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Risk Calculation

In the previous chapter, we mastered the valuation of a risk-free project . We learned to discount future cash flows at the risk-free rate to calculate a Net Present Value . But the real world is not risk-free. The future is uncertain. A project's costs may be higher than expected, its revenues lower, or a competitor may emerge and disrupt the market. This chapter introduces the tools we need to navigate this uncertainty. We move from the world of certainty to the world of probability. Our goal is to develop a framework for risk calculation —a way to measure, compare, and ultimately combine risky projects. This will lay the groundwork for determining their value in the chapters to come. 5.1 Probabilities in Economics To calculate risk, we must first quantify uncertainty. This is done through the language of probability. In finance, we rarely know with certainty what the future holds, but we can often assign probabilities to different possible outcomes. Consider a simple risky p...

The Value of a Risk-Free Project

In the preceding chapters, we built the foundational concepts of wealth, income, and money. We now arrive at the central question of finance: how do we determine what something is worth? Specifically, how do we calculate the value of a project that promises a future return? This chapter tackles the simplest version of this question: valuing a risk-free project . While true risk-free projects are rare in practice, understanding their valuation is essential. It establishes the fundamental principles of the time value of money and provides the benchmark—the risk-free rate —against which all risky investments are measured. 4.1 The Language of Value To begin, we must adopt the precise language of finance. When we speak of the value of a project, we are not guessing its price. We are performing a calculation based on its anticipated financial outcomes. This calculation revolves around two core concepts: costs and benefits. Every project, whether it's building a factory, launching a...

The Origins of Money

We have now established a clear understanding of wealth as a stock of valuable assets and income as a flow of value over time. But the common thread running through both concepts is the medium we use to measure, exchange, and store them: money. It is the lifeblood of a modern economy, yet it is so familiar that we rarely stop to ask a fundamental question: where does it actually come from? This chapter pulls back the curtain on the origins of money . We will move beyond the simple definition of money as "cash" to explore the miraculous, and often misunderstood, process by which money is created in a modern banking system . Understanding this process is essential to grasping the dynamics of inflation , economic cycles , and the very nature of financial value. 3.1 Money and the Multiplication of Goods and Services Before we explore where money comes from, we must first understand what it does. Money's primary role is to solve the problem of the double coincidence of want...

Understanding Income

In the previous chapter, we defined wealth as a stock —a reservoir of value at a given moment. We explored its components: tangible and financial assets, less any liabilities. Now, we turn our attention to the river that fills, and sometimes empties, that reservoir: income . We experience income in our daily lives—a weekly wage, a monthly salary, a dividend payment , or even a gift from a relative. But what is it, really? Where does it come from, and what are its different forms? This chapter will dissect the concept of income, moving from the familiar to the fundamental, and address some of the enduring philosophical questions it raises. 2.1 What is Income? At its simplest, income is a flow of value received over a period of time. It is the reward for providing something of value to others. Unlike wealth, which is a snapshot, income can only be measured with a time dimension: euros per hour, dollars per year. In the most basic economic sense, income is the return on the three facto...

What is Wealth?

Economic science often invites us to wish for growth. It is presented as the solution to unemployment, the savior of public finances, and the engine of a better quality of life. But a moment of honest reflection reveals a more complex picture. Pollution, the depletion of natural resources , the psychological distress that often accompanies a consumerist lifestyle , and the frantic production of goods destined for the scrapheap of vanity—all these effects suggest something deeply flawed in the blind idolatry of growth. Yet, the defense of " degrowth " seems equally senseless. We must produce wealth to live, to thrive, to heal the sick, and to educate the young. To be against all growth is to be against life itself. The real choice, then, is not between growth and degrowth. It is a foolish dichotomy. What we truly want is the growth of the good and the degrowth of the bad. We want more of what genuinely enhances human well-being and less of what diminishes it. But this rai...