0:00

Hi. Welcome back. We have had time and opportunity to do many different problems

Â and I have taken the time to go really deep in to them and I have spent a lot of

Â time today with you because I believe the value add in online is the explanation one

Â on one. And today is a lot of real world applications which will help you further

Â in the class so just bear with me for little time. We'll do one interesting

Â problem but before we go there, let's do my favorite financial concept. And my

Â favorite financial concept is called a perpetuity. A perpetuity is simply

Â something that pays you C dollars, roughly the same amount PMT which goes on forever,

Â right? It's pretty remarkable so what do you get? You get CCCCC forever and it

Â could be with or without growth. So when I saw this the first time, I said this is

Â nerdy dumb to the extreme. This is a textbook idea. When am I going to ever see

Â something like that, right? So let me just first of all give you, just think of some

Â examples of perpetuities, right? So there are bonds out there. There is something

Â that pays you say, one pound for a long period of time so that's one example. The

Â second example which is much more complicated but much more intuitive is

Â what is called a stock, a promise as opposed to a bond. I promise we'll spend

Â couple of weeks on stocks and bonds but I wanted to raise this, what's the basic

Â difference between the standard and bond? This is limited inn majority and this

Â hopefully goes on forever. So, for example when John Ford started the company, he

Â didn't say we will be there only for five years and I'll pay you some money and then

Â we are gone. That's not a company, that's not an idea. Great ideas last forever.

Â Great things last forever. What I want you to recognize in all of this is that

Â forever actually, doesn't mean forever. What do I mean by that? So take the

Â example and show you the power of perpetuities. Now let me ask you this,

Â suppose I gave you something, suppose I gave you something that paid $ten forever.

Â Guess what the power of perpetuity is. At time zero guess what the Pv is? We won't

Â derive this. I'm going to give you this one formula. When we have time towards the

Â end, I'll do stuff that is kind of nerdy and, you know interesting for derivations

Â if you have the time but I'll tell you that the terms are to be C/R. So the

Â simplest formula in the world is the formula for perpetuity. Which is the most

Â complex thing to comprehend. So what could this perpetuity be? It's a perpetuity that

Â lasts. It's like a stock that pays you $ten every year and is expected a company

Â that's expected to survive for the reasonable future. So turns out, what will

Â be the answer for this? Suppose the interest rate is ten%. This would be

Â $10/.1 is $100. Okay? So, what could be simpler, right? And would you like this

Â $ten to grow over time? Sure. If it's growing over time at the rate of G, is the

Â growth rate. So suppose the growth rate is ten%. So in the first year, how much is

Â this paying? $Ten. In the second year it's paying 1.1 and so on by the way, these

Â things in real life are called growth stocks. So something like what Microsoft

Â was in the beginning or Google, or technology firms that are successful. They

Â grow and pay out over time. Their growth rate is extremely high. What does the

Â formula become? C/r - G. Right? So because this growth rate is ten percent I can't

Â use this formula so lets make this growth rate five percent so what is R? Ten%. What

Â is G? Five percent and what is C? $Ten. Again, very simple to calculate. The

Â reason I'm introducing this now is not so much to start doing a lot of examples. I

Â just want to introduce it now because its a linear process. We went from annuity,

Â which ends after certain interval. You take loans and you pay them off. Then you

Â think of another concept that goes on forever and we'll come back to these

Â stocks. And as I showed you right now, if the growth rate is ten percent and your,

Â your interest rate is also ten%, you can't use this formula. That doesn't mean you

Â can't calculate the number. You have to the long route, long way. That emphasizes

Â one more important issue. Don't use form ulas blindly. Formulas are at your

Â disposal not the other way around, okay. So, we'll come back to perpetuities in the

Â future but for now I would say just keep it at the back of your mind that there is

Â something real world that looks like a perpetuity and it's very common it's what

Â called the share in the company or a stock of a company because it, we will last for

Â a very long period of time and in the real world, what happens is you don't know how

Â to value things beyond say ten years or 30 years, it's just too far because the world

Â is too uncertain. Such formula, C/R - G are really useful in approximating what

Â you think is going to happen. There's no point getting too refined after five or

Â six years because it's about the future. So actually these formulas, when I saw

Â first time, I said what are they talking about are the most useful ones in real

Â life because you want to get a sense of value. You don't want to get it so precise

Â when you know it's wrong, right? So approximate formulas like C/R - G are

Â actually so useful in grabbing the basics of what finance is trying to offer, okay.

Â As promised I am going to spend a little more time today and this time is not on

Â the next three slides. The next three slides that you see here, don't worry

Â about them. I'm just emphasizing them to remind myself, and to remind you, that if

Â you are oriented towards formulas which I would encourage you to be because formulas

Â reflect in the end of your understanding of what's going on, not the other way

Â around. I would encourage you to walk through these formulas and as I said I'm

Â not going to spend the time for you to read them. This is one part of this

Â overhead slides that are used or visuals that I will provide you as a resource. As

Â I said, I want the main resource to be the videos but I am providing you resources

Â like the course syllabus with chapters from various books, written by wonderful

Â people. I also want you to learn from them not just from me. I don't have the control

Â on learning. Your learning is, you are in charge but I'll give you some formulas so

Â that we can go back and confirm your knowledge. So I just wanted to remind you

Â and me, we'll do that. That will put everything together but I want to end

Â today's class by doing a problem with you and I would say I am going to read this

Â problem first. Could you try to understand the context and then I encourage you to

Â take a break. And hopefully you have taken several breaks over different days during

Â this content, because I am committed in week two to make you understand why we do

Â things the way we do, and the reason is we can learn a lot in ten weeks and I have

Â taken a lot of time today, simply to make you understand how real things are even

Â though they are problems written on a little spreadsheets or in a little

Â Powerpoint so lets go through it. You are 30 years old. You believe you'll be able

Â to save for the next twenty years until you're 50 and why am I saying that?

Â Typically, that's when a lot of people earn money and save but after that, for

Â ten years. You'll, until your retirement at 60 you will have a spike in your, I

Â shouldn't even call it a spike in your expenses, many spikes in your expenses so

Â that you will not be in a position to save for the next ten years. So remember what's

Â going on, starting at 30, 50, and then under a break at 60. These are artificial

Â but believe me, very useful points in your life. After 60 what are you going to do?

Â You want to retire but you want to be able to live, right? And you want to be able to

Â live at the standard of living which in this problem is pretty high. Because most

Â people in the world cannot afford even one-tenth of this or 1/20 but that's, I

Â want big round numbers so that I don't have to deal with decimals and I'm not

Â trying to make a statement about what my expectations or yours are. So you'll

Â retire at 60 and then you expect to live until 80 and you want to take care of the

Â next twenty years at the rate of $100,000, right? You want to but now, now what is

Â happening now? You were saving between 30 and 50 so that you could do this between

Â 60 and 80. And the fact that both are twenty years is just an artifact of the

Â example. Who controls all of this? You do. Who controls now, the next decision? What

Â interest rate will you earn on your savings will depend on you. It'll depend

Â on what type of risks you're willing to take and for convenience or for just fun,

Â I'm assuming that you are a person inclined to invest in risky stuff. And

Â therefore you will be rewarded on average in the long run at eight%. So, this is the

Â nature of the beast. This is the problem. I'm encouraging you now to do two things.

Â Think about it for about five to ten minutes and do the most important thing in

Â life which is more important than even finance, I can't believe I just said that

Â but draw a timeline and put your problem on that timeline. If you can do that, we

Â can do this problem in five minutes. If you can't do that, remember it's not the

Â problem of finance. Finance is going to help you not hurt you. It's because common

Â sense is not that common. [laugh] Is, finance is full of common sense but the

Â word common sense is a, is a wrong expression. I've found whenever I look at

Â common sense, it's pretty complicated. That's why after a while it becomes common

Â to you but finance is only going to help you. So do that, I'll come back in about

Â five minutes and we'll do this problem together and that will be the end of today

Â and I promise you this will enable you to do the assignment and crank up the heat in

Â the assignment. I want this week to be intense for you and the purpose fully

Â served. And the reason is we can go very far, we can go very far not in the

Â mechanics but in the understanding of the world, okay. So break for five to ten

Â minutes and I'll come back and do the problem.

Â