Chapter 14 is titled “the basic tools of finance.” It introduces how to measure the time value of money. It continues by discussing how to manage risk by explaining risk aversion, the markets for insurance, diversification of firm-specific risk, and the trade-off between risk and return. Finally, it discusses asset valuation by fundamental analysis, the efficient markets hypothesis, and market irrationality.
I have definitely considered the trade-off between risk and return when making an investment, because most rational people compare the risks and returns of every decision they make. While I haven’t made any large investments for my self, I make day to day choices in the trade-off between risk and return every time that I purchase something because it could have gone into my bank account and gained interest. My family and I also made the decision to have me go to college, requiring us all to take the risk of spending so much money on tuition and hoping for a higher return in the future, rather than having me work a full time job and making an income. This risk did not change my investment because we decided that education is more important and will pay off in the long-run more than a temporary income would. I do expect a risk premium related to the level of risk because people with a higher education are more qualified for more advanced and specialized jobs so that they are paid more. I would hope to make back what I have made in tuition for the investment to have been worth it.
The present value of a dollar is more than its future value because the dollar today can be invested and earn interest so that it will be worth more tomorrow. This is irregardless of inflation or deflation in the future because if the amount is gaining interest it will be worth more everyday than the day before.
CCheo Macro Economics 