Ways to carry wealth

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RISK AND INFORMATION
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INDIVIDUAL ATTITUDES TO RISK
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a FAIR GAMBLE on average yields zero monetary
profit an UNFAIR GAMBLE on average you lose
money a FAVOURABLE GAMBLE on average is
profitable
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INDIVIDUAL TASTES

• a RISK-NEUTRAL person is interested only in
  whether the odds yield a profit on average
• a RISK-AVERSE person will refuse a fair gamble
• a RISK-LOVER person bets when the odds are
  unfavourable

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Behaviour towards risk
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INSURANCE MARKET
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POOLING INDEPENDENT RISK IS THE KEY TO INSURANCE.
Risks of different jobs are independent but if we
consider them as a whole they can influence each
other.
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Risk pooling does not work when all individuals
face the same risk.
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Risk sharing works by reducing stake.
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• Two things that influance the insurance market
• moral hazard,
• adverse selection.

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WAYS TO CARRY WEALTH
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Ways to carry wealth
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Treasury bills

• Usually issued for a period of three months
• Treausry sells a bill for ex. 99 and
  simulationiusly promises to buy back the bill for
  100 in 3 months
• Not risky since the Treasury has guaranteed the
  price at which the bill will be re-purchased
• Real returnnominal return-inflation rate
• The gain is low

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Company shares

• Offer return in different ways dividends(regular
  payments of profit to shareholders) or capital
  gain(loss)
• Rate of return(dividendcapital gain)/initial
  purchase price
• More risker than bills
• This larger risk is compensed by higher return

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Why shares are risker?

• Nobody is sure what dividend the firm will pay
  (it depends what profit the firm makes and how
  conident it is about the future)
• Views about the likely capital gains change
  radically. You can never be sure your stock
  expectations.

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Shares vs Treasury bills
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PORTFOLIO SELECTION
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PORTFOLIO

• The PORTOFLIO of a financial investor is the
  bundle of financial and real assets- bank
  deposits,Treasury bills, government bonds,shares
  in industrial companies,gold,works of art- in
  which wealth is held.

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The risk-return choice

• Tastes
• Opportunities

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A diversified portfolio
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Diversification

• When there are several risky assets the investor
  may be able to reduce the risk on the whole
  portfolio without having to accept a lower
  average return on portfolio.

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Diversifying risk
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Diversification when asset returns are correlated

• When assets returns move together, we say that
  they are correlated
• When returns on two asstes tend to move in the
  same direction they are positively correlated,
  the opposite situation is called negative
  correlation.

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BETA

• Beta measures how much an assets return moves
  with the return on the whole stock market.

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EFFICIENT ASSETS MARKET
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• There are two basic images of the stock market
• Casino
• Theory of efficient market

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Testing for efficiency. The theory of efficiency
assets market says there is no neglected
information to be used to get some money.
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Speculative bubbles
The prices depend on what people today think,
people tomorrow will expect, people the next day
to expect.
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RISK
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Risk
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Spot and Forward market

• Spot market deals in contracts for immediate
  delivery payment
• Forward market deals in contracts made today for
  delivery goods at a specified future date at a
  price agreed today.
• There are forward markets for many commodities
  and assets as corn, coffee, sugar, copper, gold
  etc.

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Hedging against the risk and speculations

• It is used in forward market to shift the risk
  onto somebody else
• A speculator temporarily holds an asset in the
  hope of making a capital gain
• He expects to get money compensation for bearing
  the risk
• Forward markets do not exist for most goods
  because it is not possible to write legally
  binding and cheaply emfordable contracts and
  adequatly specify the character of good beeing
  traded.

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Compensating differentials it the return to labour
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Own buisness