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Questions and Answers
What is the main objective of investing?
How is investing different from saving?
What must be done first to provide the resources for investing?
Why do some people invest in businesses?
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According to financial advisors, what do they often recommend clients to do?
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What are the capitals that can be invested in?
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What is the interest rate considered as for the borrower?
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What is the real rate of interest concerned with?
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What is the nominal interest rate also known as?
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What is the present value formula used for?
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What does the present value represent in investment decisions?
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What is the effect of inflation on the nominal interest rate?
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What is the purpose of discounting in investment evaluation?
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Study Notes
Investing Overview
- The main objective of investing is to generate a return or profit over time, typically exceeding inflation rates.
Investing vs. Saving
- Investing focuses on long-term growth potential, often involving higher risk, while saving is typically safer and prioritizes liquidity for short-term needs.
Initial Steps for Investing
- Establishing a solid financial foundation, including emergency savings and debt management, is crucial before allocating resources to investments.
Reasons for Investing in Businesses
- Individuals invest in businesses to gain ownership, earn dividends, and benefit from potential growth in value and profit through various investment vehicles.
Financial Advisors' Recommendations
- Advisors frequently suggest diversifying portfolios across different asset classes to mitigate risk and enhance growth potential.
Types of Investable Capitals
- Capital types for investment include equity (stocks), debt (bonds), real estate, and cash equivalents.
Borrower's Interest Rate Perspective
- For the borrower, the interest rate represents the cost of borrowing money and serves as compensation for the lender.
Real Rate of Interest
- The real rate of interest accounts for inflation and reflects the true earning power of money over time.
Nominal Interest Rate
- The nominal interest rate is also referred to as the stated or contractual interest rate, not adjusted for inflation.
Present Value Formula Application
- The present value formula calculates the current worth of future cash flows by discounting them back to present terms, helping in investment decisions.
Significance of Present Value
- Present value represents the maximum price a rational investor should pay today for a given future cash flow, influencing investment choices.
Inflation's Impact on Nominal Interest Rate
- Inflation generally leads to an increase in the nominal interest rate, as lenders seek to maintain their real earnings by compensating for decreased purchasing power.
Purpose of Discounting in Investment Evaluation
- Discounting is used to assess the value of future cash flows against current expenditures, aiding in determining investment viability and attractiveness.
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Description
Learn about the reasons for investing and how it differs from saving. Understand the objective of investing to increase capital supply, whether it's physical or human capital. Explore the concept of consuming income to produce a capital resource.
