DPQ Time & Risk Short, three-part section Short, three-part section.

DPQDPQ

Time & RiskTime & Risk

Short, three-part sectionShort, three-part section

Time & RiskTime & Risk

Short, three-part sectionShort, three-part section ““Investment and Speculation”: todayInvestment and Speculation”: today ““Risks and Insurance”: January 18Risks and Insurance”: January 18 ““Overview” and test: January 25Overview” and test: January 25

Investments and Investments and SpeculationSpeculation

What is investment? What is investment?

Investment: “Spending today in Investment: “Spending today in anticipation of getting a stream of anticipation of getting a stream of benefits in the future”benefits in the future”

Can be investment of money… i.e., Can be investment of money… i.e., buying a new machinebuying a new machine

What is investment?What is investment?

Investment: “Spending today in Investment: “Spending today in anticipation of getting a stream of anticipation of getting a stream of benefits in the future”benefits in the future”

Can be investment of money… i.e., Can be investment of money… i.e., buying a new machinebuying a new machine

Can be investment of time… Can be investment of time… acquiring an M.B.A. from Harvard acquiring an M.B.A. from Harvard UniversityUniversity

What is investment?What is investment?

Investment: “Spending today in Investment: “Spending today in anticipation of getting a stream of benefits anticipation of getting a stream of benefits in the future”in the future”

Can be investment of money… i.e., buying a Can be investment of money… i.e., buying a new machinenew machine

Can be investment of time… acquiring an Can be investment of time… acquiring an M.B.A. from Harvard UniversityM.B.A. from Harvard University

Investments take many forms: hiring Investments take many forms: hiring people; building a coffee shop; software for people; building a coffee shop; software for productivity; stock in Facebook, etc. productivity; stock in Facebook, etc.

What was the point of Dr. What was the point of Dr. S’s discussion of higher S’s discussion of higher

degrees?degrees?

degrees?degrees? ““When people insist on specializing When people insist on specializing

in a field for which there is little in a field for which there is little demand, their investment has been a demand, their investment has been a waste of scarce resources that could waste of scarce resources that could have produced something else that have produced something else that others wanted...”others wanted...”

degrees?degrees? ““When people insist on specializing in a When people insist on specializing in a

field for which there is little demand, field for which there is little demand, their investment has been a waste of their investment has been a waste of scarce resources that could have scarce resources that could have produced something else that others produced something else that others wanted...”wanted...”

““From an economic standpoint, some From an economic standpoint, some education has great value, some has no education has great value, some has no value and some can even have a value and some can even have a negative value...”negative value...”

InvestmentsInvestments

Risk is an inseparable part of Risk is an inseparable part of investinginvesting

Ways of dealing with risk include Ways of dealing with risk include speculation, insurance, and issuance speculation, insurance, and issuance of stocks & bondsof stocks & bonds

Can invest eight years attaining a Can invest eight years attaining a Ph.D. in 13Ph.D. in 13thth century Persian poetry century Persian poetry

Or could invest in a 10 year T-bill Or could invest in a 10 year T-bill

Risk is an inseparable part of investingRisk is an inseparable part of investing Ways of dealing with risk include Ways of dealing with risk include

speculation, insurance, and issuance of speculation, insurance, and issuance of stocks & bondsstocks & bonds

Can invest eight years attaining a Ph.D. in Can invest eight years attaining a Ph.D. in 1313thth century Persian poetry century Persian poetry

Or could invest in a 10 year T-bill Or could invest in a 10 year T-bill Investing is way different from gambling, Investing is way different from gambling,

which creates a risk that would not exist in which creates a risk that would not exist in hopes of profithopes of profit

SpeculationSpeculation

Buying things that do not yet exist or Buying things that do not yet exist or whose value has yet to be whose value has yet to be determineddetermined

e.g., Movie scripts, currencies, e.g., Movie scripts, currencies, drilling for oildrilling for oil

Professional speculators: role is to Professional speculators: role is to relieve other people from having to relieve other people from having to speculate as part of their regular speculate as part of their regular economic activityeconomic activity

In the economic sense: “Speculation In the economic sense: “Speculation is coping with an inherent risk in is coping with an inherent risk in such a way as to minimize it and such a way as to minimize it and leave it to be borne by who are best leave it to be borne by who are best equipped to bear it”equipped to bear it”

SpeculationSpeculation In the economic sense: “Speculation is In the economic sense: “Speculation is

coping with an inherent risk in such as coping with an inherent risk in such as way as to minimize it and leave it to be way as to minimize it and leave it to be borne by who are best equipped to bear borne by who are best equipped to bear it”it”

Oil speculators and other commodity Oil speculators and other commodity speculators buy “futures” – a contract speculators buy “futures” – a contract guaranteeing the seller a specified price guaranteeing the seller a specified price in advance, regardless of what the in advance, regardless of what the market price may be at the time of market price may be at the time of deliverydelivery

Speculation Speculation

What is value of speculators?What is value of speculators?

What is value of speculators?What is value of speculators? They enable producers to focus of They enable producers to focus of

growing their crops, pumping their growing their crops, pumping their oil, mining their silver, and not oil, mining their silver, and not worry about what the price will be in worry about what the price will be in the futurethe future

Economic speculation is another way Economic speculation is another way of allocating SRTHAUof allocating SRTHAU

growing their crops, pumping their oil, growing their crops, pumping their oil, mining their silver, and not worry about mining their silver, and not worry about what the price will be in the futurewhat the price will be in the future

Economic speculation is another way of Economic speculation is another way of allocating SRTHAUallocating SRTHAU

Not in the soybean biz, in the risk mgt Not in the soybean biz, in the risk mgt bizbiz

InventoriesInventories

Why are inventories a substitute for Why are inventories a substitute for knowledge?knowledge?

Inherent risks must be dealt with by Inherent risks must be dealt with by the economy not only through the economy not only through speculation, but also by maintaining speculation, but also by maintaining inventoriesinventories

Since inventories cost $, businesses Since inventories cost $, businesses must try to limit how much inventory must try to limit how much inventory they have on handthey have on hand

Inherent risks must be dealt with by the Inherent risks must be dealt with by the economy not only through speculation, economy not only through speculation, but also by maintaining inventoriesbut also by maintaining inventories

Since inventories cost $, businesses must Since inventories cost $, businesses must try to limit how much inventory they have try to limit how much inventory they have on handon hand

Too much or too little, you lose money: Too much or too little, you lose money: why?why?

Too much: excess cost of doing Too much: excess cost of doing business compared to competitorsbusiness compared to competitors

Too little: risk losing sales and Too little: risk losing sales and customerscustomers

Return on InvestmentReturn on Investment

Delayed rewards for costs incurred Delayed rewards for costs incurred earlier: stock appreciation, earlier: stock appreciation, dividends from T-bill, higher income dividends from T-bill, higher income from college degree in fashion from college degree in fashion marketing, etc.marketing, etc.

““Unearned income”: one of those Unearned income”: one of those politically loaded terms that politically loaded terms that disparages getting current income disparages getting current income from past investments: Examples?from past investments: Examples?

Delayed rewards for costs incurred earlier: Delayed rewards for costs incurred earlier: stock appreciation, dividends from T-bill, stock appreciation, dividends from T-bill, higher income from college degree in fashion higher income from college degree in fashion marketing, etc.marketing, etc.

““Unearned income”: one of those politically Unearned income”: one of those politically loaded terms that disparages getting current loaded terms that disparages getting current income from past investments: Examples?income from past investments: Examples?

Factories, money lenders in third world, Factories, money lenders in third world, buying oil leases in hopes of getting oil 10 buying oil leases in hopes of getting oil 10 years down the roadyears down the road

Allocation of InvestmentsAllocation of Investments

General theory: A higher rate of General theory: A higher rate of return (i.e., roaring stock market) return (i.e., roaring stock market) encourages people to consume less encourages people to consume less in the present in order to consume in the present in order to consume more in the futuremore in the future

Allocation of InvestmentsAllocation of Investments

General theory: A higher rate of General theory: A higher rate of return (i.e., roaring stock market) return (i.e., roaring stock market) encourages people to consume less encourages people to consume less in the present in order to consume in the present in order to consume more in the futuremore in the future

Investment is a way of transferring Investment is a way of transferring resources to where they have resources to where they have alternative uses that are more alternative uses that are more valuable than where they arevaluable than where they are

Present ValuePresent Value

Many things are bought for Many things are bought for immediate use (a burrito from immediate use (a burrito from Tom’s) while others are bought for Tom’s) while others are bought for benefits over time (season tickets to benefits over time (season tickets to the Bucs)the Bucs)

That whole stream of benefits can be That whole stream of benefits can be purchased at a given moment for purchased at a given moment for present valuepresent value

Many things are bought for immediate use Many things are bought for immediate use (a burrito from Tom’s) while others are (a burrito from Tom’s) while others are bought for benefits over time (season bought for benefits over time (season tickets to the Bucs)tickets to the Bucs)

That whole stream of benefits can be That whole stream of benefits can be purchased at a given moment for present purchased at a given moment for present valuevalue

Things which will impact future benefits Things which will impact future benefits will affect present value: building a sewer will affect present value: building a sewer plant next to Tom’s Burrito Barnplant next to Tom’s Burrito Barn

The “present value” of an asset is its The “present value” of an asset is its anticipated future benefits, anticipated future benefits, discounted for the fact they are discounted for the fact they are delayeddelayed

Present value links future to Present value links future to present… 90-year old planting fruit present… 90-year old planting fruit trees increase PV of his landtrees increase PV of his land

The “present value” of an asset is its The “present value” of an asset is its anticipated future benefits, discounted for anticipated future benefits, discounted for the fact they are delayedthe fact they are delayed

Present value links future to present… 90-Present value links future to present… 90-year old planting fruit trees increase PV of year old planting fruit trees increase PV of his landhis land

Natch, politicians are not forced to pay Natch, politicians are not forced to pay attention to future consequences… so they attention to future consequences… so they borrow, print money and spend like crazy to borrow, print money and spend like crazy to get reelected, putting off the pain to future get reelected, putting off the pain to future generationsgenerations

Profoundly affects natural resources Profoundly affects natural resources like energy and mineralslike energy and minerals

It never pays to discover all of the oil It never pays to discover all of the oil that exists under the ground or sea. that exists under the ground or sea. Why??Why??

Present value: when PV of oil doesn’t Present value: when PV of oil doesn’t permit risky exploration, it stopspermit risky exploration, it stops

Example of Paul Erlich and Professor Example of Paul Erlich and Professor SimonSimon

the mystery of the mystery of Mark ZuckerbergMark Zuckerberg

FacebookFacebook

Mark Zuckerberg, who owns about Mark Zuckerberg, who owns about 25% of Facebook, wants to raise 25% of Facebook, wants to raise cashcash

FacebookFacebook

Mark Zuckerberg, who owns about Mark Zuckerberg, who owns about 25% of Facebook, wants to raise 25% of Facebook, wants to raise cashcash

To avoid onerous Securities and To avoid onerous Securities and Exchange Commission (SEC) rules, Exchange Commission (SEC) rules, he must keep number of investors he must keep number of investors below 500below 500

FacebookFacebook

Mark Zuckerberg, who owns about 25% of Mark Zuckerberg, who owns about 25% of Facebook, wants to raise cashFacebook, wants to raise cash

To avoid onerous Securities and Exchange To avoid onerous Securities and Exchange Commission (SEC) rules, he must keep Commission (SEC) rules, he must keep number of investors below 500number of investors below 500

So he’s having Goldman Sachs (big fave of So he’s having Goldman Sachs (big fave of Obama administration) create an Obama administration) create an investment fund to buy “as a single buyer” investment fund to buy “as a single buyer” a chunk of FB for some $1.5 billiona chunk of FB for some $1.5 billion

FacebookFacebook

The deal values FB at $50 billionThe deal values FB at $50 billion

FacebookFacebook

The deal values FB at $50 billionThe deal values FB at $50 billion Mark owns about 25%, putting his Mark owns about 25%, putting his

net worth at about $12.5 billionnet worth at about $12.5 billion

FacebookFacebook

net worth at about $12.5 billionnet worth at about $12.5 billion The deal means that Facebook The deal means that Facebook

would be worth 25x revenues!would be worth 25x revenues!

FacebookFacebook

net worth at about $12.5 billionnet worth at about $12.5 billion The deal means that Facebook The deal means that Facebook

would be worth 25x revenues!would be worth 25x revenues! Google is valued at 25xGoogle is valued at 25x profits profits

FacebookFacebook

The deal values FB at $50 billionThe deal values FB at $50 billion Mark owns about 25%, putting his net Mark owns about 25%, putting his net

worth at about $12.5 billionworth at about $12.5 billion The deal means that Facebook would The deal means that Facebook would

be worth 25x revenues!be worth 25x revenues! Google is valued at 25xGoogle is valued at 25x profits profits Fed rules meant to protect investors Fed rules meant to protect investors

is having effect of blocking ordinary is having effect of blocking ordinary people from investing in FBpeople from investing in FB

Assignments for January Assignments for January 1818

Read and study chapter 13 of Read and study chapter 13 of Basic Basic Economics:Economics: “Risks and Insurance” “Risks and Insurance”

Assignments for January Assignments for January 1818

Read and study chapter 13 of Read and study chapter 13 of Basic Basic Economics:Economics: “Risks and Insurance” “Risks and Insurance”

After that, write a 350-word essay: Mr. After that, write a 350-word essay: Mr. G has given you $10,000 to G has given you $10,000 to investinvest. You . You have a chance to invest it this month in have a chance to invest it this month in Facebook stock via Goldman Sachs. Facebook stock via Goldman Sachs. Would you do that or something else? Would you do that or something else? What do you expect from your What do you expect from your investment? Use full Sowellian thinking investment? Use full Sowellian thinking to justify your response.to justify your response.

DPQ Time & Risk Short, three-part section Short, three-part section.

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