Llad Phillips1 Introduction to Economics Elements of Personal Finance

Llad Phillips2 Econ 109 Class Page Econ Home Page: Econ Home Page:

Llad Phillips3 Labs(sections) F 9:00-9:50 AMJalama Lab, Phelps 1517 MCL12625M 2:00-2:50 PMMiramar Lab, Phelps M 7:00-7:50 PMMiramar Lab, Phelps W 8:00-8:50 AMMiramar Lab, Phelps T 6:30- 7:20 PMMiramar Lab, Phelps F 1:00-1:50 PMLedbetter Lab, Phelps Checking Instructional Computing Lab Scedules

Llad Phillips4 Announcements addresses addresses  Llad Phillips  Llad Phillips  Donghun Cho  Donghun Cho  Taeil Kang  Taeil Kang  Kirk Lesh  Kirk Lesh

Course Grading If you complete over 70 % of both the text Problems and Lab Exercises, then your course grade is increased by 1/3 grade point

Llad Phillips6 Economics in the News What can we learn from the newspaper? What can we learn from the newspaper?

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8 Bond Market Quantity of Funds, $ Supply of Funds Interest Rate On Bonds Demand for Funds

Llad Phillips9 Bond Market Quantity of Funds, $ Shift in the Supply of Funds Interest Rate On Bonds Demand for Funds

Llad Phillips10 Background on US Labor Force Definitions Civilian non-institutional population: those not in hospitals, jails etc. Civilian non-institutional population: those not in hospitals, jails etc. civilian non-institutional population is either in the labor force (working or looking for work) or not in the labor force civilian non-institutional population is either in the labor force (working or looking for work) or not in the labor force civilian labor force participation rate is the proportion of the civilian noninstitutional population in the labor force civilian labor force participation rate is the proportion of the civilian noninstitutional population in the labor force

Llad Phillips11 U S Statistical Abstract

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Llad Phillips13 Background on the US Labor Market Civilian Labor Force Participation Rate

Llad Phillips14 Male Civilian Labor Force Participation Rate

Llad Phillips15 Female Civilian Labor Force Participation Rate

Llad Phillips Years Old Civilian Labor Force Participation Rate

Llad Phillips17 Current Economic Events % of Civilian Labor Force That Is Unemployed

Llad Phillips18 Lecture Four Some people in class do not work, but study Some people in class do not work, but study Some people in class work and study Some people in class work and study Some of your friends may work full time and not study Some of your friends may work full time and not study What is the story?

Llad Phillips19 4. Tuesday, Oct 8, Lecture Four: "Markowitz Efficiency Portfolio Analysis" Wall Street Journal Video, Guide to Money and Markets ( on reserve in Kerr Hall) Markowitz Efficient Portfolio Analysis Reading Assignment: Money 101 “Basics of Investing” O’Sullivan and Sheffrin: Ch. 4, “Supply, Demand and Market Equilibrium” emphasis: the law of demand and market supply Problems O & S Text pp : 1, 2, 3, 4, 5, 6, 7

Llad Phillips20 Outline: Lecture Four Determinants of Personal Income (cont.) Determinants of Personal Income (cont.) Markowitz Efficient Portfolio Analysis Markowitz Efficient Portfolio Analysis Interest rate, % per year, APR Interest rate, % per year, APR Video Guide to Money and Markets Video Guide to Money and Markets

Llad Phillips21 Determinants of Personal Income Life Cycle Model Life Cycle Model Learning and Earning Learning and Earning Your Market Wage Depends on Your Market Wage Depends on  your human capital Allocating your time between Learning and Earning Allocating your time between Learning and Earning  24 hour endowment  your tastes for learning versus earning

Llad Phillips22 Explaining Differences in Behavior Different Opportunities Different Opportunities Different Tastes Different Tastes Possibly Both Possibly Both

Llad Phillips23 24 hours0 hours Leisure (learning) Earnings $480 Opportunities for trading leisure for earnings (income) at a rate, $20 per hour, the market wage, determined by your stock of human capital(step one of the paradigm: describing the alternatives for choice) $ 0

Llad Phillips24 24 hours 0 hours $480 $ 0 Savings, $ from home

24 hours0 hours Leisure (learning) Earnings $480 $ 0 $240 dropout college grad Comparative market wages as determined by accumulated knowledge

Llad Phillips26 Choosing Between Learning and Earning How much time for learning? How much time for learning? How much time for earning? How much time for earning? This choice, like all choices depends on your tastes This choice, like all choices depends on your tastes  Do you want to earn and consume now?  Do you want to learn, earn more in the future, and consume more in the future?

Llad Phillips27 Economists Assume You Can make Comparisons example: more leisure and less income versus less leisure and more income example: more leisure and less income versus less leisure and more income  recall Lecture One: an Altima Vs. a Taurus

Llad Phillips28 Economists Assume You Can Make Tradeoffs How much income will you demand to give up your leisure? How much income will you demand to give up your leisure?

24 hours 0 hours Leisure (learning) Earnings $480 $ 0 Iso-Preference Curves: You value all points on a curve equally(step two of the paradigm: valuing the alternatives for choice) Depicting your tastes graphically: iso-preference or indifference curves

24 hours0 hours Leisure (learning) Earnings $480 $ 0 Iso-Preference Curves: You value all points on a curve equally high low value high value Depicting your tastes graphically

24 hours0 hours Leisure (learning) Earnings $480 $ 0 Iso-Preference Curves: You value all points on a curve equally high low value high value The choice between leisure and earning now:picking the best alternative alternatives

24 hours0 hours Leisure (learning) Earnings $480 $ 0 high low value high value Optimum 15 hours of leisure $180 for 9 hrs of work Individual’s Supply of Labor

Llad Phillips33 24 hours 0 hours $480 $ 0 high low value Savings, $ from home Higher value

Llad Phillips34 24 hours 0 hours $480 $ 0 high low value Savings, $ from home Higher value

24 hours 0 hours Leisure (learning) Earnings $480 $ 0 high low value slope of the iso-preference curve through the 24 hour endowment is the lowest wage at which you are willing to work $96 dropout is unwilling to work for $4/hr

Llad Phillips36 Poverty in the United States Attributable to differences in earning power Attributable to differences in earning power  Policy: equal opportunity for education

Llad Phillips37 Personal Investing Power of Compound Interest Power of Compound Interest  exponential growth Based on Doubling Your Money Every Four Years Based on Doubling Your Money Every Four Years  rate of growth: 17% per year

Llad Phillips38 Growing Wealth at 17% per Year

Llad Phillips39 Growth of $31,250 at Two Different Rates Year Amount seventeenplus three $57,000

Llad Phillips40 Personal Investing How do you choose between stocks or bonds as a personal investment? How do you choose between stocks or bonds as a personal investment? How do you choose between mutual funds? How do you choose between mutual funds? Are stocks and bonds too risky? Should you keep your money in cash or gold? Are stocks and bonds too risky? Should you keep your money in cash or gold?

Llad Phillips41 Creed For Success Ben Franklin: “A penny saved is a penny earned” Ben Franklin: “A penny saved is a penny earned”  mind those pennies, budget and be frugal  save, I.e. tithe yourself Diversify Your investments Diversify Your investments  cash  housing  bonds  stocks Invest in a Stock Index Fund Invest in a Stock Index Fund

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Llad Phillips45 Dow Jones Industrials Index

Growth Rate 13% per Year

Llad Phillips47 Example: UC Funds Suppose you invest up to $10,000 per year in a tax sheltered 403(b) plan Suppose you invest up to $10,000 per year in a tax sheltered 403(b) plan  you have to save $10,000, but you would have to pay income taxes if you took it as income UC investment alternatives UC investment alternatives  guaranteed insurance contract(GIC)  savings fund  money market fund  bond fund  stock index fund  multi-asset fund

Llad Phillips48 Investment Concepts monthly return for June 2001 on an asset monthly return for June 2001 on an asset  price(June) - price(May) + dividends  price(June) - price(May): capital gain(loss)  dividends(interest): income from stocks(bonds) monthly rate of return for June 2001 monthly rate of return for June 2001  [price(June) - price(May) + dividends]/price(May)  in %, multiply by 100 annual rate: multiply by 12annual rate: multiply by 12

Llad Phillips49 Example: UC Funds/Mutual Funds Sources of information on UC funds Sources of information on UC funds  monthly, quarterly, annual, etc. rates of return  internet:  Notice, a publication of the UC Academic Senate Source of Information on Mutual Funds Source of Information on Mutual Funds  quarterly  The Wall Street Journal, Mutual Funds Quarterly Review, e.g. extra section in July 3, 1997 Journal

Llad Phillips53 UC Funds: Equity Vs. Insurance Insurance Insurance  steady at a rate of return of about 0.6 per month or 7.2% per year  does not vary much  never negative Equity Equity  rate of return varies a lot from month to month  range of rates of return from about plus 9% in Mar. ‘00 to minus 13% in Aug ‘98  can turn negative: 29 months out of 72

Llad Phillips56 Two Kinds of Assets low rate of return- low variability low rate of return- low variability want high rate of return return on average want high rate of return return on average want low variability want low variability  predictable average return high return-high variability high return-high variability want high rate of return on average want high rate of return on average want low variability want low variability Dilemma: which kind of asset to hold?

Llad Phillips57 Investment Principles or Maxims Don’t put all of your eggs in one basket Don’t put all of your eggs in one basket  hold a diversified portfolio  cash  bonds  stocks  real estate  advantage of a mutual fund  instead of holding one stock, e.g. Coca-Cola, you hold a bundle of stocks Choose the asset with the highest reward for a given level of risk Choose the asset with the highest reward for a given level of risk

Measures of Average Rate of Return and Variability: Mean & Std. Dev.

Mean Returns & Standard Deviations

Efficient Portfolio: Most Return for Given Risk

Llad Phillips63 Your portfolio should be on the efficient frontier But where on the frontier? But where on the frontier?  depends on your taste for reward and risk  reward, i.e. the mean rate of return is a good  risk is a bad

Llad Phillips64 Economic Paradigm: Valuation of Mean Return and Risk Assumption: Mean Return is Good, Risk is Bad: U =U(M,R) Mean Return, M Risk, R better worse Iso - Preference Curves A B C Prefer B to A; Prefer B to C

Efficient Portfolio: Most Return for Given Risk Investor A: very risk averse

Efficient Portfolio: Most Return for Given Risk

Llad Phillips67 Efficient UC Investment Portfolio f*insurance contract + (1-f)*equity fund f*insurance contract + (1-f)*equity fund  where f can range from zero to one  example: 50:50, i.e one half of your nest egg is invested in the Insurance Contract and the other half is invested in the Equity Fund. mean return: 1/2 * /2*1.09 = 0.84 % per monthmean return: 1/2 * /2*1.09 = 0.84 % per month expected risk(standard deviation: 1/2* /2*4.34 =2.18expected risk(standard deviation: 1/2* /2*4.34 =2.18

Llad Phillips68 –exercise: show that this mean portfolio return –and expected risk lie on the efficient frontier – connecting the insurance contract and the –equity fund

Llad Phillips69 Summary-Vocabulary-Concepts Markowitz Portfolio Analysis Markowitz Portfolio Analysis stock index fund stock index fund bond fund bond fund money market fund money market fund guaranteed insurance contract guaranteed insurance contract monthly rate of return monthly rate of return capital gains capital gains dividends dividends mean rate of return on an asset mean rate of return on an asset risk of holding an asset risk of holding an asset a risk averse person a risk averse person investment portfolio investment portfolio

Llad Phillips70 Interest Rate Per Year On A Loan Example: One Payment loan amount: $1000 loan amount: $1000 annual interest rate: 10% annual interest rate: 10% one payment at the end of the year one payment at the end of the year  pay back principal: $1,000  pay the interest on $1000 for a year: $100  principal*interest rate = interest  $1000*0.1 = $100  total payment due: $1100

Llad Phillips71 Interest Rate Per Year On A Loan Example: Twelve Monthly Payments loan amount: $1000 loan amount: $1000 annual interest rate: 10% annual interest rate: 10% Twelve Monthly Payments Twelve Monthly Payments  pay back principal of $1000  pay interest on the amount owed  declining amount owed since you pay back some principal each month, until balance of principal owed is zero after twelve payments  use Excel’s PMT function to calculate

Llad Phillips72 $1000 Principal Time one year Declining Balance, 12 monthly payments one payment of principal plus interest at the end of the year

Llad Phillips73 Twelve Monthly Payments