00
Risk: Volatility
Av
era
ge
Re
turn
Efficient Portfolio: Most Return for Given Risk
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Efficient UC Investment PortfolioEfficient UC Investment Portfolio f*insurance contract + (1-f)*equity fundf*insurance contract + (1-f)*equity fund
where f can range from zero to onewhere f can range from zero to oneexample: 50:50, i.e one half of your nest egg example: 50:50, i.e one half of your nest egg
is invested in the Insurance Contract and the is invested in the Insurance Contract and the other half is invested in the Equity Fund.other half is invested in the Equity Fund.
• mean return: 1/2 *0.59 + 1/2*1.09 = 0.84 % per mean return: 1/2 *0.59 + 1/2*1.09 = 0.84 % per monthmonth
• expected risk(standard deviation: 1/2*0.03 + expected risk(standard deviation: 1/2*0.03 + 1/2*4.34 =2.181/2*4.34 =2.18
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–exercise: show that this mean portfolio return exercise: show that this mean portfolio return –and expected risk lie on the efficient frontierand expected risk lie on the efficient frontier– connecting the insurance contract and the connecting the insurance contract and the –equity fundequity fund
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Summary-Vocabulary-ConceptsSummary-Vocabulary-Concepts Markowitz Portfolio Markowitz Portfolio
AnalysisAnalysis stock index fundstock index fund bond fundbond fund money market fundmoney market fund guaranteed insurance guaranteed insurance
contractcontract monthly rate of returnmonthly rate of return
capital gainscapital gains dividendsdividends mean rate of return on mean rate of return on
an assetan asset risk of holding an assetrisk of holding an asset a risk averse persona risk averse person investment portfolioinvestment portfolio
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Interest Rate Per Year On A LoanExample: One Payment
Interest Rate Per Year On A LoanExample: One Payment
loan amount: $1000loan amount: $1000 annual interest rate: 10%annual interest rate: 10% one payment at the end of the yearone payment at the end of the year
pay back principal: $1,000pay back principal: $1,000 pay the interest on $1000 for a year: $100pay the interest on $1000 for a year: $100
principal*interest rate = interestprincipal*interest rate = interest $1000*0.1 = $100$1000*0.1 = $100
total payment due: $1100total payment due: $1100
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Interest Rate Per Year On A LoanExample: Twelve Monthly PaymentsInterest Rate Per Year On A LoanExample: Twelve Monthly Payments loan amount: $1000loan amount: $1000 annual interest rate: 10%annual interest rate: 10% Twelve Monthly PaymentsTwelve Monthly Payments
pay back principal of $1000pay back principal of $1000 pay interest on the amount owedpay interest on the amount owed
declining amount owed since you pay back declining amount owed since you pay back some principal each month, until balance of some principal each month, until balance of principal owed is zero after twelve paymentsprincipal owed is zero after twelve payments
use Excel’s PMT function to calculateuse Excel’s PMT function to calculate
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$1000
Principal
Timeoneyear
DecliningBalance,12 monthly payments
one payment of principalplus interest at the endof the year
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loan 1000interest rate, per year 10%monthly payments 12
($87.92)
total payments -1054.99
interest 54.99
Twelve Monthly Payments