{"version":"1.0.0","segments":[{"startTime":0.13,"endTime":4.5,"body":"- How do we decide whether"},{"startTime":0.13,"endTime":4.5,"body":"to take a financial decision?"},{"startTime":4.5,"endTime":7.19,"body":"How do we compare investments"},{"startTime":4.5,"endTime":7.19,"body":"when they might pay off"},{"startTime":7.19,"endTime":9.15,"body":"in different time periods?"},{"startTime":9.15,"endTime":11.06,"body":"And how do we make investment decisions"},{"startTime":11.06,"endTime":12.85,"body":"when people might disagree?"},{"startTime":12.85,"endTime":15.08,"body":"Somebody might prefer"},{"startTime":12.85,"endTime":15.08,"body":"a short-term investment"},{"startTime":15.08,"endTime":18.17,"body":"and somebody else might"},{"startTime":15.08,"endTime":18.17,"body":"prefer something long term."},{"startTime":18.17,"endTime":19.81,"body":"And how do we deal with investments,"},{"startTime":19.81,"endTime":21.37,"body":"which are quite complicated"},{"startTime":21.37,"endTime":23.48,"body":"and pay lots of different cash flows"},{"startTime":23.48,"endTime":25.7,"body":"in many different time periods."},{"startTime":25.7,"endTime":28.56,"body":"So these are the questions"},{"startTime":25.7,"endTime":28.56,"body":"that I'll be exploring today"},{"startTime":28.56,"endTime":31.61,"body":"in my third lecture in"},{"startTime":28.56,"endTime":31.61,"body":"my Gresham College series"},{"startTime":31.61,"endTime":33.25,"body":"on the principles of finance."},{"startTime":33.25,"endTime":36.48,"body":"Today's lecture is called how"},{"startTime":33.25,"endTime":36.48,"body":"to make financial decisions."},{"startTime":36.48,"endTime":39.35,"body":"Thank you very much to"},{"startTime":36.48,"endTime":39.35,"body":"everybody for attending."},{"startTime":39.35,"endTime":41.79,"body":"So maybe a good place to"},{"startTime":39.35,"endTime":41.79,"body":"start is to think about,"},{"startTime":41.79,"endTime":45.0,"body":"well, what is an investment to begin with?"},{"startTime":45.0,"endTime":48.08,"body":"Now, when most people"},{"startTime":45.0,"endTime":48.08,"body":"think about investments,"},{"startTime":48.08,"endTime":51.19,"body":"they probably have in mind"},{"startTime":48.08,"endTime":51.19,"body":"buying stocks and shares."},{"startTime":51.19,"endTime":55.38,"body":"So that was what I considered"},{"startTime":51.19,"endTime":55.38,"body":"in my lecture last October,"},{"startTime":55.38,"endTime":57.79,"body":"how the stock market works."},{"startTime":57.79,"endTime":60.76,"body":"Now with shares, what you're doing is"},{"startTime":60.76,"endTime":63.802,"body":"you're spending some money"},{"startTime":60.76,"endTime":63.802,"body":"now to buy the shares"},{"startTime":63.802,"endTime":66.14,"body":"and you're getting"},{"startTime":63.802,"endTime":66.14,"body":"something in the future."},{"startTime":66.14,"endTime":67.69,"body":"What do they shares give?"},{"startTime":67.69,"endTime":70.093,"body":"They give dividends and capital gains."},{"startTime":71.36,"endTime":76.36,"body":"But if an investment is something"},{"startTime":71.36,"endTime":76.36,"body":"that costs you money now"},{"startTime":76.75,"endTime":79.8,"body":"and gives you some benefits in the future,"},{"startTime":79.8,"endTime":82.8,"body":"then it extends to more"},{"startTime":79.8,"endTime":82.8,"body":"than just buying shares."},{"startTime":82.8,"endTime":85.53,"body":"And that's really important"},{"startTime":82.8,"endTime":85.53,"body":"because if the only thing"},{"startTime":85.53,"endTime":87.57,"body":"I was going to look at"},{"startTime":85.53,"endTime":87.57,"body":"here is how to buy shares,"},{"startTime":87.57,"endTime":90.58,"body":"that's not a common decision"},{"startTime":87.57,"endTime":90.58,"body":"that we make every day"},{"startTime":90.58,"endTime":92.74,"body":"instead what I want to stress is that"},{"startTime":92.74,"endTime":96.0,"body":"we make financial decisions all the time."},{"startTime":96.0,"endTime":98.418,"body":"And therefore the power of"},{"startTime":96.0,"endTime":98.418,"body":"knowing how to make financial"},{"startTime":98.418,"endTime":101.17,"body":"decisions is actually much more important"},{"startTime":101.17,"endTime":103.3,"body":"and much more common"},{"startTime":101.17,"endTime":103.3,"body":"and much more relevant"},{"startTime":103.3,"endTime":105.09,"body":"than we might think."},{"startTime":105.09,"endTime":108.1,"body":"So what I'd look to look at"},{"startTime":105.09,"endTime":108.1,"body":"is to extend the discussion"},{"startTime":108.1,"endTime":112.51,"body":"from financial investments"},{"startTime":108.1,"endTime":112.51,"body":"to real investments."},{"startTime":112.51,"endTime":114.87,"body":"So what is a real investment?"},{"startTime":114.87,"endTime":118.4,"body":"It's anything that costs us money"},{"startTime":118.4,"endTime":121.18,"body":"and gives us a benefit in the future"},{"startTime":121.18,"endTime":125.44,"body":"and that benefit is something"},{"startTime":121.18,"endTime":125.44,"body":"with intrinsic value"},{"startTime":125.44,"endTime":127.51,"body":"in and of itself."},{"startTime":127.51,"endTime":129.61,"body":"What does it mean to have intrinsic value?"},{"startTime":129.61,"endTime":133.28,"body":"Well, if you are, for example,"},{"startTime":129.61,"endTime":133.28,"body":"a company and you're buying,"},{"startTime":133.28,"endTime":136.48,"body":"building a new factory,"},{"startTime":133.28,"endTime":136.48,"body":"that factory has value."},{"startTime":136.48,"endTime":141.0,"body":"That factory will be churning"},{"startTime":136.48,"endTime":141.0,"body":"out cars or toys or clothes"},{"startTime":141.0,"endTime":144.04,"body":"and those cars and toys and"},{"startTime":141.0,"endTime":144.04,"body":"clothes are worth something"},{"startTime":144.04,"endTime":145.48,"body":"in and of themselves."},{"startTime":145.48,"endTime":147.71,"body":"It's not just that you're getting money."},{"startTime":147.71,"endTime":150.65,"body":"Like you are with a"},{"startTime":147.71,"endTime":150.65,"body":"stock paying dividends."},{"startTime":150.65,"endTime":152.5,"body":"Similarly, as a person,"},{"startTime":152.5,"endTime":154.53,"body":"if you're going to choose"},{"startTime":152.5,"endTime":154.53,"body":"to renovate your house"},{"startTime":154.53,"endTime":156.11,"body":"or to renovate your kitchen,"},{"startTime":156.11,"endTime":160.22,"body":"that new kitchen also has"},{"startTime":156.11,"endTime":160.22,"body":"intrinsic value, right?"},{"startTime":160.22,"endTime":163.16,"body":"Because that's something"},{"startTime":160.22,"endTime":163.16,"body":"that you can enjoy."},{"startTime":163.16,"endTime":165.6,"body":"Now, interestingly, we can"},{"startTime":163.16,"endTime":165.6,"body":"think of wheel investments"},{"startTime":165.6,"endTime":168.28,"body":"as not only tangible investments,"},{"startTime":168.28,"endTime":171.61,"body":"where that benefit you get"},{"startTime":168.28,"endTime":171.61,"body":"is something that you can see"},{"startTime":171.61,"endTime":176.61,"body":"and touch, but also some"},{"startTime":171.61,"endTime":176.61,"body":"investments have intangible value."},{"startTime":177.15,"endTime":178.81,"body":"And so that's something"},{"startTime":177.15,"endTime":178.81,"body":"that you can't see,"},{"startTime":178.81,"endTime":180.46,"body":"but it still has a lot of value."},{"startTime":180.46,"endTime":182.66,"body":"For example, just attending this lecture,"},{"startTime":182.66,"endTime":184.86,"body":"hopefully there's intrinsic value to this."},{"startTime":184.86,"endTime":187.79,"body":"It might help you make financial"},{"startTime":184.86,"endTime":187.79,"body":"decisions in the future,"},{"startTime":187.79,"endTime":189.91,"body":"or maybe it's just interesting."},{"startTime":189.91,"endTime":192.99,"body":"Why? We might take the"},{"startTime":189.91,"endTime":192.99,"body":"sessions because we enjoy it."},{"startTime":192.99,"endTime":194.78,"body":"And that's something which really matters."},{"startTime":194.78,"endTime":197.08,"body":"I know economists only"},{"startTime":194.78,"endTime":197.08,"body":"like to think about things,"},{"startTime":197.08,"endTime":199.53,"body":"which we can convert into monetary terms,"},{"startTime":199.53,"endTime":202.65,"body":"but welfare and happiness and utility,"},{"startTime":202.65,"endTime":204.73,"body":"these are all really important reasons"},{"startTime":204.73,"endTime":206.483,"body":"for why we take decisions."},{"startTime":207.41,"endTime":208.76,"body":"And what about a company?"},{"startTime":208.76,"endTime":212.2,"body":"What's an example of something"},{"startTime":208.76,"endTime":212.2,"body":"within tangible value."},{"startTime":212.2,"endTime":215.4,"body":"Let's say you're going to choose"},{"startTime":212.2,"endTime":215.4,"body":"to give more parental leave"},{"startTime":215.4,"endTime":217.03,"body":"to your employees."},{"startTime":217.03,"endTime":220.45,"body":"That's something that makes"},{"startTime":217.03,"endTime":220.45,"body":"the employees more motivated"},{"startTime":220.45,"endTime":223.29,"body":"and more happy and more likely to stay."},{"startTime":223.29,"endTime":225.2,"body":"It's something you can't see,"},{"startTime":225.2,"endTime":229.38,"body":"but clearly it has future"},{"startTime":225.2,"endTime":229.38,"body":"value to those employees"},{"startTime":229.38,"endTime":230.583,"body":"and therefore to you."},{"startTime":231.72,"endTime":234.89,"body":"So the defining feature of"},{"startTime":231.72,"endTime":234.89,"body":"any investment is something"},{"startTime":234.89,"endTime":237.95,"body":"that costs us money today,"},{"startTime":237.95,"endTime":240.77,"body":"but gives you some benefits in the future."},{"startTime":240.77,"endTime":244.38,"body":"Some of those benefits might"},{"startTime":240.77,"endTime":244.38,"body":"be direct cash benefits"},{"startTime":244.38,"endTime":247.35,"body":"like dividends of a share,"},{"startTime":247.35,"endTime":250.14,"body":"or some of those other"},{"startTime":247.35,"endTime":250.14,"body":"benefits are not in cash,"},{"startTime":250.14,"endTime":252.387,"body":"but they might have monetary value."},{"startTime":252.387,"endTime":254.71,"body":"For example, if you're"},{"startTime":252.387,"endTime":254.71,"body":"factually your belt,"},{"startTime":254.71,"endTime":256.07,"body":"but making some clothes,"},{"startTime":256.07,"endTime":258.21,"body":"you might be able to sell those clothes,"},{"startTime":258.21,"endTime":261.38,"body":"or you might be able to"},{"startTime":258.21,"endTime":261.38,"body":"sell to a house for more"},{"startTime":261.38,"endTime":263.493,"body":"now that it has a better kitchen."},{"startTime":264.88,"endTime":266.97,"body":"Now you might think, well,"},{"startTime":266.97,"endTime":268.42,"body":"how do we make financial decisions?"},{"startTime":268.42,"endTime":269.93,"body":"Isn't that really simple?"},{"startTime":269.93,"endTime":273.59,"body":"Don't we just compare"},{"startTime":269.93,"endTime":273.59,"body":"all the future benefits"},{"startTime":273.59,"endTime":275.79,"body":"that we're getting, add them all up"},{"startTime":275.79,"endTime":279.673,"body":"and then compare them to"},{"startTime":275.79,"endTime":279.673,"body":"the cost of the investment."},{"startTime":279.673,"endTime":283.23,"body":"And you can't do that because"},{"startTime":279.673,"endTime":283.23,"body":"they're not apples to apples"},{"startTime":283.23,"endTime":284.91,"body":"for two reasons."},{"startTime":284.91,"endTime":288.96,"body":"The first reason is that the"},{"startTime":284.91,"endTime":288.96,"body":"cost of the investment today"},{"startTime":288.96,"endTime":293.96,"body":"is something certain, but"},{"startTime":288.96,"endTime":293.96,"body":"the future benefit is risky."},{"startTime":295.27,"endTime":297.63,"body":"For example, if we're"},{"startTime":295.27,"endTime":297.63,"body":"building any factory,"},{"startTime":297.63,"endTime":300.41,"body":"how do we know that people will"},{"startTime":297.63,"endTime":300.41,"body":"even want to buy our clothes"},{"startTime":300.41,"endTime":301.51,"body":"in the future?"},{"startTime":301.51,"endTime":304.11,"body":"How do we know what the"},{"startTime":301.51,"endTime":304.11,"body":"state of the economy will be?"},{"startTime":304.11,"endTime":306.31,"body":"Maybe there'll be a recession and nobody's"},{"startTime":306.31,"endTime":307.483,"body":"going to want to buy them."},{"startTime":308.68,"endTime":311.6,"body":"Now that is something we're"},{"startTime":308.68,"endTime":311.6,"body":"not going to look at today."},{"startTime":311.6,"endTime":313.95,"body":"We're going to look at the next lecture"},{"startTime":313.95,"endTime":316.56,"body":"on how to measure and manage risk."},{"startTime":316.56,"endTime":319.91,"body":"The fact that some of these"},{"startTime":316.56,"endTime":319.91,"body":"cash flows are certain,"},{"startTime":319.91,"endTime":323.07,"body":"but the benefits in the future"},{"startTime":319.91,"endTime":323.07,"body":"are going to be uncertain"},{"startTime":323.07,"endTime":324.52,"body":"and risky."},{"startTime":324.52,"endTime":327.08,"body":"But what we are going to look"},{"startTime":324.52,"endTime":327.08,"body":"at today is the fact that"},{"startTime":327.08,"endTime":331.26,"body":"these cash flows occur at different time."},{"startTime":331.26,"endTime":332.95,"body":"When we're making an investment,"},{"startTime":332.95,"endTime":336.26,"body":"we incur that cash cost today,"},{"startTime":336.26,"endTime":339.08,"body":"but the benefits come in the future"},{"startTime":339.08,"endTime":342.23,"body":"and we're going to explain"},{"startTime":339.08,"endTime":342.23,"body":"that cash in the future"},{"startTime":342.23,"endTime":345.02,"body":"is worth less than cash today"},{"startTime":345.02,"endTime":347.24,"body":"because of a fundamental concept called"},{"startTime":347.24,"endTime":349.35,"body":"the time value of money."},{"startTime":349.35,"endTime":350.81,"body":"And that's what I'm"},{"startTime":349.35,"endTime":350.81,"body":"going to be focusing on"},{"startTime":350.81,"endTime":352.1,"body":"in today's lecture,"},{"startTime":352.1,"endTime":354.69,"body":"how we can compare different investments"},{"startTime":354.69,"endTime":356.15,"body":"in different cash flows"},{"startTime":356.15,"endTime":360.133,"body":"when those cash occur at"},{"startTime":356.15,"endTime":360.133,"body":"different time periods."},{"startTime":362.42,"endTime":365.55,"body":"You might think the idea"},{"startTime":362.42,"endTime":365.55,"body":"of the time value of money."},{"startTime":365.55,"endTime":367.5,"body":"Well, that's quite subjective."},{"startTime":367.5,"endTime":371.79,"body":"Yes, we've got some sense"},{"startTime":367.5,"endTime":371.79,"body":"that we prefer cash today"},{"startTime":371.79,"endTime":373.63,"body":"to cash in the future,"},{"startTime":373.63,"endTime":378.01,"body":"but doesn't that preference"},{"startTime":373.63,"endTime":378.01,"body":"depend on who we are."},{"startTime":378.01,"endTime":378.85,"body":"For example,"},{"startTime":378.85,"endTime":382.523,"body":"let's take a little child or"},{"startTime":378.85,"endTime":382.523,"body":"a little child's trust fund."},{"startTime":383.7,"endTime":387.32,"body":"Now this little child"},{"startTime":383.7,"endTime":387.32,"body":"probably is willing to wait"},{"startTime":387.32,"endTime":389.82,"body":"many, many years, perhaps decades"},{"startTime":389.82,"endTime":391.45,"body":"for an investment to pay off."},{"startTime":391.45,"endTime":393.54,"body":"So maybe he's going to be quite patient."},{"startTime":393.54,"endTime":396.26,"body":"He doesn't mind in investing in a project,"},{"startTime":396.26,"endTime":399.2,"body":"let's say an electric car factory,"},{"startTime":399.2,"endTime":401.853,"body":"which might take many decades to pay off."},{"startTime":402.93,"endTime":407.06,"body":"But then in contrast,"},{"startTime":402.93,"endTime":407.06,"body":"let's take a pension fund,"},{"startTime":407.06,"endTime":410.29,"body":"which exists to make some"},{"startTime":407.06,"endTime":410.29,"body":"returns for pensioners."},{"startTime":410.29,"endTime":414.06,"body":"Now, pensioners might not be"},{"startTime":410.29,"endTime":414.06,"body":"around in several decades time."},{"startTime":414.06,"endTime":418.09,"body":"So they might want a different"},{"startTime":414.06,"endTime":418.09,"body":"project which pays back cash"},{"startTime":418.09,"endTime":420.263,"body":"flows today or next year."},{"startTime":421.34,"endTime":425.43,"body":"Now that has the potential"},{"startTime":421.34,"endTime":425.43,"body":"to create a lot of conflict."},{"startTime":425.43,"endTime":426.61,"body":"Why?"},{"startTime":426.61,"endTime":429.29,"body":"Because most companies are owned by"},{"startTime":429.29,"endTime":431.71,"body":"more than one shareholder."},{"startTime":431.71,"endTime":434.34,"body":"And those shareholders might disagree"},{"startTime":434.34,"endTime":438.53,"body":"as to what the optimal"},{"startTime":434.34,"endTime":438.53,"body":"investment decision is."},{"startTime":438.53,"endTime":441.12,"body":"Let's say you're a car"},{"startTime":438.53,"endTime":441.12,"body":"company and you think,"},{"startTime":441.12,"endTime":443.55,"body":"do I make traditional vehicles"},{"startTime":443.55,"endTime":447.96,"body":"or do I invest in self-driving"},{"startTime":443.55,"endTime":447.96,"body":"cars or electric cars?"},{"startTime":447.96,"endTime":450.88,"body":"You might have to consult"},{"startTime":447.96,"endTime":450.88,"body":"all your shareholders"},{"startTime":450.88,"endTime":454.35,"body":"and ask them, do you"},{"startTime":450.88,"endTime":454.35,"body":"want to quick buck today"},{"startTime":454.35,"endTime":456.04,"body":"ar you're willing to wait many years,"},{"startTime":456.04,"endTime":458.67,"body":"maybe decades for the future return."},{"startTime":458.67,"endTime":461.85,"body":"And that's going to be"},{"startTime":458.67,"endTime":461.85,"body":"extremely cumbersome process."},{"startTime":461.85,"endTime":464.17,"body":"And what happens if they"},{"startTime":461.85,"endTime":464.17,"body":"disagreed or they fight it out"},{"startTime":464.17,"endTime":467.02,"body":"or do they have a debate"},{"startTime":464.17,"endTime":467.02,"body":"or do they have a vote"},{"startTime":467.02,"endTime":470.69,"body":"that will make corporate"},{"startTime":467.02,"endTime":470.69,"body":"decision-making really difficult."},{"startTime":470.69,"endTime":474.55,"body":"But what we're going to show"},{"startTime":470.69,"endTime":474.55,"body":"is actually there are ways in"},{"startTime":474.55,"endTime":478.24,"body":"which both the little child's trust fund"},{"startTime":478.24,"endTime":481.32,"body":"and the pension fund will agree"},{"startTime":481.32,"endTime":484.02,"body":"on what investment decision to take."},{"startTime":484.02,"endTime":485.75,"body":"Even though the horizons are different,"},{"startTime":485.75,"endTime":488.85,"body":"the power of what I'm going"},{"startTime":485.75,"endTime":488.85,"body":"to show you is that we can get"},{"startTime":488.85,"endTime":491.633,"body":"agreement on whether"},{"startTime":488.85,"endTime":491.633,"body":"to take an investment."},{"startTime":493.25,"endTime":495.76,"body":"So how do we get to this agreement?"},{"startTime":495.76,"endTime":496.95,"body":"Well, as I promised,"},{"startTime":496.95,"endTime":500.653,"body":"I want to talk about"},{"startTime":496.95,"endTime":500.653,"body":"the time value of money."},{"startTime":501.57,"endTime":505.683,"body":"So what is this? Why does"},{"startTime":501.57,"endTime":505.683,"body":"money have time value?"},{"startTime":507.04,"endTime":509.21,"body":"If you go back to my first"},{"startTime":507.04,"endTime":509.21,"body":"lecture in the series,"},{"startTime":509.21,"endTime":512.42,"body":"how to save and invest"},{"startTime":509.21,"endTime":512.42,"body":"money has value because"},{"startTime":512.42,"endTime":516.76,"body":"if you have money now"},{"startTime":512.42,"endTime":516.76,"body":"rather than in the future,"},{"startTime":516.76,"endTime":518.93,"body":"you can do something with that money."},{"startTime":518.93,"endTime":520.66,"body":"You can save it."},{"startTime":520.66,"endTime":524.673,"body":"And why is saving useful?"},{"startTime":520.66,"endTime":524.673,"body":"Because it gives you interest."},{"startTime":524.673,"endTime":528.44,"body":"That is the return that you get"},{"startTime":524.673,"endTime":528.44,"body":"for putting your money away."},{"startTime":528.44,"endTime":531.86,"body":"So let's go to just basic"},{"startTime":528.44,"endTime":531.86,"body":"examples with some simple numbers."},{"startTime":531.86,"endTime":536.86,"body":"If you have one pound today"},{"startTime":531.86,"endTime":536.86,"body":"and the interest rate is 10%,"},{"startTime":537.6,"endTime":542.12,"body":"then it's going to be"},{"startTime":537.6,"endTime":542.12,"body":"worth 1.10 in the future."},{"startTime":542.12,"endTime":546.16,"body":"So if you have the money now,"},{"startTime":542.12,"endTime":546.16,"body":"rather than one year from now,"},{"startTime":546.16,"endTime":548.49,"body":"then it's going to be"},{"startTime":546.16,"endTime":548.49,"body":"worth something because"},{"startTime":548.49,"endTime":551.96,"body":"you can put it away at"},{"startTime":548.49,"endTime":551.96,"body":"the interest rate of 10%."},{"startTime":551.96,"endTime":553.93,"body":"Now, I know this is an"},{"startTime":551.96,"endTime":553.93,"body":"elementary first example,"},{"startTime":553.93,"endTime":556.24,"body":"but why I'm stressing this is that"},{"startTime":556.24,"endTime":561.24,"body":"both the child's trust funds"},{"startTime":556.24,"endTime":561.24,"body":"and the pension fund will agree"},{"startTime":563.02,"endTime":565.56,"body":"on the time value of money."},{"startTime":565.56,"endTime":570.18,"body":"Money today is worth 10%"},{"startTime":565.56,"endTime":570.18,"body":"more than money next year."},{"startTime":570.18,"endTime":575.18,"body":"Why? Because everybody can"},{"startTime":570.18,"endTime":575.18,"body":"invest at the 10% interest rate."},{"startTime":575.78,"endTime":578.84,"body":"If banks were offering"},{"startTime":575.78,"endTime":578.84,"body":"you a 10% interest rate"},{"startTime":578.84,"endTime":581.67,"body":"then that is the time value of money."},{"startTime":581.67,"endTime":584.97,"body":"It has nothing to do with"},{"startTime":581.67,"endTime":584.97,"body":"preferences or time horizons."},{"startTime":584.97,"endTime":587.803,"body":"It's something that"},{"startTime":584.97,"endTime":587.803,"body":"everybody will agree on."},{"startTime":589.64,"endTime":592.68,"body":"Now let's more generalize this"},{"startTime":589.64,"endTime":592.68,"body":"let's say the interest rate"},{"startTime":592.68,"endTime":596.85,"body":"is not 10%, but it's an amount or percent."},{"startTime":596.85,"endTime":600.61,"body":"So maybe it's 1%, maybe"},{"startTime":596.85,"endTime":600.61,"body":"8%, whatever it is,"},{"startTime":600.61,"endTime":603.86,"body":"then the time value of"},{"startTime":600.61,"endTime":603.86,"body":"money is given by the r."},{"startTime":603.86,"endTime":608.86,"body":"And so one pound a day is"},{"startTime":603.86,"endTime":608.86,"body":"going to grow to one plus R"},{"startTime":608.95,"endTime":609.793,"body":"in the future."},{"startTime":611.14,"endTime":613.27,"body":"And let's generalize this even more."},{"startTime":613.27,"endTime":615.93,"body":"Let's say, we're not going"},{"startTime":613.27,"endTime":615.93,"body":"to invest for one year."},{"startTime":615.93,"endTime":618.82,"body":"Maybe we're not invest for T years"},{"startTime":618.82,"endTime":621.93,"body":"where T could be 5, 10 50, anything."},{"startTime":621.93,"endTime":625.07,"body":"What we looked at back in lecture one is"},{"startTime":625.07,"endTime":627.47,"body":"how do we find the time value of money?"},{"startTime":627.47,"endTime":630.906,"body":"You multiply it by one"},{"startTime":627.47,"endTime":630.906,"body":"plus the interest rate,"},{"startTime":630.906,"endTime":634.47,"body":"and you turn it to the power of T."},{"startTime":634.47,"endTime":636.143,"body":"You compound it T times."},{"startTime":637.24,"endTime":639.8,"body":"So just to sum up, what"},{"startTime":637.24,"endTime":639.8,"body":"was we had in lecture one,"},{"startTime":639.8,"endTime":641.57,"body":"and why is this relevant today?"},{"startTime":641.57,"endTime":643.82,"body":"What we talked about back then was"},{"startTime":643.82,"endTime":646.72,"body":"the future value of money."},{"startTime":646.72,"endTime":651.2,"body":"Money today is worth much"},{"startTime":646.72,"endTime":651.2,"body":"more in the future. Why?"},{"startTime":651.2,"endTime":652.87,"body":"Because we can invest it."},{"startTime":652.87,"endTime":657.5,"body":"We can compound it by"},{"startTime":652.87,"endTime":657.5,"body":"investing it at that same rate"},{"startTime":657.5,"endTime":660.74,"body":"every year for those T years,"},{"startTime":660.74,"endTime":663.78,"body":"the future value of one pound is given by"},{"startTime":663.78,"endTime":668.78,"body":"one times one plus r all"},{"startTime":663.78,"endTime":668.78,"body":"raised to the power of T."},{"startTime":671.84,"endTime":674.143,"body":"So that's what we looked at previously."},{"startTime":675.21,"endTime":677.68,"body":"But what we're going to look at now today"},{"startTime":677.68,"endTime":680.62,"body":"is what is the present value."},{"startTime":680.62,"endTime":683.906,"body":"If we have money in the future,"},{"startTime":683.906,"endTime":687.223,"body":"what is that money going"},{"startTime":683.906,"endTime":687.223,"body":"to be worth back to today?"},{"startTime":688.71,"endTime":692.0,"body":"So what we looked at"},{"startTime":688.71,"endTime":692.0,"body":"previously was converting money"},{"startTime":692.0,"endTime":694.913,"body":"from now into the future."},{"startTime":696.22,"endTime":699.33,"body":"Now, what we're looking"},{"startTime":696.22,"endTime":699.33,"body":"at today is the reverse."},{"startTime":699.33,"endTime":700.67,"body":"If we have some money,"},{"startTime":700.67,"endTime":704.34,"body":"which we know we're going"},{"startTime":700.67,"endTime":704.34,"body":"to get in the future, why?"},{"startTime":704.34,"endTime":707.07,"body":"Because we're going to sell"},{"startTime":704.34,"endTime":707.07,"body":"clothes from the factory."},{"startTime":707.07,"endTime":711.2,"body":"How much is that future money worth today?"},{"startTime":711.2,"endTime":715.103,"body":"And that is exactly going to"},{"startTime":711.2,"endTime":715.103,"body":"be this, but just in reverse."},{"startTime":716.12,"endTime":719.89,"body":"So we previously established"},{"startTime":716.12,"endTime":719.89,"body":"that one pound a day,"},{"startTime":719.89,"endTime":722.313,"body":"it's worth 1.10 next year."},{"startTime":723.52,"endTime":724.85,"body":"Then in contrast,"},{"startTime":724.85,"endTime":728.5,"body":"if my clothes factory is going"},{"startTime":724.85,"endTime":728.5,"body":"to be generating one pound 10"},{"startTime":728.5,"endTime":732.87,"body":"for me next year, how much is"},{"startTime":728.5,"endTime":732.87,"body":"that worth in today's terms."},{"startTime":732.87,"endTime":735.8,"body":"We just do that calculation"},{"startTime":735.8,"endTime":739.3,"body":"and do it in the opposite direction."},{"startTime":739.3,"endTime":742.24,"body":"The one pound 10 in the"},{"startTime":739.3,"endTime":742.24,"body":"future is going to be worth"},{"startTime":742.24,"endTime":745.69,"body":"one pound today, because one pound today,"},{"startTime":745.69,"endTime":750.08,"body":"we could invest for that"},{"startTime":745.69,"endTime":750.08,"body":"10% and it would grow"},{"startTime":750.08,"endTime":752.46,"body":"to be one pound 10 in the future."},{"startTime":752.46,"endTime":754.76,"body":"So these two things are"},{"startTime":752.46,"endTime":754.76,"body":"worth exactly the same."},{"startTime":754.76,"endTime":758.48,"body":"We should begin different"},{"startTime":754.76,"endTime":758.48,"body":"between one pound today"},{"startTime":758.48,"endTime":760.89,"body":"and one pound 10 in the future."},{"startTime":760.89,"endTime":762.49,"body":"And again, so if the"},{"startTime":760.89,"endTime":762.49,"body":"same straight forward,"},{"startTime":762.49,"endTime":764.8,"body":"but let me just belabor the point."},{"startTime":764.8,"endTime":768.443,"body":"People will typically say"},{"startTime":764.8,"endTime":768.443,"body":"more money is always better,"},{"startTime":769.71,"endTime":771.02,"body":"but it's not true."},{"startTime":771.02,"endTime":773.51,"body":"What matters is when"},{"startTime":771.02,"endTime":773.51,"body":"you're getting the money."},{"startTime":773.51,"endTime":778.01,"body":"Here, this is more one pound"},{"startTime":773.51,"endTime":778.01,"body":"10 is greater than one,"},{"startTime":778.01,"endTime":781.57,"body":"but it's not better because"},{"startTime":778.01,"endTime":781.57,"body":"it occurs in the future,"},{"startTime":781.57,"endTime":783.443,"body":"it has less time value."},{"startTime":784.47,"endTime":786.51,"body":"And again, one other thing I"},{"startTime":784.47,"endTime":786.51,"body":"want to stress to highlight,"},{"startTime":786.51,"endTime":788.16,"body":"why this is non-obvious."},{"startTime":788.16,"endTime":793.16,"body":"Everybody agrees on what the present value"},{"startTime":793.25,"endTime":795.62,"body":"of this one pound tenets."},{"startTime":795.62,"endTime":796.453,"body":"Why?"},{"startTime":796.453,"endTime":801.453,"body":"Because they all divide it"},{"startTime":796.453,"endTime":801.453,"body":"by this 10% interest rates,"},{"startTime":801.59,"endTime":804.77,"body":"even though the child's trust fund"},{"startTime":804.77,"endTime":806.63,"body":"and even though the pension fund,"},{"startTime":806.63,"endTime":809.16,"body":"they might have different time horizons"},{"startTime":809.16,"endTime":811.42,"body":"because some are more patient than others."},{"startTime":811.42,"endTime":815.61,"body":"Everybody agrees that"},{"startTime":811.42,"endTime":815.61,"body":"cash flows in the future"},{"startTime":815.61,"endTime":820.16,"body":"are worth less than cash flows"},{"startTime":815.61,"endTime":820.16,"body":"today by this amount, 10%."},{"startTime":820.16,"endTime":821.0,"body":"Why?"},{"startTime":821.0,"endTime":824.9,"body":"Because that is what you"},{"startTime":821.0,"endTime":824.9,"body":"could invest money in"},{"startTime":824.9,"endTime":827.523,"body":"if you had it today"},{"startTime":824.9,"endTime":827.523,"body":"rather than in the future."},{"startTime":828.41,"endTime":831.54,"body":"So the new terminology"},{"startTime":828.41,"endTime":831.54,"body":"I'm going to introduce is"},{"startTime":831.54,"endTime":832.663,"body":"the discount rate."},{"startTime":833.63,"endTime":835.01,"body":"What do I mean by this?"},{"startTime":835.01,"endTime":837.55,"body":"Well, we've talked about"},{"startTime":835.01,"endTime":837.55,"body":"the interest rates."},{"startTime":837.55,"endTime":840.53,"body":"And the interest rate"},{"startTime":837.55,"endTime":840.53,"body":"is what we're applying"},{"startTime":840.53,"endTime":843.55,"body":"to grow money from now to the future."},{"startTime":843.55,"endTime":847.433,"body":"When we think about the"},{"startTime":843.55,"endTime":847.433,"body":"future value of today's money,"},{"startTime":848.613,"endTime":849.446,"body":"what the discount rate,"},{"startTime":849.446,"endTime":853.96,"body":"the first two is the present"},{"startTime":849.446,"endTime":853.96,"body":"value of future money,"},{"startTime":853.96,"endTime":858.08,"body":"what we do in reverse to"},{"startTime":853.96,"endTime":858.08,"body":"convert something in the future"},{"startTime":858.08,"endTime":859.423,"body":"back to today."},{"startTime":860.66,"endTime":863.07,"body":"And so let me just go through"},{"startTime":860.66,"endTime":863.07,"body":"some more terminology,"},{"startTime":863.07,"endTime":865.37,"body":"just so that we're all on the same terms."},{"startTime":865.37,"endTime":868.48,"body":"What I did on the last slide"},{"startTime":865.37,"endTime":868.48,"body":"is when I bring something from"},{"startTime":868.48,"endTime":873.48,"body":"the present to the future, we"},{"startTime":868.48,"endTime":873.48,"body":"are compounding the cashflow."},{"startTime":875.0,"endTime":877.07,"body":"What we're doing when we're"},{"startTime":875.0,"endTime":877.07,"body":"moving things in reverse,"},{"startTime":877.07,"endTime":880.28,"body":"as we're going to be"},{"startTime":877.07,"endTime":880.28,"body":"discounting the cash flows."},{"startTime":880.28,"endTime":883.49,"body":"So anything in the future"},{"startTime":880.28,"endTime":883.49,"body":"is going to be discounted."},{"startTime":883.49,"endTime":886.75,"body":"It is worth less because"},{"startTime":883.49,"endTime":886.75,"body":"it is not benefiting"},{"startTime":886.75,"endTime":888.423,"body":"from that time value of money."},{"startTime":890.11,"endTime":893.01,"body":"And again, what we can"},{"startTime":890.11,"endTime":893.01,"body":"do is generalize this."},{"startTime":893.01,"endTime":895.94,"body":"So let's move from just one year"},{"startTime":895.94,"endTime":900.94,"body":"and move from just 10%"},{"startTime":895.94,"endTime":900.94,"body":"to any interest rate"},{"startTime":901.01,"endTime":902.65,"body":"and any number of years, right?"},{"startTime":902.65,"endTime":903.76,"body":"Because it might be,"},{"startTime":903.76,"endTime":906.09,"body":"we're investing in the"},{"startTime":903.76,"endTime":906.09,"body":"electric car factory,"},{"startTime":906.09,"endTime":909.08,"body":"which might not pay off for 30 years."},{"startTime":909.08,"endTime":911.853,"body":"So when the interest rate is r percent,"},{"startTime":912.92,"endTime":916.64,"body":"one pound, this year is"},{"startTime":912.92,"endTime":916.64,"body":"worth one plus r next year"},{"startTime":917.7,"endTime":922.283,"body":"in contrast, if we're getting"},{"startTime":917.7,"endTime":922.283,"body":"now one pounds next year,"},{"startTime":923.43,"endTime":925.003,"body":"how much is it worth today?"},{"startTime":926.32,"endTime":931.32,"body":"What we now do is we"},{"startTime":926.32,"endTime":931.32,"body":"divide by one plus r, okay?"},{"startTime":932.8,"endTime":936.95,"body":"So to move from today"},{"startTime":932.8,"endTime":936.95,"body":"to next year's money,"},{"startTime":936.95,"endTime":940.053,"body":"we multiply by one plus r."},{"startTime":940.93,"endTime":943.01,"body":"When we moved from next year,"},{"startTime":943.01,"endTime":946.47,"body":"back to today, we divide, okay."},{"startTime":946.47,"endTime":948.56,"body":"So this is how we're converting back."},{"startTime":948.56,"endTime":950.71,"body":"And so what we'll do is we just divide by"},{"startTime":950.71,"endTime":953.493,"body":"one plus the interest rate."},{"startTime":955.03,"endTime":956.76,"body":"And then if we want them to convert,"},{"startTime":956.76,"endTime":958.64,"body":"it's something which"},{"startTime":956.76,"endTime":958.64,"body":"occurs many years from now,"},{"startTime":958.64,"endTime":960.77,"body":"two years from now."},{"startTime":960.77,"endTime":962.2,"body":"Well, what did we do?"},{"startTime":962.2,"endTime":964.44,"body":"We just do exactly the same as previously."},{"startTime":964.44,"endTime":966.1,"body":"We're going to be dividing."},{"startTime":966.1,"endTime":970.46,"body":"But remember we're using"},{"startTime":966.1,"endTime":970.46,"body":"that power T as we did many,"},{"startTime":970.46,"endTime":972.22,"body":"many slides ago, right?"},{"startTime":972.22,"endTime":975.56,"body":"So whenever we have a cashflow"},{"startTime":972.22,"endTime":975.56,"body":"and we're going through many,"},{"startTime":975.56,"endTime":980.41,"body":"many years, all we do is"},{"startTime":975.56,"endTime":980.41,"body":"we raise this right here,"},{"startTime":980.41,"endTime":984.32,"body":"the compounding rate or"},{"startTime":980.41,"endTime":984.32,"body":"discount rate to the power T,"},{"startTime":984.32,"endTime":986.41,"body":"which shows you the number of years"},{"startTime":986.41,"endTime":989.333,"body":"that we're investing for, or"},{"startTime":986.41,"endTime":989.333,"body":"we're bringing it back to."},{"startTime":990.23,"endTime":994.09,"body":"And so what I've shown you"},{"startTime":990.23,"endTime":994.09,"body":"here is the general formula"},{"startTime":994.09,"endTime":997.6,"body":"for a present value."},{"startTime":997.6,"endTime":1001.4,"body":"So the present value of any"},{"startTime":997.6,"endTime":1001.4,"body":"cashflow that you're receiving"},{"startTime":1001.4,"endTime":1006.27,"body":"at some point in time in the"},{"startTime":1001.4,"endTime":1006.27,"body":"future is simply achieved"},{"startTime":1006.27,"endTime":1010.9,"body":"by getting that cashflow, dividing it by"},{"startTime":1010.9,"endTime":1015.41,"body":"one plus the interest rates"},{"startTime":1010.9,"endTime":1015.41,"body":"and raising it to the power,"},{"startTime":1015.41,"endTime":1018.483,"body":"which is given by the number"},{"startTime":1015.41,"endTime":1018.483,"body":"of years that we are investing."},{"startTime":1019.67,"endTime":1020.85,"body":"And the key concept here,"},{"startTime":1020.85,"endTime":1023.9,"body":"which is one of the most"},{"startTime":1020.85,"endTime":1023.9,"body":"fundamental concepts in finance is"},{"startTime":1023.9,"endTime":1027.36,"body":"the whole idea of an opportunity cost."},{"startTime":1027.36,"endTime":1031.81,"body":"Why is it bad to have cash in"},{"startTime":1027.36,"endTime":1031.81,"body":"the future other than today?"},{"startTime":1031.81,"endTime":1035.24,"body":"Because if you're only"},{"startTime":1031.81,"endTime":1035.24,"body":"getting cash in the future,"},{"startTime":1035.24,"endTime":1039.47,"body":"you fall go the opportunity"},{"startTime":1035.24,"endTime":1039.47,"body":"of doing something else"},{"startTime":1039.47,"endTime":1041.16,"body":"with that cash."},{"startTime":1041.16,"endTime":1043.37,"body":"And what is the other thing you can do is"},{"startTime":1043.37,"endTime":1045.54,"body":"you can invest it elsewhere."},{"startTime":1045.54,"endTime":1049.27,"body":"And because both the old man"},{"startTime":1045.54,"endTime":1049.27,"body":"and the child's trust fund"},{"startTime":1049.27,"endTime":1052.93,"body":"could invest it in the"},{"startTime":1049.27,"endTime":1052.93,"body":"exact same opportunities,"},{"startTime":1052.93,"endTime":1056.47,"body":"everybody has the same opportunity cost."},{"startTime":1056.47,"endTime":1059.61,"body":"It does not depend on preferences."},{"startTime":1059.61,"endTime":1063.87,"body":"And therefore everybody"},{"startTime":1059.61,"endTime":1063.87,"body":"will be able to agree"},{"startTime":1063.87,"endTime":1065.8,"body":"on the time value of money,"},{"startTime":1065.8,"endTime":1069.25,"body":"because they all agree on"},{"startTime":1065.8,"endTime":1069.25,"body":"what the opportunity cost is."},{"startTime":1069.25,"endTime":1071.67,"body":"And that is given by the interest rate,"},{"startTime":1071.67,"endTime":1072.97,"body":"which everybody agrees on."},{"startTime":1074.5,"endTime":1077.71,"body":"Now, I realize I've shown"},{"startTime":1074.5,"endTime":1077.71,"body":"you a lot of numbers and RS"},{"startTime":1077.71,"endTime":1080.46,"body":"and equations point"},{"startTime":1077.71,"endTime":1080.46,"body":"that we have an example."},{"startTime":1080.46,"endTime":1082.94,"body":"To put this into practice and show you,"},{"startTime":1082.94,"endTime":1085.963,"body":"how do we use it to make an"},{"startTime":1082.94,"endTime":1085.963,"body":"actual financial decision?"},{"startTime":1086.83,"endTime":1088.15,"body":"I'm not going to do that right now."},{"startTime":1088.15,"endTime":1090.89,"body":"I'm going to do it in"},{"startTime":1088.15,"endTime":1090.89,"body":"one more slide from now."},{"startTime":1090.89,"endTime":1095.023,"body":"But because I need to introduce"},{"startTime":1090.89,"endTime":1095.023,"body":"a couple of things before."},{"startTime":1096.27,"endTime":1100.78,"body":"One thing I want to do is"},{"startTime":1096.27,"endTime":1100.78,"body":"show you why this matters."},{"startTime":1100.78,"endTime":1104.54,"body":"So what this graph looks"},{"startTime":1100.78,"endTime":1104.54,"body":"up is the present value"},{"startTime":1104.54,"endTime":1109.54,"body":"of one pound and how all this"},{"startTime":1104.54,"endTime":1109.54,"body":"depends on the interest rate,"},{"startTime":1110.53,"endTime":1112.15,"body":"the discount, rate"},{"startTime":1112.15,"endTime":1116.023,"body":"and how it depends on how many"},{"startTime":1112.15,"endTime":1116.023,"body":"years we're investing for."},{"startTime":1116.87,"endTime":1118.55,"body":"Now, if you start here,"},{"startTime":1118.55,"endTime":1121.5,"body":"if you're only investing"},{"startTime":1118.55,"endTime":1121.5,"body":"for maybe one or two years,"},{"startTime":1121.5,"endTime":1124.18,"body":"it really doesn't matter"},{"startTime":1121.5,"endTime":1124.18,"body":"what the interest rate is."},{"startTime":1124.18,"endTime":1126.44,"body":"There isn't that much of a difference."},{"startTime":1126.44,"endTime":1129.69,"body":"However, if you're investing for 25 years,"},{"startTime":1129.69,"endTime":1134.69,"body":"then whether the interest"},{"startTime":1129.69,"endTime":1134.69,"body":"rate is 5% or 10% or 15%,"},{"startTime":1135.75,"endTime":1137.593,"body":"that really, really matters."},{"startTime":1138.53,"endTime":1139.45,"body":"Why?"},{"startTime":1139.45,"endTime":1143.01,"body":"Because if I'm having to wait 25 years"},{"startTime":1143.01,"endTime":1147.17,"body":"before my electric car factory"},{"startTime":1143.01,"endTime":1147.17,"body":"actually pays some dividends,"},{"startTime":1147.17,"endTime":1151.98,"body":"then I'm going to be having"},{"startTime":1147.17,"endTime":1151.98,"body":"to full go the interest rate"},{"startTime":1151.98,"endTime":1152.82,"body":"for many, many years."},{"startTime":1152.82,"endTime":1156.89,"body":"So I really care about whether"},{"startTime":1152.82,"endTime":1156.89,"body":"I'm giving up 5% per year"},{"startTime":1156.89,"endTime":1158.73,"body":"or 15% per year,"},{"startTime":1158.73,"endTime":1161.53,"body":"because what I'm giving up"},{"startTime":1158.73,"endTime":1161.53,"body":"by building that electric car"},{"startTime":1161.53,"endTime":1165.05,"body":"factory, I'm going to have to"},{"startTime":1161.53,"endTime":1165.05,"body":"give it up for many many years."},{"startTime":1165.05,"endTime":1167.47,"body":"And then let's lean out,"},{"startTime":1165.05,"endTime":1167.47,"body":"link this to the real world."},{"startTime":1167.47,"endTime":1169.16,"body":"Let's think of Tesla."},{"startTime":1169.16,"endTime":1173.0,"body":"So why does Tesla stock"},{"startTime":1169.16,"endTime":1173.0,"body":"price go up and down so much"},{"startTime":1173.0,"endTime":1174.72,"body":"and change so much?"},{"startTime":1174.72,"endTime":1177.34,"body":"Well, one thing which causes it to change"},{"startTime":1177.34,"endTime":1179.15,"body":"is the interest rate."},{"startTime":1179.15,"endTime":1181.83,"body":"What changes in the interest rate"},{"startTime":1181.83,"endTime":1184.3,"body":"from 5% to 10 or 15,"},{"startTime":1184.3,"endTime":1189.3,"body":"that will cause a huge"},{"startTime":1184.3,"endTime":1189.3,"body":"fluctuation in the value of Tesla."},{"startTime":1189.48,"endTime":1190.313,"body":"Why?"},{"startTime":1190.313,"endTime":1194.22,"body":"Because its cash flows"},{"startTime":1190.313,"endTime":1194.22,"body":"are so far in the future"},{"startTime":1194.22,"endTime":1199.2,"body":"that the opportunity cost"},{"startTime":1194.22,"endTime":1199.2,"body":"of investing in Tesla"},{"startTime":1199.2,"endTime":1202.38,"body":"rather than investing in the"},{"startTime":1199.2,"endTime":1202.38,"body":"bank is really, really high."},{"startTime":1204.32,"endTime":1207.211,"body":"Final thing that I want to go"},{"startTime":1204.32,"endTime":1207.211,"body":"through before I go through"},{"startTime":1207.211,"endTime":1211.01,"body":"the numerical example is"},{"startTime":1207.211,"endTime":1211.01,"body":"the fact that investments"},{"startTime":1211.01,"endTime":1213.33,"body":"often make many cash flows."},{"startTime":1213.33,"endTime":1216.33,"body":"All I've shown you so"},{"startTime":1213.33,"endTime":1216.33,"body":"far is what happens when"},{"startTime":1216.33,"endTime":1218.87,"body":"you have one cashflow."},{"startTime":1218.87,"endTime":1221.81,"body":"But if you have a car factory,"},{"startTime":1221.81,"endTime":1224.53,"body":"it's going to make you some"},{"startTime":1221.81,"endTime":1224.53,"body":"cash next year and two years"},{"startTime":1224.53,"endTime":1225.75,"body":"from now, three years from now,"},{"startTime":1225.75,"endTime":1228.8,"body":"maybe it will make your cash"},{"startTime":1225.75,"endTime":1228.8,"body":"flows 100 years from now,"},{"startTime":1228.8,"endTime":1231.103,"body":"if people are still using electric cars."},{"startTime":1232.36,"endTime":1237.36,"body":"So how do things change"},{"startTime":1232.36,"endTime":1237.36,"body":"when investments pay cash"},{"startTime":1237.86,"endTime":1239.713,"body":"at many different points in time."},{"startTime":1240.96,"endTime":1243.05,"body":"The nice thing is it doesn't get"},{"startTime":1243.05,"endTime":1245.03,"body":"that more and more complicated."},{"startTime":1245.03,"endTime":1249.363,"body":"All we do is we take"},{"startTime":1245.03,"endTime":1249.363,"body":"each individual cashflow,"},{"startTime":1250.49,"endTime":1254.01,"body":"take the present value of"},{"startTime":1250.49,"endTime":1254.01,"body":"it, bring it back today,"},{"startTime":1254.01,"endTime":1256.43,"body":"and then once you bought"},{"startTime":1254.01,"endTime":1256.43,"body":"it back to you today,"},{"startTime":1256.43,"endTime":1259.393,"body":"all you do is you sum up those cash flows."},{"startTime":1260.29,"endTime":1262.76,"body":"So let's say, take your factory."},{"startTime":1262.76,"endTime":1266.563,"body":"A factory pays you one"},{"startTime":1262.76,"endTime":1266.563,"body":"pound one year from now,"},{"startTime":1267.74,"endTime":1270.3,"body":"what is that one pound worth today?"},{"startTime":1270.3,"endTime":1272.79,"body":"Remember we discounted, we divide it"},{"startTime":1272.79,"endTime":1274.883,"body":"by one plus the interest rate."},{"startTime":1275.79,"endTime":1278.993,"body":"And so that now becomes a"},{"startTime":1275.79,"endTime":1278.993,"body":"present value as of today."},{"startTime":1280.41,"endTime":1284.66,"body":"Let's say we also have the"},{"startTime":1280.41,"endTime":1284.66,"body":"factory and it also makes us"},{"startTime":1284.66,"endTime":1289.66,"body":"one pounds two years from now,"},{"startTime":1284.66,"endTime":1289.66,"body":"how much is that worth today?"},{"startTime":1290.2,"endTime":1292.3,"body":"We discount it."},{"startTime":1292.3,"endTime":1297.3,"body":"We bring it back by one plus"},{"startTime":1292.3,"endTime":1297.3,"body":"the interest rate squared,"},{"startTime":1297.3,"endTime":1301.66,"body":"because the opportunity cost is now twice."},{"startTime":1301.66,"endTime":1304.743,"body":"And that also brings it"},{"startTime":1301.66,"endTime":1304.743,"body":"back to a cash flow today."},{"startTime":1305.7,"endTime":1308.51,"body":"And maybe we're also going"},{"startTime":1305.7,"endTime":1308.51,"body":"to get another cash flow"},{"startTime":1308.51,"endTime":1310.48,"body":"in two years from now."},{"startTime":1310.48,"endTime":1312.2,"body":"We can bring that back similarly,"},{"startTime":1312.2,"endTime":1314.67,"body":"all the way back to today by using"},{"startTime":1314.67,"endTime":1317.75,"body":"the T year discount rates."},{"startTime":1317.75,"endTime":1321.17,"body":"And the beauty is that because"},{"startTime":1317.75,"endTime":1321.17,"body":"all of these are cash flows"},{"startTime":1321.17,"endTime":1324.22,"body":"in the same year that all cash flows today"},{"startTime":1324.22,"endTime":1326.22,"body":"because we've already discounted them."},{"startTime":1326.22,"endTime":1328.117,"body":"We can now add them up."},{"startTime":1328.117,"endTime":1330.12,"body":"But we can't add these up."},{"startTime":1330.12,"endTime":1331.76,"body":"They're not apples to apples."},{"startTime":1331.76,"endTime":1335.06,"body":"They occur at different periods,"},{"startTime":1331.76,"endTime":1335.06,"body":"but once we've converted"},{"startTime":1335.06,"endTime":1338.74,"body":"all the cash flows into"},{"startTime":1335.06,"endTime":1338.74,"body":"today's cash flows,"},{"startTime":1338.74,"endTime":1340.52,"body":"they are apples to apples."},{"startTime":1340.52,"endTime":1343.44,"body":"We can sum them up and we can say,"},{"startTime":1343.44,"endTime":1348.09,"body":"well, the present value of"},{"startTime":1343.44,"endTime":1348.09,"body":"a sequence of cash flows"},{"startTime":1348.09,"endTime":1351.8,"body":"is simply the sum of the present value"},{"startTime":1351.8,"endTime":1353.94,"body":"of each individual cashflow."},{"startTime":1353.94,"endTime":1356.9,"body":"Here if you're getting"},{"startTime":1353.94,"endTime":1356.9,"body":"one pound each year,"},{"startTime":1356.9,"endTime":1360.42,"body":"then you just convert"},{"startTime":1356.9,"endTime":1360.42,"body":"each of those one pounds"},{"startTime":1360.42,"endTime":1363.283,"body":"into the present values and then sum."},{"startTime":1365.82,"endTime":1370.07,"body":"So maybe now is the time that"},{"startTime":1365.82,"endTime":1370.07,"body":"we're going to go through"},{"startTime":1370.07,"endTime":1373.33,"body":"our much needed example"},{"startTime":1370.07,"endTime":1373.33,"body":"to put this into practice."},{"startTime":1373.33,"endTime":1375.82,"body":"All I've done here is"},{"startTime":1373.33,"endTime":1375.82,"body":"summarized everything I've done"},{"startTime":1375.82,"endTime":1378.59,"body":"up to the point or we're doing"},{"startTime":1375.82,"endTime":1378.59,"body":"when we take an investment,"},{"startTime":1378.59,"endTime":1380.43,"body":"is we can take the cashflow"},{"startTime":1380.43,"endTime":1383.66,"body":"and every individual year in the future,"},{"startTime":1383.66,"endTime":1385.123,"body":"convert it back to today."},{"startTime":1386.2,"endTime":1389.53,"body":"We can sum up all those cash"},{"startTime":1386.2,"endTime":1389.53,"body":"flows and we can compare"},{"startTime":1389.53,"endTime":1393.33,"body":"the sum of all those"},{"startTime":1389.53,"endTime":1393.33,"body":"cash flows to the cost"},{"startTime":1393.33,"endTime":1394.39,"body":"of the investment."},{"startTime":1394.39,"endTime":1397.5,"body":"How much did it cost to build the factory?"},{"startTime":1397.5,"endTime":1402.5,"body":"And if the costs are"},{"startTime":1397.5,"endTime":1402.5,"body":"less than the benefits,"},{"startTime":1403.01,"endTime":1406.453,"body":"then we want to go ahead"},{"startTime":1403.01,"endTime":1406.453,"body":"and build that factory."},{"startTime":1407.42,"endTime":1410.64,"body":"So let's now go to this example."},{"startTime":1410.64,"endTime":1414.24,"body":"So the example I'm going"},{"startTime":1410.64,"endTime":1414.24,"body":"to give you is let's say"},{"startTime":1414.24,"endTime":1417.7,"body":"we're considering building a gym."},{"startTime":1417.7,"endTime":1420.68,"body":"Now, what we think is that the gym"},{"startTime":1420.68,"endTime":1423.623,"body":"will cost us 1000 pounds to build."},{"startTime":1424.56,"endTime":1427.683,"body":"And let's say the gym is"},{"startTime":1424.56,"endTime":1427.683,"body":"going to last for three years."},{"startTime":1428.59,"endTime":1430.46,"body":"And we're predicting,"},{"startTime":1428.59,"endTime":1430.46,"body":"we're going to get revenue."},{"startTime":1430.46,"endTime":1433.4,"body":"We're going to get profit of"},{"startTime":1430.46,"endTime":1433.4,"body":"200 pounds in the first year."},{"startTime":1433.4,"endTime":1435.49,"body":"It's not going to make much money because"},{"startTime":1435.49,"endTime":1437.44,"body":"we're still trying to get customers."},{"startTime":1437.44,"endTime":1440.58,"body":"We're going to be batch one year to 350"},{"startTime":1440.58,"endTime":1444.41,"body":"and we're going to do do"},{"startTime":1440.58,"endTime":1444.41,"body":"even better in year three"},{"startTime":1444.41,"endTime":1447.16,"body":"and we're going to get 600"},{"startTime":1444.41,"endTime":1447.16,"body":"and then we're just going to"},{"startTime":1447.16,"endTime":1448.253,"body":"shut down the gym."},{"startTime":1449.45,"endTime":1453.85,"body":"Now, how do we figure out"},{"startTime":1449.45,"endTime":1453.85,"body":"whether to take the gym"},{"startTime":1453.85,"endTime":1455.44,"body":"as an investment?"},{"startTime":1455.44,"endTime":1458.16,"body":"Now, one thing you might"},{"startTime":1455.44,"endTime":1458.16,"body":"do is you might think,"},{"startTime":1458.16,"endTime":1461.76,"body":"well, let's just add up all"},{"startTime":1458.16,"endTime":1461.76,"body":"of these different cash flows."},{"startTime":1461.76,"endTime":1466.76,"body":"So minus 1,00, plus"},{"startTime":1461.76,"endTime":1466.76,"body":"200, plus 350, plus 600,"},{"startTime":1468.06,"endTime":1473.06,"body":"all of these that adds up to 1,150,"},{"startTime":1473.84,"endTime":1477.4,"body":"we get more out than what we put in."},{"startTime":1477.4,"endTime":1480.22,"body":"We get 150 more than what we put in."},{"startTime":1480.22,"endTime":1485.02,"body":"So you might think, well, we"},{"startTime":1480.22,"endTime":1485.02,"body":"should want to take the gym,"},{"startTime":1485.02,"endTime":1486.94,"body":"but we should know that that's"},{"startTime":1485.02,"endTime":1486.94,"body":"not the right thing to do"},{"startTime":1486.94,"endTime":1489.68,"body":"because these things occur"},{"startTime":1486.94,"endTime":1489.68,"body":"at different time periods."},{"startTime":1489.68,"endTime":1493.36,"body":"So instead what we do is we"},{"startTime":1489.68,"endTime":1493.36,"body":"take each individual cashflow"},{"startTime":1494.994,"endTime":1496.794,"body":"we discount it by the interest rate."},{"startTime":1497.662,"endTime":1500.783,"body":"And interest rate here is given by 8%."},{"startTime":1502.16,"endTime":1502.993,"body":"So what do we?"},{"startTime":1504.427,"endTime":1505.6,"body":"Do when we take the investment,"},{"startTime":1505.6,"endTime":1507.233,"body":"it costs us 1000 today,"},{"startTime":1508.32,"endTime":1511.89,"body":"it's giving us 200 pounds next year,"},{"startTime":1511.89,"endTime":1514.873,"body":"and that is discounted by 1.08."},{"startTime":1516.19,"endTime":1519.93,"body":"It gives us 350 two years from now."},{"startTime":1519.93,"endTime":1522.513,"body":"We discount it by 1.08 squared."},{"startTime":1523.39,"endTime":1526.58,"body":"And finally the cashflow"},{"startTime":1523.39,"endTime":1526.58,"body":"in the third year is 600."},{"startTime":1526.58,"endTime":1529.233,"body":"We discount that by 1.08 cubed."},{"startTime":1530.17,"endTime":1533.64,"body":"And after we do this and"},{"startTime":1530.17,"endTime":1533.64,"body":"put it into a calculator"},{"startTime":1533.64,"endTime":1537.793,"body":"what we get is minus 38."},{"startTime":1539.52,"endTime":1541.32,"body":"So what this is is negative."},{"startTime":1541.32,"endTime":1546.32,"body":"What this means is that the"},{"startTime":1541.32,"endTime":1546.32,"body":"present value of all the future"},{"startTime":1546.82,"endTime":1551.82,"body":"benefits of the gym are"},{"startTime":1546.82,"endTime":1551.82,"body":"greater than the present cost."},{"startTime":1552.8,"endTime":1555.01,"body":"If the benefits are less than the costs,"},{"startTime":1555.01,"endTime":1557.683,"body":"the nobody should build the gym."},{"startTime":1559.22,"endTime":1560.61,"body":"And you might think, well,"},{"startTime":1560.61,"endTime":1561.62,"body":"why should it be nobody?"},{"startTime":1561.62,"endTime":1564.11,"body":"What happens if you"},{"startTime":1561.62,"endTime":1564.11,"body":"have a child trust fund"},{"startTime":1564.11,"endTime":1566.06,"body":"with no other need for the money,"},{"startTime":1566.06,"endTime":1567.06,"body":"you're willing to wait?"},{"startTime":1567.06,"endTime":1570.15,"body":"Yeah. Maybe the return is not that great,"},{"startTime":1570.15,"endTime":1573.28,"body":"but you're still getting"},{"startTime":1570.15,"endTime":1573.28,"body":"more than what you put in."},{"startTime":1573.28,"endTime":1575.49,"body":"But if you're the child's trust fund,"},{"startTime":1575.49,"endTime":1577.68,"body":"the other thing you should"},{"startTime":1575.49,"endTime":1577.68,"body":"do is you should just put"},{"startTime":1577.68,"endTime":1580.92,"body":"the money in the bank, because"},{"startTime":1577.68,"endTime":1580.92,"body":"if you put it in the bank,"},{"startTime":1580.92,"endTime":1585.91,"body":"you get the 8% return and"},{"startTime":1580.92,"endTime":1585.91,"body":"you'd end up with 1,260"},{"startTime":1586.75,"endTime":1590.493,"body":"in three years, rather than this 1150."},{"startTime":1592.48,"endTime":1595.68,"body":"Let's just take a step back"},{"startTime":1592.48,"endTime":1595.68,"body":"from all of the equations"},{"startTime":1595.68,"endTime":1596.84,"body":"and four of the numbers,"},{"startTime":1596.84,"endTime":1600.38,"body":"and just look at the"},{"startTime":1596.84,"endTime":1600.38,"body":"power of the methodology"},{"startTime":1600.38,"endTime":1602.61,"body":"that we've derived."},{"startTime":1602.61,"endTime":1604.78,"body":"But many decisions we make in life"},{"startTime":1604.78,"endTime":1607.187,"body":"are consumption decisions."},{"startTime":1607.187,"endTime":1610.41,"body":"But what wine do we choose?"},{"startTime":1610.41,"endTime":1612.41,"body":"What do we choose to eat?"},{"startTime":1612.41,"endTime":1615.14,"body":"Where do we choose to go on holiday."},{"startTime":1615.14,"endTime":1617.95,"body":"And for consumption decision"},{"startTime":1615.14,"endTime":1617.95,"body":"where we're going to get"},{"startTime":1617.95,"endTime":1620.0,"body":"some immediate benefits."},{"startTime":1620.0,"endTime":1621.84,"body":"That depends on taste."},{"startTime":1621.84,"endTime":1625.75,"body":"So there's no possibility"},{"startTime":1621.84,"endTime":1625.75,"body":"of having a general rule"},{"startTime":1625.75,"endTime":1629.04,"body":"that applies to everybody"},{"startTime":1625.75,"endTime":1629.04,"body":"on what wine to choose."},{"startTime":1629.04,"endTime":1634.04,"body":"It depends on weather where"},{"startTime":1629.04,"endTime":1634.04,"body":"a liker of say sweet wines"},{"startTime":1634.55,"endTime":1638.21,"body":"or full body dread and"},{"startTime":1634.55,"endTime":1638.21,"body":"suddenly Whetstone holiday,"},{"startTime":1638.21,"endTime":1640.74,"body":"but different people have"},{"startTime":1638.21,"endTime":1640.74,"body":"different preferences."},{"startTime":1640.74,"endTime":1641.79,"body":"What book to read,"},{"startTime":1641.79,"endTime":1645.08,"body":"what concert to go to"},{"startTime":1641.79,"endTime":1645.08,"body":"nobody's ever going to have"},{"startTime":1645.08,"endTime":1648.35,"body":"a possibility of coming"},{"startTime":1645.08,"endTime":1648.35,"body":"up with a general rule"},{"startTime":1648.35,"endTime":1649.9,"body":"or knowing which one to choose."},{"startTime":1651.06,"endTime":1654.46,"body":"But the power of looking"},{"startTime":1651.06,"endTime":1654.46,"body":"at an investment decision"},{"startTime":1654.46,"endTime":1656.87,"body":"where what we're getting is benefits,"},{"startTime":1656.87,"endTime":1660.72,"body":"where you can at least"},{"startTime":1656.87,"endTime":1660.72,"body":"roughly put those benefits"},{"startTime":1660.72,"endTime":1665.37,"body":"in monetary terms is that"},{"startTime":1660.72,"endTime":1665.37,"body":"we can come up with a rule,"},{"startTime":1665.37,"endTime":1669.22,"body":"which is the net present"},{"startTime":1665.37,"endTime":1669.22,"body":"value that I've shown"},{"startTime":1669.22,"endTime":1670.97,"body":"where, what we do is convert this"},{"startTime":1670.97,"endTime":1673.91,"body":"into some financial benefits."},{"startTime":1673.91,"endTime":1676.61,"body":"And then we bring them back to today"},{"startTime":1676.61,"endTime":1679.91,"body":"at an interest rate that"},{"startTime":1676.61,"endTime":1679.91,"body":"everybody agrees on."},{"startTime":1679.91,"endTime":1684.91,"body":"Then there is one objective"},{"startTime":1679.91,"endTime":1684.91,"body":"way to make a decision."},{"startTime":1685.33,"endTime":1686.3,"body":"And that objective,"},{"startTime":1686.3,"endTime":1689.573,"body":"why is something which is"},{"startTime":1686.3,"endTime":1689.573,"body":"independent of preferences."},{"startTime":1690.69,"endTime":1693.0,"body":"That's one point I wanted to draw out."},{"startTime":1693.0,"endTime":1694.88,"body":"The second point I want draw out was,"},{"startTime":1694.88,"endTime":1698.42,"body":"well, if indeed there"},{"startTime":1694.88,"endTime":1698.42,"body":"was one objective way"},{"startTime":1698.42,"endTime":1701.55,"body":"of evaluating investment decisions."},{"startTime":1701.55,"endTime":1704.57,"body":"Why is that that investment"},{"startTime":1701.55,"endTime":1704.57,"body":"decisions are so difficult"},{"startTime":1704.57,"endTime":1705.403,"body":"to make."},{"startTime":1705.403,"endTime":1706.98,"body":"And why do people still disagree?"},{"startTime":1706.98,"endTime":1707.813,"body":"I've just argued."},{"startTime":1707.813,"endTime":1711.08,"body":"I've made this really big"},{"startTime":1707.813,"endTime":1711.08,"body":"thing about why the old man"},{"startTime":1711.08,"endTime":1713.9,"body":"and the child's trust fund should agree."},{"startTime":1713.9,"endTime":1715.71,"body":"So was that so much disagreement?"},{"startTime":1715.71,"endTime":1718.35,"body":"Why some people say"},{"startTime":1715.71,"endTime":1718.35,"body":"actually this car company"},{"startTime":1718.35,"endTime":1720.517,"body":"should invest in self-driving"},{"startTime":1718.35,"endTime":1720.517,"body":"cars and others say,"},{"startTime":1720.517,"endTime":1722.51,"body":"well, that's just too risky."},{"startTime":1722.51,"endTime":1725.11,"body":"They should just build"},{"startTime":1722.51,"endTime":1725.11,"body":"traditional vehicles."},{"startTime":1725.11,"endTime":1727.64,"body":"But the reason why people"},{"startTime":1725.11,"endTime":1727.64,"body":"disagree is because"},{"startTime":1727.64,"endTime":1730.283,"body":"they will disagree about"},{"startTime":1727.64,"endTime":1730.283,"body":"the future cashflow."},{"startTime":1731.362,"endTime":1734.04,"body":"Like people don't really know"},{"startTime":1731.362,"endTime":1734.04,"body":"whether the gym is going to be"},{"startTime":1734.04,"endTime":1739.04,"body":"a success, maybe it's not"},{"startTime":1734.04,"endTime":1739.04,"body":"going to get 600 in year three."},{"startTime":1739.09,"endTime":1741.06,"body":"Maybe it's only going to get 400."},{"startTime":1741.06,"endTime":1743.47,"body":"Maybe we're just over optimistic"},{"startTime":1743.47,"endTime":1744.92,"body":"about how well it's going to do."},{"startTime":1746.03,"endTime":1747.83,"body":"So that is where people disagree."},{"startTime":1747.83,"endTime":1749.75,"body":"They don't know what the cash flows"},{"startTime":1749.75,"endTime":1751.6,"body":"are going to be in the future."},{"startTime":1751.6,"endTime":1756.6,"body":"But all I'm telling you is"},{"startTime":1751.6,"endTime":1756.6,"body":"that given a set of cash flows,"},{"startTime":1758.196,"endTime":1763.196,"body":"there is an objective way"},{"startTime":1758.196,"endTime":1763.196,"body":"that everybody can agree on"},{"startTime":1764.11,"endTime":1768.863,"body":"in order to bring those"},{"startTime":1764.11,"endTime":1768.863,"body":"cash flows back to today."},{"startTime":1770.25,"endTime":1772.72,"body":"And you might think, well,"},{"startTime":1770.25,"endTime":1772.72,"body":"why does that really help us?"},{"startTime":1772.72,"endTime":1775.48,"body":"Because it's really difficult"},{"startTime":1772.72,"endTime":1775.48,"body":"to forecast cash flows"},{"startTime":1775.48,"endTime":1777.18,"body":"to begin with,"},{"startTime":1777.18,"endTime":1779.83,"body":"but there are certain types of investments"},{"startTime":1779.83,"endTime":1784.16,"body":"where actually the cash flows"},{"startTime":1779.83,"endTime":1784.16,"body":"are quite simple to forecast."},{"startTime":1784.16,"endTime":1786.65,"body":"For example, investing in certain bonds"},{"startTime":1786.65,"endTime":1789.01,"body":"or maybe some housing and so forth."},{"startTime":1789.01,"endTime":1791.54,"body":"And even if there is some uncertainty,"},{"startTime":1791.54,"endTime":1795.95,"body":"what we can do is we can play"},{"startTime":1791.54,"endTime":1795.95,"body":"through different scenarios"},{"startTime":1795.95,"endTime":1799.95,"body":"and look at how does this"},{"startTime":1795.95,"endTime":1799.95,"body":"investment decision change"},{"startTime":1799.95,"endTime":1803.91,"body":"under an upside case with"},{"startTime":1799.95,"endTime":1803.91,"body":"the gym is really successful"},{"startTime":1804.77,"endTime":1808.57,"body":"and a downside case where"},{"startTime":1804.77,"endTime":1808.57,"body":"the gym is not so successful"},{"startTime":1808.57,"endTime":1811.393,"body":"and see how that changes"},{"startTime":1808.57,"endTime":1811.393,"body":"the investment decision."},{"startTime":1812.44,"endTime":1814.41,"body":"So again, I'm giving you a framework"},{"startTime":1814.41,"endTime":1816.99,"body":"so that once we were"},{"startTime":1814.41,"endTime":1816.99,"body":"given some cash flows,"},{"startTime":1816.99,"endTime":1821.37,"body":"we can figure out whether the"},{"startTime":1816.99,"endTime":1821.37,"body":"investment decision is good."},{"startTime":1821.37,"endTime":1823.97,"body":"I fully acknowledged that we"},{"startTime":1821.37,"endTime":1823.97,"body":"don't know what the cash flows"},{"startTime":1823.97,"endTime":1824.87,"body":"are going to be,"},{"startTime":1824.87,"endTime":1827.709,"body":"but we can just repeat this"},{"startTime":1824.87,"endTime":1827.709,"body":"with different cash flows"},{"startTime":1827.709,"endTime":1830.66,"body":"and see what's going to turn out."},{"startTime":1830.66,"endTime":1833.12,"body":"So let's try to do this."},{"startTime":1833.12,"endTime":1834.78,"body":"So let me actually change something."},{"startTime":1834.78,"endTime":1836.97,"body":"And what I'm going to"},{"startTime":1834.78,"endTime":1836.97,"body":"change here is not so much"},{"startTime":1836.97,"endTime":1840.343,"body":"the cash flows, but I'm going"},{"startTime":1836.97,"endTime":1840.343,"body":"to change the interest rate."},{"startTime":1841.23,"endTime":1844.59,"body":"So in the previous slide,"},{"startTime":1841.23,"endTime":1844.59,"body":"the interest rate was 8%."},{"startTime":1844.59,"endTime":1848.5,"body":"Let's say the government just"},{"startTime":1844.59,"endTime":1848.5,"body":"cuts interest rates to 5%."},{"startTime":1848.5,"endTime":1849.333,"body":"So I not the government,"},{"startTime":1849.333,"endTime":1852.36,"body":"the central bank cuts"},{"startTime":1849.333,"endTime":1852.36,"body":"interest rates to 5%."},{"startTime":1852.36,"endTime":1854.13,"body":"What changes?"},{"startTime":1854.13,"endTime":1856.11,"body":"Well, if the cash rates"},{"startTime":1854.13,"endTime":1856.11,"body":"have stayed the same,"},{"startTime":1856.11,"endTime":1861.11,"body":"but now we're discounting"},{"startTime":1856.11,"endTime":1861.11,"body":"by 5%, not by 8%."},{"startTime":1863.66,"endTime":1866.21,"body":"And so what this means"},{"startTime":1863.66,"endTime":1866.21,"body":"is because we're dividing"},{"startTime":1866.21,"endTime":1868.69,"body":"by a smaller number."},{"startTime":1868.69,"endTime":1873.69,"body":"Now, the net present value of the project,"},{"startTime":1874.0,"endTime":1877.99,"body":"which is how much the benefits"},{"startTime":1874.0,"endTime":1877.99,"body":"are exceeding the cost by,"},{"startTime":1877.99,"endTime":1880.75,"body":"this now becomes a positive number."},{"startTime":1880.75,"endTime":1882.87,"body":"It becomes 26."},{"startTime":1882.87,"endTime":1886.083,"body":"So now everybody should"},{"startTime":1882.87,"endTime":1886.083,"body":"want to build the gym."},{"startTime":1887.05,"endTime":1888.48,"body":"Why is this?"},{"startTime":1888.48,"endTime":1893.48,"body":"Let's go back to the"},{"startTime":1888.48,"endTime":1893.48,"body":"concept of opportunity cost."},{"startTime":1893.67,"endTime":1898.09,"body":"So opportunity cost is if"},{"startTime":1893.67,"endTime":1898.09,"body":"you did not build the gym,"},{"startTime":1898.09,"endTime":1900.19,"body":"you could put your money in the bank,"},{"startTime":1900.19,"endTime":1902.49,"body":"but now putting your money in the bank"},{"startTime":1902.49,"endTime":1907.49,"body":"is less attractive because the"},{"startTime":1902.49,"endTime":1907.49,"body":"bank is only paying you 5%."},{"startTime":1908.4,"endTime":1911.99,"body":"And therefore the gym with"},{"startTime":1908.4,"endTime":1911.99,"body":"the returns that's giving"},{"startTime":1911.99,"endTime":1914.65,"body":"is a more attractive option."},{"startTime":1914.65,"endTime":1918.71,"body":"And this is why now"},{"startTime":1914.65,"endTime":1918.71,"body":"this becomes a positive"},{"startTime":1918.71,"endTime":1921.19,"body":"net positive value decision"},{"startTime":1921.19,"endTime":1923.433,"body":"when previously it was negative."},{"startTime":1924.41,"endTime":1927.43,"body":"And again, let me take a"},{"startTime":1924.41,"endTime":1927.43,"body":"step back from the numbers,"},{"startTime":1927.43,"endTime":1930.8,"body":"but this is why central banks"},{"startTime":1927.43,"endTime":1930.8,"body":"can influence investment"},{"startTime":1930.8,"endTime":1933.24,"body":"decisions by changing the interest rate."},{"startTime":1933.24,"endTime":1936.29,"body":"But when the Bank of"},{"startTime":1933.24,"endTime":1936.29,"body":"England chooses to increase"},{"startTime":1936.29,"endTime":1941.29,"body":"the interest that set to be"},{"startTime":1936.29,"endTime":1941.29,"body":"a way of cooling the economy"},{"startTime":1941.95,"endTime":1944.71,"body":"and reducing economic activity."},{"startTime":1944.71,"endTime":1946.05,"body":"And why is this?"},{"startTime":1946.05,"endTime":1948.96,"body":"Because it means it's less attractive now"},{"startTime":1948.96,"endTime":1950.94,"body":"for companies to make some investments,"},{"startTime":1950.94,"endTime":1953.86,"body":"to go out and buy stuff and build stuff,"},{"startTime":1953.86,"endTime":1956.91,"body":"because it's much more"},{"startTime":1953.86,"endTime":1956.91,"body":"attractive to save that money"},{"startTime":1956.91,"endTime":1960.54,"body":"in the bank and that's"},{"startTime":1956.91,"endTime":1960.54,"body":"one way of the economy"},{"startTime":1960.54,"endTime":1962.813,"body":"and reducing some inflationary repression."},{"startTime":1966.95,"endTime":1971.02,"body":"So now the gym example you might think,"},{"startTime":1971.02,"endTime":1973.0,"body":"okay, great, I came up with an example,"},{"startTime":1973.0,"endTime":1974.94,"body":"but that example was not that realistic"},{"startTime":1974.94,"endTime":1977.87,"body":"because the gym only"},{"startTime":1974.94,"endTime":1977.87,"body":"lasted for three years."},{"startTime":1977.87,"endTime":1981.17,"body":"In reality, maybe a gym"},{"startTime":1977.87,"endTime":1981.17,"body":"will last for 50 years."},{"startTime":1981.17,"endTime":1983.01,"body":"And if the gym lasts for 50 years,"},{"startTime":1983.01,"endTime":1984.75,"body":"then you're going to have"},{"startTime":1983.01,"endTime":1984.75,"body":"to calculate all of these"},{"startTime":1984.75,"endTime":1987.26,"body":"different cash flows for 50 years time."},{"startTime":1987.26,"endTime":1989.64,"body":"You can see, I had lots of fun writing"},{"startTime":1989.64,"endTime":1991.41,"body":"this particular slide."},{"startTime":1991.41,"endTime":1993.7,"body":"And that's not something"},{"startTime":1991.41,"endTime":1993.7,"body":"that is going to be that easy"},{"startTime":1993.7,"endTime":1994.533,"body":"to do."},{"startTime":1994.533,"endTime":1999.31,"body":"So how can we come up with"},{"startTime":1994.533,"endTime":1999.31,"body":"perhaps a shortcut to save us,"},{"startTime":1999.31,"endTime":2001.513,"body":"having to have cash flows for 50 years?"},{"startTime":2002.54,"endTime":2006.32,"body":"Now, one thing we can"},{"startTime":2002.54,"endTime":2006.32,"body":"look up is what happens"},{"startTime":2006.32,"endTime":2008.95,"body":"if we have not cash C this for 50 years,"},{"startTime":2008.95,"endTime":2011.75,"body":"but in fact, cash flows"},{"startTime":2008.95,"endTime":2011.75,"body":"for infinity years?"},{"startTime":2011.75,"endTime":2015.07,"body":"What do I start with infinity, not 50?"},{"startTime":2015.07,"endTime":2016.41,"body":"Because this is when we actually have"},{"startTime":2016.41,"endTime":2018.71,"body":"the simplest possible shortcuts."},{"startTime":2018.71,"endTime":2022.17,"body":"What if we had an investment which paid"},{"startTime":2022.17,"endTime":2025.413,"body":"the same cashflow every year forever?"},{"startTime":2026.87,"endTime":2031.39,"body":"So this is something which"},{"startTime":2026.87,"endTime":2031.39,"body":"is called a perpetuity."},{"startTime":2031.39,"endTime":2036.39,"body":"It's paying a perpetual cash"},{"startTime":2031.39,"endTime":2036.39,"body":"flow until the end of time."},{"startTime":2037.54,"endTime":2040.23,"body":"So here, the shortcut is really simple."},{"startTime":2040.23,"endTime":2043.23,"body":"If you have an investment"},{"startTime":2040.23,"endTime":2043.23,"body":"which pays a cashflow"},{"startTime":2043.23,"endTime":2047.32,"body":"of C every year until the end of time,"},{"startTime":2047.32,"endTime":2050.6,"body":"then you would find the"},{"startTime":2047.32,"endTime":2050.6,"body":"present value by taking"},{"startTime":2050.6,"endTime":2055.6,"body":"that cashflow and simply"},{"startTime":2050.6,"endTime":2055.6,"body":"dividing it by the interest rate."},{"startTime":2057.69,"endTime":2060.63,"body":"Well, that makes sense because the lower"},{"startTime":2060.63,"endTime":2064.78,"body":"the interest rate is the"},{"startTime":2060.63,"endTime":2064.78,"body":"higher, the present value."},{"startTime":2064.78,"endTime":2069.75,"body":"Again, a lower interest rate"},{"startTime":2064.78,"endTime":2069.75,"body":"means a low opportunity cost,"},{"startTime":2069.75,"endTime":2072.44,"body":"investments become more of attractive"},{"startTime":2072.44,"endTime":2075.083,"body":"when the opportunity cost is lower."},{"startTime":2076.65,"endTime":2080.41,"body":"And you might think, well,"},{"startTime":2076.65,"endTime":2080.41,"body":"that's a great shortcut,"},{"startTime":2080.41,"endTime":2083.33,"body":"but it's completely useless"},{"startTime":2080.41,"endTime":2083.33,"body":"because no investment"},{"startTime":2083.33,"endTime":2088.16,"body":"last forever, but actually some do, right?"},{"startTime":2088.16,"endTime":2090.5,"body":"So there are companies"},{"startTime":2088.16,"endTime":2090.5,"body":"where these companies"},{"startTime":2090.5,"endTime":2092.44,"body":"have been existing for"},{"startTime":2090.5,"endTime":2092.44,"body":"many hundreds of years"},{"startTime":2092.44,"endTime":2095.27,"body":"and might keep existing for"},{"startTime":2092.44,"endTime":2095.27,"body":"hundreds of years going forward."},{"startTime":2095.27,"endTime":2097.95,"body":"It's not clear that the"},{"startTime":2095.27,"endTime":2097.95,"body":"products they're making,"},{"startTime":2097.95,"endTime":2101.89,"body":"let's say clothes will ever"},{"startTime":2097.95,"endTime":2101.89,"body":"stop being in glistens."},{"startTime":2101.89,"endTime":2105.55,"body":"And even if they will only"},{"startTime":2101.89,"endTime":2105.55,"body":"exist for maybe 500 years,"},{"startTime":2105.55,"endTime":2107.83,"body":"maybe that's sort of close to good enough"},{"startTime":2107.83,"endTime":2110.49,"body":"and we can still use this approximation."},{"startTime":2110.49,"endTime":2114.81,"body":"And there are some investments"},{"startTime":2110.49,"endTime":2114.81,"body":"literally that last forever."},{"startTime":2114.81,"endTime":2119.81,"body":"So in the 18 hundreds,"},{"startTime":2114.81,"endTime":2119.81,"body":"after the Napoleonic wars,"},{"startTime":2120.96,"endTime":2123.54,"body":"the British government"},{"startTime":2120.96,"endTime":2123.54,"body":"wanted to consolidate"},{"startTime":2123.54,"endTime":2125.96,"body":"all of the debt that they had accumulated."},{"startTime":2125.96,"endTime":2128.87,"body":"And so what they did was"},{"startTime":2125.96,"endTime":2128.87,"body":"they introduced a bond,"},{"startTime":2128.87,"endTime":2131.96,"body":"which they called a consol and this bond"},{"startTime":2131.96,"endTime":2134.08,"body":"would never be paid back,"},{"startTime":2134.08,"endTime":2137.22,"body":"but it would pay you interest every year"},{"startTime":2137.22,"endTime":2138.833,"body":"until the end of time."},{"startTime":2139.86,"endTime":2142.17,"body":"And then the consol don't"},{"startTime":2139.86,"endTime":2142.17,"body":"just exist in the UK."},{"startTime":2142.17,"endTime":2144.93,"body":"Here's an example of an American consul."},{"startTime":2144.93,"endTime":2148.083,"body":"If you look at this, it says 4% consols."},{"startTime":2149.72,"endTime":2150.96,"body":"What does that mean?"},{"startTime":2150.96,"endTime":2154.02,"body":"It means they are going to be"},{"startTime":2150.96,"endTime":2154.02,"body":"paying an interest rate of 4%"},{"startTime":2155.219,"endTime":2158.08,"body":"and it will pay paying"},{"startTime":2155.219,"endTime":2158.08,"body":"the interest rate of 4%"},{"startTime":2158.08,"endTime":2163.08,"body":"on the amount of $50, which is"},{"startTime":2158.08,"endTime":2163.08,"body":"the face value of that bond."},{"startTime":2166.68,"endTime":2169.97,"body":"So let's again, use an example."},{"startTime":2169.97,"endTime":2172.48,"body":"Let's try to apply that shortcut formula"},{"startTime":2172.48,"endTime":2175.82,"body":"that I've just made this"},{"startTime":2172.48,"endTime":2175.82,"body":"big thing about introducing."},{"startTime":2175.82,"endTime":2178.84,"body":"So let's say we are now in the US"},{"startTime":2178.84,"endTime":2181.21,"body":"the common interest rate is 3%."},{"startTime":2181.21,"endTime":2183.41,"body":"What that means is we could"},{"startTime":2181.21,"endTime":2183.41,"body":"put our money in the bank"},{"startTime":2183.41,"endTime":2187.19,"body":"and earn 3%, but we own one"},{"startTime":2183.41,"endTime":2187.19,"body":"of these beautiful looking"},{"startTime":2187.19,"endTime":2188.74,"body":"bonds, which says,"},{"startTime":2188.74,"endTime":2193.63,"body":"we're going to pay you 4%"},{"startTime":2188.74,"endTime":2193.63,"body":"on a face value of $50."},{"startTime":2193.63,"endTime":2196.853,"body":"How much should that bond cost?"},{"startTime":2198.2,"endTime":2199.93,"body":"Remember what the formula is."},{"startTime":2199.93,"endTime":2202.62,"body":"This is something which"},{"startTime":2199.93,"endTime":2202.62,"body":"is going to give us"},{"startTime":2202.62,"endTime":2204.82,"body":"how much interest every year."},{"startTime":2204.82,"endTime":2209.273,"body":"Is it a pious 4% on the face value of 40."},{"startTime":2210.834,"endTime":2211.923,"body":"$% of 50 is $2."},{"startTime":2212.99,"endTime":2217.64,"body":"That bond entitles us to $2 every year"},{"startTime":2217.64,"endTime":2220.86,"body":"until the end of time, I'm"},{"startTime":2217.64,"endTime":2220.86,"body":"pretty boring investment,"},{"startTime":2220.86,"endTime":2222.1,"body":"but a really safe investment."},{"startTime":2222.1,"endTime":2226.293,"body":"We're going to get $2 now and"},{"startTime":2222.1,"endTime":2226.293,"body":"at every point in the future."},{"startTime":2227.58,"endTime":2232.26,"body":"Remember the formula was the"},{"startTime":2227.58,"endTime":2232.26,"body":"present value of a perpetuity"},{"startTime":2233.386,"endTime":2235.67,"body":"is going to be the"},{"startTime":2233.386,"endTime":2235.67,"body":"cashflow that we're getting"},{"startTime":2235.67,"endTime":2238.873,"body":"divided by the interest rate of 3%."},{"startTime":2240.0,"endTime":2243.853,"body":"And this is going to be worth $66.7."},{"startTime":2245.68,"endTime":2247.04,"body":"Now, one thing that I've tried to stress"},{"startTime":2247.04,"endTime":2249.27,"body":"throughout my principles of finance course"},{"startTime":2249.27,"endTime":2251.98,"body":"is the importance of"},{"startTime":2249.27,"endTime":2251.98,"body":"sanity checking and think,"},{"startTime":2251.98,"endTime":2254.033,"body":"well, do these things make sense?"},{"startTime":2254.033,"endTime":2257.223,"body":"Step back from the"},{"startTime":2254.033,"endTime":2257.223,"body":"equations and think about,"},{"startTime":2258.651,"endTime":2260.851,"body":"is that something which"},{"startTime":2258.651,"endTime":2260.851,"body":"passes common sense?"},{"startTime":2261.74,"endTime":2264.56,"body":"And the answer is yes. Why?"},{"startTime":2264.56,"endTime":2268.33,"body":"The face value of the bond is 50."},{"startTime":2268.33,"endTime":2273.33,"body":"The bond is only worth $50 on paper."},{"startTime":2273.5,"endTime":2275.18,"body":"Why? That's what it says."},{"startTime":2275.18,"endTime":2278.31,"body":"It says it's a bond, which is worth 50."},{"startTime":2278.31,"endTime":2282.223,"body":"However, why is it that"},{"startTime":2278.31,"endTime":2282.223,"body":"you're willing to pay $66"},{"startTime":2285.24,"endTime":2288.993,"body":"for something with a"},{"startTime":2285.24,"endTime":2288.993,"body":"paper value of only $50?"},{"startTime":2289.88,"endTime":2294.88,"body":"It's because the interest"},{"startTime":2289.88,"endTime":2294.88,"body":"rate that is offering of 4%"},{"startTime":2295.02,"endTime":2300.02,"body":"is greater than the 3%"},{"startTime":2295.02,"endTime":2300.02,"body":"that banks are offering."},{"startTime":2301.28,"endTime":2305.69,"body":"So the bond is paying more"},{"startTime":2301.28,"endTime":2305.69,"body":"than the opportunity cost."},{"startTime":2305.69,"endTime":2306.7,"body":"If you had your money,"},{"startTime":2306.7,"endTime":2308.35,"body":"if you took your money and"},{"startTime":2306.7,"endTime":2308.35,"body":"you put it in the bank,"},{"startTime":2308.35,"endTime":2313.35,"body":"you'd earn 3% given this bond"},{"startTime":2308.35,"endTime":2313.35,"body":"is going to be paying you 4%"},{"startTime":2313.81,"endTime":2318.18,"body":"you should be willing to pay"},{"startTime":2313.81,"endTime":2318.18,"body":"than the face value of $50"},{"startTime":2318.18,"endTime":2319.38,"body":"for it."},{"startTime":2319.38,"endTime":2324.38,"body":"And that's why you're willing"},{"startTime":2319.38,"endTime":2324.38,"body":"to pay as much as $66.70."},{"startTime":2325.39,"endTime":2328.21,"body":"And so this is the"},{"startTime":2325.39,"endTime":2328.21,"body":"concept of a premium bond,"},{"startTime":2328.21,"endTime":2331.06,"body":"which you might remember in lecture one,"},{"startTime":2331.06,"endTime":2336.06,"body":"once you have a bond where"},{"startTime":2331.06,"endTime":2336.06,"body":"the interest rate is greater"},{"startTime":2337.07,"endTime":2338.88,"body":"than the opportunity cost,"},{"startTime":2338.88,"endTime":2343.71,"body":"it should trade at a"},{"startTime":2338.88,"endTime":2343.71,"body":"premium to its face value."},{"startTime":2343.71,"endTime":2344.543,"body":"Why?"},{"startTime":2344.543,"endTime":2347.02,"body":"Because it's given you a higher return"},{"startTime":2347.02,"endTime":2348.47,"body":"than you could get elsewhere."},{"startTime":2350.65,"endTime":2351.97,"body":"Now then let's look at what happens"},{"startTime":2351.97,"endTime":2353.67,"body":"when the interest rate changes."},{"startTime":2353.67,"endTime":2357.613,"body":"Let's now change the interest rate to 4%."},{"startTime":2359.27,"endTime":2360.74,"body":"Now what will happen?"},{"startTime":2360.74,"endTime":2362.89,"body":"We do the same calculation."},{"startTime":2362.89,"endTime":2365.9,"body":"Now the discount rate is 4%."},{"startTime":2365.9,"endTime":2369.56,"body":"And so the value of the bond is 50."},{"startTime":2369.56,"endTime":2372.323,"body":"Exactly the same as the face value."},{"startTime":2373.5,"endTime":2376.47,"body":"Does that make sense? Yes."},{"startTime":2376.47,"endTime":2380.971,"body":"Well, the bond is offering"},{"startTime":2376.47,"endTime":2380.971,"body":"you 4%, bank offering you 4%."},{"startTime":2380.971,"endTime":2383.26,"body":"The bond is neither a"},{"startTime":2380.971,"endTime":2383.26,"body":"good deal, nor a bad deal"},{"startTime":2383.26,"endTime":2386.94,"body":"it's often only just the same"},{"startTime":2383.26,"endTime":2386.94,"body":"as you could get elsewhere."},{"startTime":2386.94,"endTime":2390.37,"body":"And therefore you would pay"},{"startTime":2386.94,"endTime":2390.37,"body":"exactly what it's worth."},{"startTime":2390.37,"endTime":2391.983,"body":"You pay exactly that $50."},{"startTime":2393.92,"endTime":2396.71,"body":"And let's move this one more"},{"startTime":2393.92,"endTime":2396.71,"body":"time in the same direction."},{"startTime":2396.71,"endTime":2400.893,"body":"Let's now increase the"},{"startTime":2396.71,"endTime":2400.893,"body":"interest rate to 5%,"},{"startTime":2402.1,"endTime":2404.27,"body":"we do the same calculation."},{"startTime":2404.27,"endTime":2409.27,"body":"We find that when we discount"},{"startTime":2404.27,"endTime":2409.27,"body":"by 5%, the present value,"},{"startTime":2409.66,"endTime":2413.483,"body":"the value of that bond now falls to $40."},{"startTime":2414.44,"endTime":2417.7,"body":"Does that make sense? Yes."},{"startTime":2417.7,"endTime":2421.8,"body":"What the bonds face value is $50,"},{"startTime":2421.8,"endTime":2425.5,"body":"but why are you only willing to pay $40"},{"startTime":2425.5,"endTime":2428.77,"body":"for a bond with a paper value 50?"},{"startTime":2428.77,"endTime":2433.77,"body":"It's because the bond is only"},{"startTime":2428.77,"endTime":2433.77,"body":"giving you a 4% interest rate"},{"startTime":2435.15,"endTime":2438.33,"body":"whereas you could get 5% with the bank"},{"startTime":2438.33,"endTime":2440.92,"body":"because that is the opportunity cost,"},{"startTime":2440.92,"endTime":2442.433,"body":"that is the outside option."},{"startTime":2444.14,"endTime":2449.05,"body":"So what I've highlighted is"},{"startTime":2444.14,"endTime":2449.05,"body":"how the value of anything,"},{"startTime":2449.05,"endTime":2452.45,"body":"a bonds, a gym, any investment"},{"startTime":2452.45,"endTime":2457.45,"body":"goes in the opposite direction"},{"startTime":2452.45,"endTime":2457.45,"body":"to the interest rates."},{"startTime":2458.43,"endTime":2460.93,"body":"With the gym, remember that"},{"startTime":2458.43,"endTime":2460.93,"body":"was initially something"},{"startTime":2460.93,"endTime":2462.93,"body":"we didn't want to invest in,"},{"startTime":2462.93,"endTime":2465.2,"body":"but when the interest rate fell,"},{"startTime":2465.2,"endTime":2467.47,"body":"we did want to invest in the gym."},{"startTime":2467.47,"endTime":2469.31,"body":"And same for the sponsors here,"},{"startTime":2469.31,"endTime":2471.47,"body":"the lower the interest rates,"},{"startTime":2471.47,"endTime":2473.63,"body":"the higher the value of the bond,"},{"startTime":2473.63,"endTime":2475.393,"body":"the bond is worth more to us."},{"startTime":2477.171,"endTime":2478.254,"body":"And you might think,"},{"startTime":2478.254,"endTime":2479.27,"body":"well, does that really makes sense."},{"startTime":2479.27,"endTime":2480.58,"body":"Let's do the sanity check"},{"startTime":2480.58,"endTime":2482.72,"body":"that Alex has always been emphasizing."},{"startTime":2482.72,"endTime":2485.04,"body":"Well, bonds pay interest."},{"startTime":2485.04,"endTime":2489.263,"body":"Shouldn't a bond be worth more,"},{"startTime":2485.04,"endTime":2489.263,"body":"the more interest it pays."},{"startTime":2490.14,"endTime":2493.35,"body":"But remember, the interest"},{"startTime":2490.14,"endTime":2493.35,"body":"rate I'm talking about here"},{"startTime":2493.35,"endTime":2496.8,"body":"is the outside interest rates."},{"startTime":2496.8,"endTime":2499.32,"body":"That is what we could get elsewhere,"},{"startTime":2499.32,"endTime":2502.193,"body":"if we were to put the"},{"startTime":2499.32,"endTime":2502.193,"body":"money in the bank instead."},{"startTime":2503.1,"endTime":2506.43,"body":"So that is why we have"},{"startTime":2503.1,"endTime":2506.43,"body":"the negative relationship."},{"startTime":2506.43,"endTime":2508.42,"body":"This is the opportunity cost."},{"startTime":2508.42,"endTime":2511.86,"body":"This is what else you"},{"startTime":2508.42,"endTime":2511.86,"body":"could do with your money,"},{"startTime":2511.86,"endTime":2514.18,"body":"if you didn't buy the bond,"},{"startTime":2514.18,"endTime":2516.32,"body":"if you didn't invest in the factory,"},{"startTime":2516.32,"endTime":2518.46,"body":"if you didn't renovate your kitchen."},{"startTime":2518.46,"endTime":2521.62,"body":"The better the outside option,"},{"startTime":2521.62,"endTime":2525.56,"body":"the lower the desirability"},{"startTime":2521.62,"endTime":2525.56,"body":"of building the factory"},{"startTime":2525.56,"endTime":2528.373,"body":"or renovating your kitchen and so on."},{"startTime":2529.21,"endTime":2531.11,"body":"The worst, the outside option,"},{"startTime":2531.11,"endTime":2534.77,"body":"the more attractive the"},{"startTime":2531.11,"endTime":2534.77,"body":"investment decision is."},{"startTime":2534.77,"endTime":2536.35,"body":"Well, this is just like,"},{"startTime":2536.35,"endTime":2539.29,"body":"if we had the World Cup"},{"startTime":2536.35,"endTime":2539.29,"body":"final on at the moment,"},{"startTime":2539.29,"endTime":2540.96,"body":"nobody would be in this lecture"},{"startTime":2540.96,"endTime":2543.15,"body":"if maybe the strictly"},{"startTime":2540.96,"endTime":2543.15,"body":"conducting final was on"},{"startTime":2543.15,"endTime":2545.39,"body":"or anything else, which"},{"startTime":2543.15,"endTime":2545.39,"body":"is really attractive,"},{"startTime":2545.39,"endTime":2549.11,"body":"that would reduce the attractiveness"},{"startTime":2545.39,"endTime":2549.11,"body":"of making the decision"},{"startTime":2549.11,"endTime":2550.45,"body":"to come here."},{"startTime":2550.45,"endTime":2552.68,"body":"But if there isn't so much else on,"},{"startTime":2552.68,"endTime":2554.1,"body":"then an it decision to come here,"},{"startTime":2554.1,"endTime":2556.71,"body":"it's going to be more"},{"startTime":2554.1,"endTime":2556.71,"body":"attractive whenever we make"},{"startTime":2556.71,"endTime":2559.15,"body":"any decision, which costs us something,"},{"startTime":2559.15,"endTime":2561.13,"body":"be it money, be it time,"},{"startTime":2561.13,"endTime":2564.6,"body":"this is something with an"},{"startTime":2561.13,"endTime":2564.6,"body":"outside opportunity costs."},{"startTime":2564.6,"endTime":2567.45,"body":"So what we need to look"},{"startTime":2564.6,"endTime":2567.45,"body":"at is what is the cost"},{"startTime":2567.45,"endTime":2569.64,"body":"of the outside option and here"},{"startTime":2569.64,"endTime":2571.24,"body":"it's given by the interest rate."},{"startTime":2574.02,"endTime":2576.5,"body":"So there's a couple more shortcuts"},{"startTime":2574.02,"endTime":2576.5,"body":"that I want to go through"},{"startTime":2576.5,"endTime":2579.13,"body":"before closing and"},{"startTime":2576.5,"endTime":2579.13,"body":"opening it to questions."},{"startTime":2579.13,"endTime":2579.963,"body":"You might think,"},{"startTime":2579.963,"endTime":2582.68,"body":"well, the bond that I"},{"startTime":2579.963,"endTime":2582.68,"body":"showed you is really boring."},{"startTime":2582.68,"endTime":2587.193,"body":"It's just paying you the amount"},{"startTime":2582.68,"endTime":2587.193,"body":"of 4% every year, forever."},{"startTime":2588.04,"endTime":2591.59,"body":"In reality, many investments"},{"startTime":2588.04,"endTime":2591.59,"body":"that you might realistically"},{"startTime":2591.59,"endTime":2595.19,"body":"want to take will grow over time."},{"startTime":2595.19,"endTime":2598.36,"body":"So let's say we're going to"},{"startTime":2595.19,"endTime":2598.36,"body":"bail that close factory again."},{"startTime":2598.36,"endTime":2601.98,"body":"That closed factory might"},{"startTime":2598.36,"endTime":2601.98,"body":"generate maybe 100 pounds"},{"startTime":2601.98,"endTime":2605.52,"body":"in the first year, but each future year,"},{"startTime":2605.52,"endTime":2609.362,"body":"that will grow maybe you're"},{"startTime":2605.52,"endTime":2609.362,"body":"going to make the clothes"},{"startTime":2609.362,"endTime":2612.4,"body":"more better maybe you're going"},{"startTime":2609.362,"endTime":2612.4,"body":"to be building a brand and so on"},{"startTime":2612.4,"endTime":2615.45,"body":"and so you're going to be"},{"startTime":2612.4,"endTime":2615.45,"body":"having some growth here."},{"startTime":2615.45,"endTime":2617.87,"body":"So how do you things change when,"},{"startTime":2617.87,"endTime":2622.02,"body":"what you have is a growing"},{"startTime":2617.87,"endTime":2622.02,"body":"perpetuity where the cashflow"},{"startTime":2622.02,"endTime":2625.06,"body":"is not this boiling"},{"startTime":2622.02,"endTime":2625.06,"body":"amount, see every year,"},{"startTime":2625.06,"endTime":2630.06,"body":"but it grows every year by"},{"startTime":2625.06,"endTime":2630.06,"body":"a growth rate given by g."},{"startTime":2632.41,"endTime":2635.38,"body":"How does the present value change"},{"startTime":2635.38,"endTime":2637.82,"body":"rather than having C divided by r"},{"startTime":2638.74,"endTime":2643.123,"body":"we're now having C divided by r minus G."},{"startTime":2644.08,"endTime":2647.633,"body":"So in the denominator, we're"},{"startTime":2644.08,"endTime":2647.633,"body":"reducing the denominator?"},{"startTime":2648.62,"endTime":2650.54,"body":"Does that make sense?"},{"startTime":2650.54,"endTime":2652.4,"body":"The answer was yes."},{"startTime":2652.4,"endTime":2653.68,"body":"The higher the growth rate,"},{"startTime":2653.68,"endTime":2656.75,"body":"the faster the cash flows"},{"startTime":2653.68,"endTime":2656.75,"body":"from an investment grow"},{"startTime":2657.89,"endTime":2661.13,"body":"a lot higher growth rate"},{"startTime":2657.89,"endTime":2661.13,"body":"means a lower denominator,"},{"startTime":2661.13,"endTime":2663.1,"body":"which means a higher value."},{"startTime":2663.1,"endTime":2667.403,"body":"So something is more"},{"startTime":2663.1,"endTime":2667.403,"body":"valuable when it's growing."},{"startTime":2668.38,"endTime":2671.71,"body":"And so going back to companies like Tesla,"},{"startTime":2671.71,"endTime":2675.133,"body":"Tesla doesn't produce much cash right now."},{"startTime":2676.06,"endTime":2679.88,"body":"However, because the growth"},{"startTime":2676.06,"endTime":2679.88,"body":"prospects are so high,"},{"startTime":2679.88,"endTime":2682.73,"body":"this is why the company could be trading"},{"startTime":2682.73,"endTime":2685.14,"body":"at much, much, many, many times"},{"startTime":2685.14,"endTime":2686.95,"body":"it's common cash flows."},{"startTime":2686.95,"endTime":2690.1,"body":"Why? Because the expected"},{"startTime":2686.95,"endTime":2690.1,"body":"growth rate is so high."},{"startTime":2690.1,"endTime":2693.833,"body":"That's what justifies the"},{"startTime":2690.1,"endTime":2693.833,"body":"extra astronomical valuations."},{"startTime":2694.95,"endTime":2698.753,"body":"Again, let's put this into"},{"startTime":2694.95,"endTime":2698.753,"body":"practice with an example."},{"startTime":2699.69,"endTime":2701.063,"body":"Let's go back to our gym."},{"startTime":2702.02,"endTime":2704.38,"body":"And let's say that as before,"},{"startTime":2704.38,"endTime":2707.78,"body":"the gym is costing us 1,000 today,"},{"startTime":2707.78,"endTime":2710.523,"body":"and it's going to give us"},{"startTime":2707.78,"endTime":2710.523,"body":"200 pounds one year from now."},{"startTime":2711.886,"endTime":2713.63,"body":"And let's say, then that 200 pounds"},{"startTime":2713.63,"endTime":2718.63,"body":"is going to grow at a rate"},{"startTime":2713.63,"endTime":2718.63,"body":"of 2% every year forever."},{"startTime":2721.33,"endTime":2726.33,"body":"So how do we calculate whether"},{"startTime":2721.33,"endTime":2726.33,"body":"the gym is worth it or not?"},{"startTime":2726.33,"endTime":2728.913,"body":"The interest rate is 8% as previously."},{"startTime":2730.14,"endTime":2733.233,"body":"We're going to use the exact"},{"startTime":2730.14,"endTime":2733.233,"body":"same formula as before."},{"startTime":2734.18,"endTime":2738.99,"body":"We said to calculate the"},{"startTime":2734.18,"endTime":2738.99,"body":"value of a growing perpetuity,"},{"startTime":2738.99,"endTime":2741.6,"body":"which is growing until the future,"},{"startTime":2741.6,"endTime":2746.6,"body":"take the first year's"},{"startTime":2741.6,"endTime":2746.6,"body":"cashflow divided by r minus g."},{"startTime":2749.07,"endTime":2754.07,"body":"The interest rates minus the"},{"startTime":2749.07,"endTime":2754.07,"body":"growth rates, 8% minus 2%."},{"startTime":2756.06,"endTime":2759.75,"body":"This gives you the value of"},{"startTime":2756.06,"endTime":2759.75,"body":"all the future cash flows."},{"startTime":2759.75,"endTime":2762.77,"body":"And remember, we will not"},{"startTime":2759.75,"endTime":2762.77,"body":"the net present value."},{"startTime":2762.77,"endTime":2765.98,"body":"We want to net off the initial costs."},{"startTime":2765.98,"endTime":2770.14,"body":"We pay 1,000 for something worth this."},{"startTime":2770.14,"endTime":2773.833,"body":"And so if all, what we have"},{"startTime":2770.14,"endTime":2773.833,"body":"is something worth 2,333,"},{"startTime":2775.38,"endTime":2778.21,"body":"the value is much, much"},{"startTime":2775.38,"endTime":2778.21,"body":"higher than the cost."},{"startTime":2778.21,"endTime":2782.09,"body":"And therefore everybody"},{"startTime":2778.21,"endTime":2782.09,"body":"would want to go ahead"},{"startTime":2782.09,"endTime":2783.04,"body":"and build this gym."},{"startTime":2786.0,"endTime":2788.01,"body":"The final thing I'm going"},{"startTime":2786.0,"endTime":2788.01,"body":"to go through in terms of"},{"startTime":2788.01,"endTime":2789.52,"body":"a final shortcut is, well,"},{"startTime":2789.52,"endTime":2791.95,"body":"what happens if we don't have something"},{"startTime":2791.95,"endTime":2793.91,"body":"which is going to last forever?"},{"startTime":2793.91,"endTime":2794.743,"body":"Well, okay."},{"startTime":2794.743,"endTime":2797.66,"body":"Yeah, we get it consul"},{"startTime":2794.743,"endTime":2797.66,"body":"as they last forever."},{"startTime":2797.66,"endTime":2800.62,"body":"And maybe we've got a business"},{"startTime":2797.66,"endTime":2800.62,"body":"model, which is going to be"},{"startTime":2800.62,"endTime":2803.75,"body":"not clearly terminating at some point,"},{"startTime":2803.75,"endTime":2806.01,"body":"we can assume that it might last forever."},{"startTime":2806.01,"endTime":2809.47,"body":"But there's some things which"},{"startTime":2806.01,"endTime":2809.47,"body":"last for short period of time."},{"startTime":2809.47,"endTime":2812.98,"body":"And so what we're going to look"},{"startTime":2809.47,"endTime":2812.98,"body":"at is that type of cashflow."},{"startTime":2812.98,"endTime":2814.98,"body":"It's called an annuity."},{"startTime":2814.98,"endTime":2818.23,"body":"An annuity is something which"},{"startTime":2814.98,"endTime":2818.23,"body":"pays cash for certain number"},{"startTime":2818.23,"endTime":2821.22,"body":"of periods, and then just stops."},{"startTime":2821.22,"endTime":2824.71,"body":"And one big example of that is a mortgage."},{"startTime":2824.71,"endTime":2827.04,"body":"So what do we do when"},{"startTime":2824.71,"endTime":2827.04,"body":"we take out a mortgage,"},{"startTime":2827.04,"endTime":2829.457,"body":"I'm going to borrow it from a bank."},{"startTime":2829.457,"endTime":2831.52,"body":"I'm going to pay back to the bank,"},{"startTime":2831.52,"endTime":2836.52,"body":"the same amount every"},{"startTime":2831.52,"endTime":2836.52,"body":"month, that's not changing"},{"startTime":2836.65,"endTime":2839.53,"body":"and then hopefully after 25 years,"},{"startTime":2839.53,"endTime":2841.83,"body":"I have fully paid back the mortgage."},{"startTime":2841.83,"endTime":2844.89,"body":"So the bank is getting"},{"startTime":2841.83,"endTime":2844.89,"body":"money from me every month,"},{"startTime":2844.89,"endTime":2847.0,"body":"but I only for 25 years,"},{"startTime":2847.0,"endTime":2849.9,"body":"they're not getting it in perpetuity."},{"startTime":2849.9,"endTime":2852.203,"body":"I'm only slaved to them for 25 years."},{"startTime":2853.23,"endTime":2856.03,"body":"So the question is, is if"},{"startTime":2853.23,"endTime":2856.03,"body":"you do have this investment,"},{"startTime":2856.03,"endTime":2859.08,"body":"which is paying for only"},{"startTime":2856.03,"endTime":2859.08,"body":"a finite length of time,"},{"startTime":2859.08,"endTime":2860.75,"body":"how much is it worth?"},{"startTime":2860.75,"endTime":2865.3,"body":"Is here, the stream of"},{"startTime":2860.75,"endTime":2865.3,"body":"cash flows is C every year"},{"startTime":2866.15,"endTime":2868.73,"body":"for an amount of time, which is T periods."},{"startTime":2868.73,"endTime":2870.96,"body":"It's not coming on forever."},{"startTime":2870.96,"endTime":2875.613,"body":"And what we have is this formula"},{"startTime":2870.96,"endTime":2875.613,"body":"here as being the shortcut."},{"startTime":2876.51,"endTime":2881.31,"body":"So it is like, it starts"},{"startTime":2876.51,"endTime":2881.31,"body":"off being a perpetuity,"},{"startTime":2881.31,"endTime":2884.04,"body":"but it's worth less than a perpetuity"},{"startTime":2884.04,"endTime":2885.693,"body":"because of this minus term here."},{"startTime":2886.716,"endTime":2888.77,"body":"And that kind of makes sense, right?"},{"startTime":2888.77,"endTime":2893.57,"body":"Because an annuity stops"},{"startTime":2888.77,"endTime":2893.57,"body":"at a certain point in time"},{"startTime":2893.57,"endTime":2895.15,"body":"is going to be worth less."},{"startTime":2895.15,"endTime":2898.38,"body":"And that's reflected by the"},{"startTime":2895.15,"endTime":2898.38,"body":"fact that we're multiplying"},{"startTime":2898.38,"endTime":2901.68,"body":"by this number, which is less than one."},{"startTime":2901.68,"endTime":2906.68,"body":"And obviously the fortress"},{"startTime":2901.68,"endTime":2906.68,"body":"stops the lower T,"},{"startTime":2907.64,"endTime":2911.15,"body":"when T is lower, this is higher."},{"startTime":2911.15,"endTime":2913.54,"body":"And so when T is lower,"},{"startTime":2913.54,"endTime":2916.68,"body":"this whole thing here"},{"startTime":2913.54,"endTime":2916.68,"body":"is going to be higher."},{"startTime":2916.68,"endTime":2919.29,"body":"We're subtracting a bigger number"},{"startTime":2919.29,"endTime":2922.533,"body":"and therefore the whole present"},{"startTime":2919.29,"endTime":2922.533,"body":"value is also going down."},{"startTime":2924.09,"endTime":2927.23,"body":"So this gives me my final example."},{"startTime":2927.23,"endTime":2930.03,"body":"And I'm getting, can I use"},{"startTime":2927.23,"endTime":2930.03,"body":"the example of a mortgage?"},{"startTime":2930.03,"endTime":2933.52,"body":"I'm taking out a mortgage"},{"startTime":2930.03,"endTime":2933.52,"body":"for 100,000 pounds"},{"startTime":2933.52,"endTime":2935.733,"body":"at a fixed interest rate of 3%."},{"startTime":2936.86,"endTime":2939.96,"body":"The mortgage will be repaid each year."},{"startTime":2939.96,"endTime":2941.83,"body":"I know that in reality it's months,"},{"startTime":2941.83,"endTime":2946.47,"body":"but let me keep it simple and"},{"startTime":2941.83,"endTime":2946.47,"body":"have it years, over 25 years."},{"startTime":2946.47,"endTime":2948.863,"body":"How much will I need"},{"startTime":2946.47,"endTime":2948.863,"body":"to pay back every year?"},{"startTime":2950.02,"endTime":2952.75,"body":"So what am I doing when"},{"startTime":2950.02,"endTime":2952.75,"body":"I'm paying back a mortgage"},{"startTime":2952.75,"endTime":2957.75,"body":"I'm making an amount"},{"startTime":2952.75,"endTime":2957.75,"body":"every year for 25 years,"},{"startTime":2957.87,"endTime":2961.7,"body":"it has to be that the present value of all"},{"startTime":2961.7,"endTime":2965.37,"body":"of those future 25 payments"},{"startTime":2965.37,"endTime":2970.003,"body":"has to equal 100,000 pounds today."},{"startTime":2971.23,"endTime":2973.71,"body":"And so how do I calculate"},{"startTime":2971.23,"endTime":2973.71,"body":"the present value"},{"startTime":2973.71,"endTime":2977.02,"body":"of all of those future 25 payments?"},{"startTime":2977.02,"endTime":2979.303,"body":"I use the annuity formula."},{"startTime":2980.3,"endTime":2985.3,"body":"It has to be that whatever my"},{"startTime":2980.3,"endTime":2985.3,"body":"annual payment is every year,"},{"startTime":2985.48,"endTime":2990.48,"body":"that when I take that over"},{"startTime":2985.48,"endTime":2990.48,"body":"25 years has to give me"},{"startTime":2990.747,"endTime":2992.543,"body":"100,000 pounds."},{"startTime":2993.51,"endTime":2998.133,"body":"Why? I'm boring a hundred"},{"startTime":2993.51,"endTime":2998.133,"body":"thousand pounds from the bank."},{"startTime":2999.12,"endTime":3003.33,"body":"What I have to pay back the"},{"startTime":2999.12,"endTime":3003.33,"body":"bank in the future every year"},{"startTime":3003.33,"endTime":3006.92,"body":"for 25 years at an interest rate of 3%,"},{"startTime":3007.802,"endTime":3011.9,"body":"must be worth the 100,000 pounds"},{"startTime":3011.9,"endTime":3014.683,"body":"that I'm borrowing from it to begin with."},{"startTime":3015.54,"endTime":3018.01,"body":"And when I put this into calculator,"},{"startTime":3018.01,"endTime":3022.997,"body":"what I get is I get the cashflow is 5,743."},{"startTime":3024.93,"endTime":3029.13,"body":"How much I need to pay back"},{"startTime":3024.93,"endTime":3029.13,"body":"to the bank every year,"},{"startTime":3029.13,"endTime":3032.833,"body":"is this for me to have"},{"startTime":3029.13,"endTime":3032.833,"body":"fully repaid the loan?"},{"startTime":3034.21,"endTime":3037.13,"body":"The question is, well,"},{"startTime":3034.21,"endTime":3037.13,"body":"does that make sense?"},{"startTime":3037.13,"endTime":3038.37,"body":"And the answer is yes,"},{"startTime":3038.37,"endTime":3043.37,"body":"because if I type that and"},{"startTime":3038.37,"endTime":3043.37,"body":"I multiply it by 25 years,"},{"startTime":3043.72,"endTime":3046.387,"body":"then I'm going to be"},{"startTime":3043.72,"endTime":3046.387,"body":"paying back overall 143,570"},{"startTime":3048.99,"endTime":3050.51,"body":"to the bank."},{"startTime":3050.51,"endTime":3052.67,"body":"And that makes sense because"},{"startTime":3050.51,"endTime":3052.67,"body":"I need to pay the bank"},{"startTime":3052.67,"endTime":3053.95,"body":"some interest."},{"startTime":3053.95,"endTime":3057.04,"body":"So it makes sense that"},{"startTime":3053.95,"endTime":3057.04,"body":"I'm bothering 100,000 now,"},{"startTime":3057.04,"endTime":3059.0,"body":"and I'm paying back an amount much higher"},{"startTime":3059.0,"endTime":3063.18,"body":"than a hundred thousands"},{"startTime":3059.0,"endTime":3063.18,"body":"because I need to pay interest."},{"startTime":3063.18,"endTime":3065.67,"body":"Now, before today's lecture,"},{"startTime":3063.18,"endTime":3065.67,"body":"I'd asked you this question,"},{"startTime":3065.67,"endTime":3069.09,"body":"you might think if I'm having"},{"startTime":3065.67,"endTime":3069.09,"body":"to pay back 100,000 pounds"},{"startTime":3069.09,"endTime":3073.02,"body":"over 25 years, how much"},{"startTime":3069.09,"endTime":3073.02,"body":"will I pay back every year?"},{"startTime":3073.02,"endTime":3077.55,"body":"100,000 divided by 25,"},{"startTime":3073.02,"endTime":3077.55,"body":"4,000 pounds per year,"},{"startTime":3077.55,"endTime":3080.23,"body":"but that's clearly wrong"},{"startTime":3077.55,"endTime":3080.23,"body":"because that doesn't take"},{"startTime":3080.23,"endTime":3081.78,"body":"the interest rate into account"},{"startTime":3081.78,"endTime":3083.56,"body":"that shows you how to do this."},{"startTime":3083.56,"endTime":3085.87,"body":"And this gives you the answer here,"},{"startTime":3085.87,"endTime":3087.583,"body":"which indeed makes sense."},{"startTime":3088.58,"endTime":3089.57,"body":"Before I close and answer the Q\u0026A,"},{"startTime":3089.57,"endTime":3092.57,"body":"let me just go through"},{"startTime":3089.57,"endTime":3092.57,"body":"some final practical tips"},{"startTime":3092.57,"endTime":3094.68,"body":"of how to do these things"},{"startTime":3092.57,"endTime":3094.68,"body":"in practice, right?"},{"startTime":3094.68,"endTime":3096.39,"body":"I've shown you the formulas"},{"startTime":3096.39,"endTime":3098.06,"body":"and I've shown you how to apply them"},{"startTime":3098.06,"endTime":3099.6,"body":"but as I alluded to earlier,"},{"startTime":3099.6,"endTime":3102.14,"body":"so often some of this skill of this"},{"startTime":3102.14,"endTime":3105.24,"body":"is to think about what numbers"},{"startTime":3102.14,"endTime":3105.24,"body":"to put into the formulas"},{"startTime":3105.24,"endTime":3106.99,"body":"to begin with rather than actually"},{"startTime":3106.99,"endTime":3108.443,"body":"how to implement the formula."},{"startTime":3109.6,"endTime":3111.56,"body":"And one really important"},{"startTime":3109.6,"endTime":3111.56,"body":"thing is to realize"},{"startTime":3111.56,"endTime":3115.86,"body":"that you need to take all"},{"startTime":3111.56,"endTime":3115.86,"body":"incremental cash flows"},{"startTime":3115.86,"endTime":3117.4,"body":"into account."},{"startTime":3117.4,"endTime":3119.31,"body":"So what does it mean by incremental?"},{"startTime":3119.31,"endTime":3123.99,"body":"Any new cashflow, which comes as a result"},{"startTime":3123.99,"endTime":3127.09,"body":"of having to put on at the investment,"},{"startTime":3127.09,"endTime":3128.68,"body":"this needs to be taken into account."},{"startTime":3128.68,"endTime":3130.42,"body":"So example of Gresham College"},{"startTime":3130.42,"endTime":3133.58,"body":"is going to be trying to"},{"startTime":3130.42,"endTime":3133.58,"body":"introduce a new subject."},{"startTime":3133.58,"endTime":3136.12,"body":"And let's say, we're going to"},{"startTime":3133.58,"endTime":3136.12,"body":"do a new series of lectures"},{"startTime":3136.12,"endTime":3137.44,"body":"on this new topic."},{"startTime":3137.44,"endTime":3140.82,"body":"If this means that we need to"},{"startTime":3137.44,"endTime":3140.82,"body":"hire out the Museum of London"},{"startTime":3140.82,"endTime":3143.14,"body":"to have that new lecture series,"},{"startTime":3143.14,"endTime":3147.48,"body":"then those cash flows"},{"startTime":3143.14,"endTime":3147.48,"body":"need to be incorporated."},{"startTime":3147.48,"endTime":3152.04,"body":"However, it is that this"},{"startTime":3147.48,"endTime":3152.04,"body":"requires some marketing"},{"startTime":3152.04,"endTime":3154.44,"body":"and that marketing we already have,"},{"startTime":3154.44,"endTime":3156.9,"body":"the website, we've already built it,"},{"startTime":3156.9,"endTime":3159.01,"body":"then we might not think"},{"startTime":3156.9,"endTime":3159.01,"body":"that that is something"},{"startTime":3159.01,"endTime":3160.25,"body":"which is incremental."},{"startTime":3160.25,"endTime":3165.08,"body":"So we only to include things"},{"startTime":3160.25,"endTime":3165.08,"body":"that are going to be added"},{"startTime":3165.08,"endTime":3169.163,"body":"as a result of having to"},{"startTime":3165.08,"endTime":3169.163,"body":"launch that new investment."},{"startTime":3170.02,"endTime":3174.18,"body":"On the flip side, what we need"},{"startTime":3170.02,"endTime":3174.18,"body":"to do is ignore sunk costs."},{"startTime":3174.18,"endTime":3175.843,"body":"So what do you mean by a sunk cost?"},{"startTime":3175.843,"endTime":3178.82,"body":"That is a cost that happened in the past."},{"startTime":3178.82,"endTime":3180.22,"body":"It's the bygone."},{"startTime":3180.22,"endTime":3183.12,"body":"It's not something that we can change."},{"startTime":3183.12,"endTime":3187.027,"body":"For example, let's say I"},{"startTime":3183.12,"endTime":3187.027,"body":"have spent as a company,"},{"startTime":3187.027,"endTime":3191.69,"body":"$10 million developing this new drug."},{"startTime":3191.69,"endTime":3193.42,"body":"And now I'm going to think about,"},{"startTime":3193.42,"endTime":3196.65,"body":"do I actually commercialize the drug?"},{"startTime":3196.65,"endTime":3199.85,"body":"And if I was to commercialize the drug,"},{"startTime":3199.85,"endTime":3202.96,"body":"I would get revenues of 5 million,"},{"startTime":3202.96,"endTime":3205.37,"body":"but it would cost me 6 million to do that."},{"startTime":3205.37,"endTime":3208.53,"body":"Now you might think, well,"},{"startTime":3205.37,"endTime":3208.53,"body":"it's obvious I shouldn't do it."},{"startTime":3208.53,"endTime":3212.176,"body":"I'm going to pay six and get"},{"startTime":3208.53,"endTime":3212.176,"body":"five, but you might think,"},{"startTime":3212.176,"endTime":3213.35,"body":"well, at the back of my mind,"},{"startTime":3213.35,"endTime":3216.22,"body":"I've already spent 10"},{"startTime":3213.35,"endTime":3216.22,"body":"million developing the drug."},{"startTime":3216.22,"endTime":3218.89,"body":"If I don't commercialize"},{"startTime":3216.22,"endTime":3218.89,"body":"that that 10 million"},{"startTime":3218.89,"endTime":3220.04,"body":"would have been wasted."},{"startTime":3220.96,"endTime":3224.36,"body":"But that 10 million what's already wasted"},{"startTime":3224.36,"endTime":3227.71,"body":"what you can't change the"},{"startTime":3224.36,"endTime":3227.71,"body":"fact that that 10 million"},{"startTime":3227.71,"endTime":3229.44,"body":"has already been spent."},{"startTime":3229.44,"endTime":3234.44,"body":"The only thing that you care"},{"startTime":3229.44,"endTime":3234.44,"body":"about now is any future cost,"},{"startTime":3234.81,"endTime":3238.73,"body":"which comes from taking"},{"startTime":3234.81,"endTime":3238.73,"body":"that investment decision."},{"startTime":3238.73,"endTime":3242.66,"body":"And the only relevant thing is"},{"startTime":3238.73,"endTime":3242.66,"body":"the six it's going to cost me"},{"startTime":3242.66,"endTime":3244.16,"body":"to develop the drug,"},{"startTime":3244.16,"endTime":3247.07,"body":"verse the five I'm going"},{"startTime":3244.16,"endTime":3247.07,"body":"to get by doing so."},{"startTime":3247.07,"endTime":3249.427,"body":"And because the benefits"},{"startTime":3247.07,"endTime":3249.427,"body":"are less than the costs,"},{"startTime":3249.427,"endTime":3251.61,"body":"I'm not going to want to go ahead."},{"startTime":3251.61,"endTime":3253.62,"body":"So when you have a witness at a trial,"},{"startTime":3253.62,"endTime":3256.66,"body":"the witness has to"},{"startTime":3253.62,"endTime":3256.66,"body":"swear to tell the truth,"},{"startTime":3256.66,"endTime":3260.18,"body":"the whole truth and nothing but the truth."},{"startTime":3260.18,"endTime":3262.5,"body":"And that principle"},{"startTime":3260.18,"endTime":3262.5,"body":"applies to the cash flows."},{"startTime":3262.5,"endTime":3264.44,"body":"Like we want to have the whole truth,"},{"startTime":3264.44,"endTime":3267.32,"body":"any incremental new cashflow,"},{"startTime":3267.32,"endTime":3270.8,"body":"which comes about that"},{"startTime":3267.32,"endTime":3270.8,"body":"needs to be included,"},{"startTime":3270.8,"endTime":3272.75,"body":"but nothing but the truth,"},{"startTime":3272.75,"endTime":3275.69,"body":"anything which is irrelevant"},{"startTime":3272.75,"endTime":3275.69,"body":"because it was already spent"},{"startTime":3275.69,"endTime":3278.24,"body":"in the past and is not affected"},{"startTime":3278.24,"endTime":3279.87,"body":"by the new investment decision,"},{"startTime":3279.87,"endTime":3282.57,"body":"we should make sure that we're"},{"startTime":3279.87,"endTime":3282.57,"body":"not going to be including."},{"startTime":3283.47,"endTime":3285.21,"body":"Well, thank you very much"},{"startTime":3283.47,"endTime":3285.21,"body":"for everybody's attention."},{"startTime":3285.21,"endTime":3287.24,"body":"We're going to have"},{"startTime":3285.21,"endTime":3287.24,"body":"time for some questions."},{"startTime":3287.24,"endTime":3288.725,"body":"Let's invite Claire on stage."},{"startTime":3288.725,"endTime":3291.725,"body":"(audience clapping)"},{"startTime":3294.82,"endTime":3297.273,"body":"- So the first question is,"},{"startTime":3298.152,"endTime":3300.8,"body":"how do you decide on investing"},{"startTime":3298.152,"endTime":3300.8,"body":"in connection with inflation"},{"startTime":3300.8,"endTime":3303.25,"body":"and you kind of dressed a little bit here."},{"startTime":3303.25,"endTime":3306.01,"body":"For example, if you buy the PV bond at $50"},{"startTime":3306.01,"endTime":3308.08,"body":"and its value when it matures to 67,"},{"startTime":3308.08,"endTime":3310.52,"body":"has the overall value"},{"startTime":3308.08,"endTime":3310.52,"body":"of the bond decreased"},{"startTime":3310.52,"endTime":3312.17,"body":"because of inflation."},{"startTime":3312.17,"endTime":3313.06,"body":"- Yes. Thanks very much."},{"startTime":3313.06,"endTime":3314.75,"body":"And that's actually"},{"startTime":3313.06,"endTime":3314.75,"body":"something I didn't come to"},{"startTime":3314.75,"endTime":3315.77,"body":"just an interest of times."},{"startTime":3315.77,"endTime":3317.02,"body":"I'm glad you've asked it."},{"startTime":3317.02,"endTime":3319.57,"body":"So all I've done here is"},{"startTime":3317.02,"endTime":3319.57,"body":"I've always considered"},{"startTime":3319.57,"endTime":3321.43,"body":"nominal cash flows."},{"startTime":3321.43,"endTime":3322.56,"body":"And so what are those?"},{"startTime":3322.56,"endTime":3325.69,"body":"Those are cash flows which"},{"startTime":3322.56,"endTime":3325.69,"body":"incorporate inflation."},{"startTime":3325.69,"endTime":3326.95,"body":"So why is that?"},{"startTime":3326.95,"endTime":3328.71,"body":"When I look at the discount rate,"},{"startTime":3328.71,"endTime":3331.69,"body":"that is a nominal financial discount rate,"},{"startTime":3331.69,"endTime":3334.75,"body":"which does take inflation into account."},{"startTime":3334.75,"endTime":3337.07,"body":"So all of the cash flows and the numerator"},{"startTime":3337.07,"endTime":3339.29,"body":"should also incorporate inflation."},{"startTime":3339.29,"endTime":3342.08,"body":"So when I think about"},{"startTime":3339.29,"endTime":3342.08,"body":"how fast the cash flows"},{"startTime":3342.08,"endTime":3344.43,"body":"of the gym are going to grow every year,"},{"startTime":3344.43,"endTime":3347.46,"body":"that should include any inflation as well."},{"startTime":3347.46,"endTime":3349.22,"body":"So what I'm looking at is the cash flows"},{"startTime":3349.22,"endTime":3353.27,"body":"in financial terms, how much"},{"startTime":3349.22,"endTime":3353.27,"body":"money does this give you,"},{"startTime":3353.27,"endTime":3355.97,"body":"including any effect of inflation?"},{"startTime":3355.97,"endTime":3358.18,"body":"And that is apples to"},{"startTime":3355.97,"endTime":3358.18,"body":"apples with the fact that"},{"startTime":3358.18,"endTime":3360.45,"body":"the discount rate, the interest rate,"},{"startTime":3360.45,"endTime":3364.32,"body":"that also is something which"},{"startTime":3360.45,"endTime":3364.32,"body":"incorporates inflation as well."},{"startTime":3364.32,"endTime":3366.07,"body":"So I have inflation in the numerator"},{"startTime":3366.07,"endTime":3367.7,"body":"and inflation the denominator."},{"startTime":3367.7,"endTime":3369.23,"body":"- [Man] I want to ask about"},{"startTime":3370.22,"endTime":3374.36,"body":"now it seems the age of cheap"},{"startTime":3370.22,"endTime":3374.36,"body":"credit is coming to an end."},{"startTime":3374.36,"endTime":3376.563,"body":"Inflation is skyrocketing,"},{"startTime":3377.605,"endTime":3381.12,"body":"because of huge government"},{"startTime":3377.605,"endTime":3381.12,"body":"spending it seems,"},{"startTime":3381.12,"endTime":3385.9,"body":"how would that affect house"},{"startTime":3381.12,"endTime":3385.9,"body":"prices and mortgage price"},{"startTime":3385.9,"endTime":3389.5,"body":"is more like a mortgage rate"},{"startTime":3385.9,"endTime":3389.5,"body":"and and government debt."},{"startTime":3389.5,"endTime":3392.79,"body":"So, I mean, particularly in house prices,"},{"startTime":3392.79,"endTime":3396.103,"body":"there's mortgage rates go"},{"startTime":3392.79,"endTime":3396.103,"body":"up, house prices also go up."},{"startTime":3397.76,"endTime":3400.173,"body":"What would you say about house buying?"},{"startTime":3401.14,"endTime":3402.287,"body":"- Actually I think when mortgage rates"},{"startTime":3402.287,"endTime":3405.09,"body":"and interest rates go up,"},{"startTime":3402.287,"endTime":3405.09,"body":"house prices will go down"},{"startTime":3405.09,"endTime":3406.1,"body":"rather than going up."},{"startTime":3406.1,"endTime":3407.13,"body":"So why is that?"},{"startTime":3407.13,"endTime":3410.5,"body":"Because the opportunity cost"},{"startTime":3407.13,"endTime":3410.5,"body":"is instead of buying a house,"},{"startTime":3410.5,"endTime":3412.5,"body":"what it could do is put"},{"startTime":3410.5,"endTime":3412.5,"body":"your money in the bank"},{"startTime":3412.5,"endTime":3414.3,"body":"and that's going to be"},{"startTime":3412.5,"endTime":3414.3,"body":"a more attractive option"},{"startTime":3414.3,"endTime":3415.79,"body":"when interest rates go up."},{"startTime":3415.79,"endTime":3417.15,"body":"Alternatively, you might say, well,"},{"startTime":3417.15,"endTime":3418.65,"body":"in order to buy the house,"},{"startTime":3418.65,"endTime":3421.32,"body":"you need to finance that house"},{"startTime":3418.65,"endTime":3421.32,"body":"purchase with a mortgage."},{"startTime":3421.32,"endTime":3424.12,"body":"That mortgage is going to"},{"startTime":3421.32,"endTime":3424.12,"body":"be much less affordable"},{"startTime":3424.12,"endTime":3425.93,"body":"with a higher interest rate."},{"startTime":3425.93,"endTime":3429.21,"body":"And therefore that the"},{"startTime":3425.93,"endTime":3429.21,"body":"house is going to be a less"},{"startTime":3429.21,"endTime":3430.21,"body":"attractive proposition."},{"startTime":3430.21,"endTime":3432.54,"body":"So typically when interest rates go up,"},{"startTime":3432.54,"endTime":3435.1,"body":"then house prices will typically go down."},{"startTime":3435.1,"endTime":3438.11,"body":"Now, if the market is efficient,"},{"startTime":3438.11,"endTime":3441.06,"body":"then the market should have"},{"startTime":3438.11,"endTime":3441.06,"body":"ready have factored that in."},{"startTime":3441.06,"endTime":3443.58,"body":"So the current house prices right now"},{"startTime":3443.58,"endTime":3444.89,"body":"should already take into account"},{"startTime":3444.89,"endTime":3447.37,"body":"the fact that we think that"},{"startTime":3444.89,"endTime":3447.37,"body":"the age of cheap credit"},{"startTime":3447.37,"endTime":3449.94,"body":"is going to be over."},{"startTime":3449.94,"endTime":3452.75,"body":"So what should then it"},{"startTime":3449.94,"endTime":3452.75,"body":"determine whether or not"},{"startTime":3452.75,"endTime":3456.78,"body":"you would want to buy the house"},{"startTime":3452.75,"endTime":3456.78,"body":"is not whether interest rates"},{"startTime":3456.78,"endTime":3459.42,"body":"are going up because everybody"},{"startTime":3456.78,"endTime":3459.42,"body":"agrees that they are,"},{"startTime":3459.42,"endTime":3464.07,"body":"but whether your view is more"},{"startTime":3459.42,"endTime":3464.07,"body":"optimistic or more pessimistic"},{"startTime":3464.07,"endTime":3465.26,"body":"than the current view."},{"startTime":3465.26,"endTime":3467.07,"body":"So let's say everybody"},{"startTime":3465.26,"endTime":3467.07,"body":"thinks interest rates"},{"startTime":3467.07,"endTime":3469.9,"body":"are going to go up to, let's"},{"startTime":3467.07,"endTime":3469.9,"body":"say, just to pick a number 4%"},{"startTime":3469.9,"endTime":3471.8,"body":"by 2025,"},{"startTime":3471.8,"endTime":3473.69,"body":"you think you're interested"},{"startTime":3471.8,"endTime":3473.69,"body":"is going to go up,"},{"startTime":3473.69,"endTime":3476.89,"body":"but maybe they're only"},{"startTime":3473.69,"endTime":3476.89,"body":"going to go up by to 3%."},{"startTime":3476.89,"endTime":3479.18,"body":"You would still buy the house,"},{"startTime":3479.18,"endTime":3481.03,"body":"even though interest rates are rising."},{"startTime":3481.03,"endTime":3483.28,"body":"Why? Because you're not"},{"startTime":3481.03,"endTime":3483.28,"body":"pessimistic as everybody else."},{"startTime":3483.28,"endTime":3486.34,"body":"So what matters is your"},{"startTime":3483.28,"endTime":3486.34,"body":"view on interest rate,"},{"startTime":3486.34,"endTime":3488.03,"body":"not compared to where they are now,"},{"startTime":3488.03,"endTime":3490.54,"body":"but compared to where the"},{"startTime":3488.03,"endTime":3490.54,"body":"market thinks it's going."},{"startTime":3490.54,"endTime":3492.2,"body":"- Thank you all very much for attending"},{"startTime":3492.2,"endTime":3494.57,"body":"and for again, for a fantastic lecture,"},{"startTime":3494.57,"endTime":3498.15,"body":"please do come back for"},{"startTime":3494.57,"endTime":3498.15,"body":"Professor Edmans next lecture,"},{"startTime":3498.15,"endTime":3500.92,"body":"which is on how to"},{"startTime":3498.15,"endTime":3500.92,"body":"measure and manage risk."},{"startTime":3500.92,"endTime":3504.37,"body":"And that will be held on"},{"startTime":3500.92,"endTime":3504.37,"body":"Thursday, the 24th of February"},{"speaker":"at 6","startTime":3505.24,"endTime":3508.51,"body":"00 PM back here in"},{"speaker":"at 6","startTime":3505.24,"endTime":3508.51,"body":"the museum and online."},{"speaker":"at 6","startTime":3508.51,"endTime":3510.12,"body":"Thank you very much"},{"speaker":"at 6","startTime":3508.51,"endTime":3510.12,"body":"for coming this evening"},{"speaker":"at 6","startTime":3510.12,"endTime":3512.423,"body":"and thank you to our"},{"speaker":"at 6","startTime":3510.12,"endTime":3512.423,"body":"online audience as well."},{"speaker":"at 6","startTime":3513.277,"endTime":3516.277,"body":"(audience clapping)"}]}