Please provide your own example of how tIn general, stock prices depend on how m

Question

Please provide your own example of how tIn general, stock prices depend on how much investors expect companies to make in the future. You can think of the change in the price of a stock as the result of a vote by investors on whether they think the company will make more or less money in the future. If more investors think the company will do better in the future than those who think the company will do worse in the future, the price of a stock will go up because of the law of supply and demand as discussed earlier in the chapter. Likewise, if more investors think the company will do worse in the future than those who think the company will do better in the future, the price of a stock will go down. When you add the element of inflation, the movement in the price of stock gets more interesting. The higher the inflation rate, the smaller the present value of a company's future earnings because inflation increases the discount rate to be applied to future earnings of the company. If you recall our previous discussion, the present value of money to be received in the future is as follows: Present Value = Future Value / (1 + Rate of Return on Investment) Where Rate of Return On Investment is the discount rate As the denominator of the equation above increases (that is, as the discount rate increases), the present value of the company's future earnings gets smaller and smaller. What this means is that a company's future earnings is worth less and less as inflation creeps up because inflation is reflected in the discount rate--the higher the inflation, the higher the discount rate. This is the main reason why investors hate inflation. Please provide your own example of how this works using the TVM formula, assume a rate of return and an inflation rate.his works using the TVM formula, assume a rate of return and an inflation rate.

Explanation / Answer

The time value of money is very important investing concept.Time value of money simply says that a dollar received today is worth more than a dollar received in one day, one month, or a year because the dollar received today can start earning interest immediately. An example of how this idea can be applied.

Suppose someone told you that you can have $100,000 today or you can have $105,000 a year from now (assuming you have no immediate need for the money). Which would you prefer?

You cannot really answer this question until we supply you with one more piece of information: the return you can earn in one year by putting the $100,000 in an alternate investment. You can easily answer the question if you know that you can put the $100,000 you'd receive today, in a bank account paying 10% yearly compound interest.

Think about the choices again: receive $100,000 today or receive $105,000 one year from now. For those of you who would rather have the $105,000 one year from now, you would have cheated yourself out of $5,000. If you collect $100,000 today, you can deposit it in the bank and earn 10% interest for the year, or $10,000, on that money. In one year, you would have a principal and interest total of $110,000. This is $5,000 more than you would get if you'd opted to receive $105,000 one year in the future.

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.