Professional Documents
Culture Documents
Introduction
They are known as Bowie bonds. The returns on the first Bowie bonds, which were issued in 1997, are based on royalties generated by sales of songs and albums by 1970s rock star David Bowie. Bowie bonds are just one particular type of bond traded in markets for securities, or legal claims on firms that most of us more commonly refer to as stocks and bonds. In this chapter, you will learn about how securities markets function. In addition, you will learn about economic rents, economic profits, and the allocative role of interest.
22-2
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Learning Objectives
Understand the concept of economic rent Distinguish among the main organizational forms of business and explain the chief advantages and disadvantages of each Explain the difference between accounting profits and economic profits
22-3
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-4
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Chapter Outline
Economic Rent Firms and Profits Interest Corporate Financing Methods The Markets for Stocks and Bonds
22-5
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Economic Rent
Economic Rent
A payment for the use of any resource over and above its opportunity cost Thus, rent has a different meaning in economics.
22-7
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-8
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-9
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-10
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-11
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-12
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Example: Do Entertainment Superstars Make Super Economic Rents? How much of superstars earnings can be called economic rent? A newcomer would almost certainly work for much less than he or she earns, implying that the newcomer is making high economic rent. Seasoned entertainers probably have very high accumulated wealth and also a more jaded outlook about their work. It is therefore not clear how much they would work if they were not offered those huge sums of money. Even if some superstars would work for less, what forces cause them to make so much income anyway?
22-13
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-14
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-15
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-16
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-17
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-18
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-19
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-20
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Limited ability to raise funds Proprietorship normally ends with the death of the proprietor.
22-21
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-22
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-23
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-24
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-25
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-26
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-27
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-28
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-29
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-30
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-31
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-32
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-33
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-34
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-35
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-36
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-37
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-38
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-39
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Interest
Interest is the price paid from debtors to creditors for the use of loanable funds. Businesses use financial capital in order to invest in physical capital.
22-40
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Interest (cont'd)
Financial Capital
Funds used to purchase physical capital goods, such as buildings and equipment
Interest
The payment for current rather than future command over resources; the cost of obtaining credit
22-41
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Interest (cont'd)
Variations in the rate of annual interest that must be paid for credit depend on
1. Length of loan 2. Risk 3. Handing charges
22-42
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Interest (cont'd)
Nominal Rate of Interest
The market rate of interest expressed in todays dollars
22-43
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Interest (cont'd)
We can say that the nominal, or market, rate of interest is approximately equal to the real rate of interest plus anticipated inflation, or in = ir + anticipated inflation rate
22-44
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Interest (cont'd)
Interest is a price that allocates loanable funds (credit) to consumers and businesses. Investment, or capital, projects with rates of return higher than the market rate of interest will be undertaken. The interest rate performs the function of allocating financial capital thus ultimately allocating physical capital.
22-45
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Interest (cont'd)
Businesses make investments which often incur large costs. They need to compare their investment cost today with a stream of future profits. They must relate present costs to future benefits. Interest rates are used to link the present with the future.
22-46
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Interest (cont'd)
Present Value
The value of a future amount expressed in todays dollars The most that someone would pay today to receive a certain sum at some point in the future
22-47
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Interest (cont'd)
PV1 = FV1 / 1 + i
where
PV1 = Present value of a sum one year hence FV1 = Future sum paid or received one year hence i = Market rate of interest
22-48
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Interest (contd)
Present value of $105 to be received one year from now, if the interest rate is 5%:
PV = 105/(1.05) = $100 The present value is $100
22-49
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Interest (contd)
How much would have to be put in a savings account today to have $105 two years from now if the account pays 5% per year compounded annually?
PV2 x (1.05)2 = $105 PV2 x $105 = $95.24 (105)2
22-50
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-51
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Interest (cont'd)
Discounting
The method by which the present value of a future sum or a future stream of sums is obtained
Rate of Discount
The rate of interest used to discount future sums back to present value
22-52
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Interest (cont'd)
Your own personal discount rate will determine how willing you are to save and to borrow. The market interest rate lies between the upper and lower ranges of personal rates of discount.
22-53
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-54
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Preferred stock
Owners are accorded preferential treatment in the payment of dividends
22-55
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-56
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-57
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Bonds
1. Bonds represent debt.
2. Interest on bonds must always be paid, whether or not any profit is earned. 3. Stockholders can elect a board of 3. Bondholders usually have no voice in or directors, which controls the corporation. over management of the corporation. 4. Stocks do not have a maturity date; 4. Bonds have a maturity date on which the corporation does not usually the bondholder is to be repaid the face repay the stockholder. value of the bond. 5. All corporations issue or offer to sell 5. Corporations need not issue bonds. stocks. This is the usual definition of a corporation. 6. Stockholders have a claim against the property and income of a corporation 6. Bondholders have a claim against the after all creditors claims have been met. property and income of a corporation that must be met before the claims of stockholders. 22-58
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-59
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-60
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-61
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-63
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-64
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
22-66
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Issues and Applications: How Musicians Increasingly Rely on Stocks and Bonds Professional classical musicians increasingly are issuing stocks and bonds to finance activities. Some musicians sell shares to raise funds for expensive instruments. German company SellaBand coordinates start-up funding efforts for more than 250 fledgling rock bands. Fans can buy shares online for $10 apiece. Musicians like David Bowie raise money by issuing securities with returns derived from the stream of revenues from continuing sales of his albums. Why might shares in a cello or a violin be less liquid than shares of stock in a major U.S. Corporation?
22-67
Copyright 2010 Pearson Addison-Wesley. All rights reserved.