Present Discounted Values Bonds The Stock Market • Firms raise funds in two ways: ○ Debt finance: bonds and loans ○ Equity finance: through issues of stocks (shares)
• Stocks pay dividends of an amount decided by the firm Graph showing the S&P composite index since 1950
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Stock prices ○ Price of a stock must equal the PV of future expected dividends ○ In real terms:
• This relation has two important implications: • Expected future real dividends ↑ Real stock price ↑ • Current and expected future one-year real interest rate ↓ Real stock price ↓
Stock market & economic activity Graph demonstrating the effect of an unanticipated monetary expansion