CHAPTER 14

These flashcards cover key concepts from Mankiw's Principles of Economics, specifically focusing on finance tools such as present value, risk aversion, insurance markets, efficient markets hypothesis, and investment strategies.

What is the present value?

The amount of money today needed to produce a future amount of money, given prevailing interest rates.

What does risk aversion mean?

Most people dislike uncertainty and prefer to avoid bad outcomes.

How can risk-averse individuals manage risk?

By using tools such as insurance and diversification.

What is the efficient markets hypothesis?

The theory that asset prices reflect all publicly available information about the value of an asset.

Why is it nearly impossible to beat the market?

Because stock prices should reflect all available information, making no stock a better buy than others.

What is compounding in finance?

The accumulation of interest on an amount of money, where the interest earned also earns additional interest over time.

What is the Rule of 70?

If an amount grows at a rate of x% per year, that amount will double in about 70/x years.

What happens to a $1,000 investment at 8% over 30 years?

It grows to $10,063.

What does it mean for stocks to be undervalued?

When the price of the stock is less than its intrinsic value.

What is the utility function?

A person's subjective measure of well-being or satisfaction from wealth.

What is adverse selection in insurance?

The tendency for high-risk individuals to purchase insurance more than low-risk individuals.

What is moral hazard?

The phenomenon where insured individuals may take more risks because they are covered.

How can diversification reduce risk?

By replacing a single risk with a large number of smaller, unrelated risks, eliminating firm-specific risk.

What is the trade-off between risk and return?

Riskier assets tend to pay a higher return on average to compensate for the extra risk.

What can cause speculative bubbles in the market?

When an asset's price rises above its perceived fundamental value.

What is the effect of irrational market behavior?

It can lead to price movements that do not reflect rational valuations.

What is fundamental analysis?

The study of a company’s accounting statements and future prospects to determine its value.