Introduction to Finance... 5 Definitions... 5 Finance Financial Markets... 10

Transcription

1 Cntents Intrductin t Finance... 5 Definitins... 5 Finance... 5 Financial Markets... 5 Mney... 5 Mney vs. Barter Ecnmy... 5 Functins f Mney... 5 Evlutin f Mney... 6 Questins... 6 The Financial System... 7 Financial Agents... 7 Husehlds... 7 Firms... 8 Financial Markets Primary vs. Secndary markets Whlesale vs. Retail markets Mney markets vs. Capital markets Over-the-cunter vs. Exchange-traded markets Debt vs. Equity markets Intrductin t Financial Intermediaries Frms f Finance The Flw f Funds Internatinal Transfer f Funds Functins f the Financial System Questins Financial Intermediaries Characteristics f Financial Intermediaries Categrizatin by prducts and services Financial Intermediatin Cmmercial Banks Investment Banks Bank Accepted Bills Risk Regulatin Time Value f Mney Interest Rates... 25! 1

2 Simple Interest Cmpund Interest Ecnmic Determinants f Rates f Return Rate f returns n financial instruments Rate f return n Risky Assets Histrical Averages Inflatin and Interest Rates Questins The Mney Market Characteristics Functins Benefits f Mney Market Financial Instruments Pricing Calculating Dealer s spread Investment Risk Calculating Hlding perid return and Capital Gain Price Risk Mnetary Plicy What is the cash rate? Objectives f Mnetary Plicy Implementatin f Mnetary Plicy Open Market Operatins Transmissin f Mnetary Plicy t Ecnmy Questins Allcating Resurces ver Time Cmpunding Frequency f Cmpunding Discunting Investment Decisin Rules Decisin Rules as a Deficit Unit Multiple Cash Flws Annuities Perpetual Annuities Lan Amrtizatin Carry Trade Inflatin and Discunted Cash Flw Analysis... 43! 2

3 Taxes and Investment Decisins Questins nt dne Husehld Saving and Investment Decisins A Life Cycle Mdel f Saving Scial Security Deferring Taxes thrugh Vluntary Retirement Plans Shuld yu invest in a Prfessinal Degree? Shuld yu buy r rent? Questins nt dne Principle f Market Valuatin The relatin between an asset s Value and Price Value Maximisatin and Financial Decisins The Law f One Price and Arbitrage Arbitrage and the Prices f Financial Assets Interest Rates and the Law f One Price Triangular Arbitrage Valuatin Using Cmparables Tradable vs. Nn-tradable Valuatin Mdels Valuatin Shares f Stck Accunting Measures f Value The Efficient Market Hypthesis Different Frms f EMH Questins nt dne Valuatin f Knw Cash Flws: Bnds Characteristics f the Bnd Market Using PV Factrs t value knwn Cash Flws Pure Discunt Bnds/Zer Cupn Bnds Is there a single discunt rate? Cupn Bnds, Current Yield and Yield t Maturity Par Bnds Premium Bnds Discunt Bnds Current Yield Yield t Maturity Yields Yield fr the Same Maturity May Differ... 58! 3

4 ! The Effect f the Cupn Rate The Effect f Default Risk and Taxes Other Effects n Bnd Yields Saw Tth Yield Curve Risk Questins nt dne Valuatin f unknwn cash flws: Shares Characteristics f Share Market Types f Shares Share Pricing Dividend Discunt Mdel Cnstant Grwth Mdel Share Issue Rights Issue Risk CAPM Expected Return Prblems with CAPM... 63! 4

5 ! Intrductin t Finance Definitins Finance The study f hw peple allcate scarce resurces ver time Different as: Cst and benefits are spread ver time Cst and benefits are usually nt knwn in advance Financial Markets Set f markets and ther institutins used fr financial cntracting, exchange infrmatin and the exchange f assets and risk Mney A widely accepted medium f payment fr gds and services r the repayment f debt (e.g. currency, precius metals, savings depsits) Mney vs. Barter Ecnmy Barter is a methd by which gds and services are directly exchanged fr ther gds and services withut the use f a medium f exchange (e.g. wheat fr clthes) Prices in barter ecnmy =, where N is n. f gds in ecnmy Barter ecnmy is time cnsuming and difficult t undertake Mney vercmes inefficiency f barter ecnmy Functins f Mney Medium f exchange Methd f payment fr gds and services Minimises time spent exchanging gds and services Unit f Accunt Measure t establish cmparable prices between gds and services Decreases n. f prices in ecnmy Stre f Value Save the purchasing pwer frm time incme is received t the time it is spent Smth ut cnsumptin ver time! 5

6 Evlutin f Mney Cmmdity Mney mney by precius metals r valuable cmmdities Fiat Mney paper currency established by gvt. as legal tender Checks instructin t transfer mney between peple s accunts Electrnic Payment allw payment f bills via internet withut mailing checks E-mney mney existing in electrnic frm (e.g. debit card) Questins 1. Since we studied the evlutin f the payment system, d yu think we are heading twards a cashless sciety? (nt fully)! Scieties based n alternative frms f payments (credit card, debit cards and smart cards) will becme mre cmmn, hwever pilt prjects f intrducing smart cards t cnvert cnsumers t the use f e-mney have nt been a great success. Althugh e- mney might be mre cnvenient and may be mre efficient than a payments system based n paper, several factrs wrk against the disappearance f the paper system. First, it is very expensive t set up the cmputer, card reader, and telecmmunicatins netwrks necessary t make electrnic mney the dminant frm f payment. Secnd, electrnic means f payment raise security and privacy cncerns (hackers accessing bank details). A further cncern is that the use f electrnic means f payment leaves an electrnic trail that cntains a large amunt f persnal data n buying habits. There are wrries that gvernments, emplyers might be able t access this data, thereby encraching n ur privacy. 2. One cmpnent f mney is currency in circulatin. Assume there are billin Eurs in circulatin, wh d yu think will hld all these Eurs? If this amunt was t be averaged ver every Eurpean citizen, each persn in Eurpe wuld hld mre than 2200 Eur in cash. Hlding currency means incurring a large pprtunity cst. Peple wh hld mst f the cash are: businesses (makes transactins less traceable fr tax purpses) criminals (n recrd r evidence), freigners (uncertainty abut their wn currency). Half f the Eurs (and USD fr that matters) are held abrad.! 6

7 Financial Decisins f Husehlds Cnsumptin and Saving hw much f current wealth shuld be spent n cnsumptin and hw much shuld be saved? Investment what frm shuld mney saved be invested? (e.g. term depsit vs. shares) Financing when and hw shuld husehlds brrw (use thers mney) t implement cnsumptin and investment plans? (e.g. buy r rent a huse) Risk Management hw, why and n what terms shuld husehlds reduce r increase risk? (e.g. insurance against fire and theft) Firms Entities whse primary functin is t prduce gds and services Branch f finance fr financial decisins f firms is business/ crprate finance Financial Psitin: Surplus Unit: Prfit - Dividends = Retained Earnings (Saving) = Saving - Investment = (+) Deficit Unit: Saving - Investment = (-) Firms require capital as bth: Physical Capital buildings, machinery etc. Financial Capital stcks, bnds Financial Decisins f Firms Strategic Planning what business firm wants t be in (invlves evaluatin f csts and benefits spread ver time) Capital Budgeting Prcess plan fr acquiring lng-lived assets and persnnel training Investment Prject identifying ideas, evaluating, deciding apprpriate prject, implementing prject Capital Structure finances f entire firm, determine a feasible financing plan then issuing ptimal financing mix. Determines wh gets what share f future cash flw and cntrl f cmpany (sharehlders elect bard members, bnds (cvenants) restrict activities f management) Wrking Capital Management management f day t day cash flws, e.g. ensure cash flw deficits are financed and cash flw surpluses are efficiently invested Chices are dependent upn: Technlgy Industry Regulatins Market Structures Tax Systems! 8

8 Separatin f Ownership and Management Owner shuld delegate respnsibility t prfessinal managers as: Superir Ability pr managers have better technical knwledge, mre experience, mre suitable persnality Pling f Resurces t achieve an efficient scale f business requires many wners, all f which cannt actively manage the business Diversificatin f Risk wners hld stakes acrss many firms, thus ne wner cannt successfully manage many firms f which they wn a stake in Efficient Infrmatin gathering pr managers gather inf mre efficiently thrugh day t day actin with cmpany Learning Curve when wner sells stake in business, the manager cntinues in place t wrk fr new wners Allws frequent changes in wners by share transfer withut affecting the peratins f the firm Changes in wnership shuld be mre frequent than changes in cmpsitin f management Hwever, separatin f wnership can cause; Cnflict f Interest manager may neglect their bligatins t the sharehlders due t incmplete inf surrunding manager Principle Agent prblem principle hires agent t act in principle s interest, yet agent acts in wn interest The Gal f Management T maximise the wealth f current stckhlders Desn t require the managers t knw the risk preferences r pinins f the sharehlders Market Disciplines: Takevers Imprtant mechanism fr aligning the incentives f managers with thse f sharehlders E.g. Management has chsen an investment plan leading t a market value less than the max. value btainable (mismanaged). A bidder successfully buys enugh shares in firm, replaces the managers with nes wh will perate it ptimally, bidder sells the shares at new market prices, immediate prfit! 9