FOUNDATIONS OF FINANCE BFC1001. Semester 1, 2017 Notes

Transcription

1 FOUNDATIONS OF FINANCE BFC1001 Semester 1, 2017 Ntes

2 Table f Cntents WHAT IS FINANCE? Investment and Fnancng Decsns Flw f Funds Fnancal Markets Rates f Return FINANCIAL MARKETS AND REGULATIONS Why Regulate? RBA APRA ASIC WEALTH, TIME AND MONEY (INTRODUCTION TO FINANCIAL MATHS) Value and Prce The Tme Value f Mney Cash Flw Tmelnes Fnancal Maths Frmulae VALUE, TIME AND MONEY (ANNUITY FINANCIAL MATH) Annutes Ordnary Annutes Annuty Dues Annuty Applcatns Grwth Annutes Perpetutes Annuty Learnng Map FINANCIAL CHOICES AND DECISIONS (CAPITAL BUDGETING) Intrductn t Rsk Captal Budgetng APPLICATIONS OF FINANCE Hme Mrtgages Managed Funds Superannuatn Funds FINANCIAL INSTITUTIONS Rle f Fnancal Insttutns Types f Fnancal Insttutns Banks ADI Regulatn Nn-Bank Fnancal Insttutns DEBT AND MARKETS (DEBT SECURITIES) Fnance Usng Debt Securtes Debt Securtes Lfecycles Debt Securtes Market STOCKS AND MARKETS (EQUITY SECURITIES) Fnancng Usng Equty Securtes Types and Characterstcs f Shares Cmmn Share Termnlgy The Share Market and Share Indces

3 Share Valuatn Asset Prcng RISK AND FINANCIAL PROTECTION Rsk Management Hedgng and Dervatves FINANCE AND GLOBALISATION Exchange Rates The Fregn Exchange (FX) Market

4 What s Fnance? Fnance: The rasng f mney (captal). Captal: Mney that s used fr nvestment Equty: Owners' mney Debt: Brrwed mney Hw t fnance: 1. Exstng funds f wners (Equty) 2. Sharng wnershp sellng part f the busness t the publc (Equty) 3. Brrw mney (Debt) Investment: The makng f mney, usng captal. Captal rased s used t buy assets that make mney (generate a return) Assets bught depend f the type f busness beng run Captal Budgetng: The prcess f usng captal t buy assets. Investment and Fnancng Decsns Investment Decsns Assets Fnancng Decsns Labltes/Debt, Equty Cst f Captal: Hw much (%) needs t be pad fr debt and equty. Weght Average Cst f Captal (WACC): Measure f the cst f captal, usng a weghted average f debt and equty csts. Captal Structure: Parttn f captal between debt and equty. Assets bught must earn a return that s greater that RRR (requred rate f return) E(R) Assets > RRR Captal Flw f Funds Flw f Funds: Where captal s transferred frm surplus unts t defct unts n an ecnmy. Imprtant as t enables mney t be transferred frm thse wh have excess captal t thse wh need t e.g. Peple wh need t take ut a lan t start a busness - 1 -

5 A well functnng and develped fnancal system allws fr the effcent flws f funds Three ways fr the flw f funds t ccur n an ecnmy: 1. Drect transfer between surplus and defct unts 2. Indrect transfer usng an nvestment bank 3. Indrect transfer usng a fnancal ntermedary (apart frm an nvestment bank) Cmpnents f the Fnancal System f an ecnmy: 1. Fnancal Insttutns: Busness that facltate the flw and transfer f funds by prvdng ntermedatn. 2. Fnancal Instruments: Prmarly types f debt and equty that are vehcles fr the flw/transfer f funds. 3. Fnancal Markets: Where fnancal nstruments are created and traded. Effcent flw f funds means: Captal s nt msprced Prce pad fr captal s apprprate, nt severely ver/under captal's far value Surplus and defct unts have lqudty Ease wth whch mney s able t be taken ut / spent Defct unts are able t rase the captal they need and surplus unts have enugh captal t meet defct unts they need There s suffcent depth f fnancal markets Suffcent partcpants and mney such that the market stll hlds n the case f the falure f ndvdual partcpants Fnancal Intermedatn vs Drect Fnancng Intermedatn: The use f a thrd party t brng tgether surplus and defct unts allws the preferences f bth partes t be met. Key benefts: Asset transfrmatn Turnng depsts nt lans Credt rsk transfrmatn and dversfcatn Lw rsk depsts turned nt hgher rsk lans and dfferent types f lans Lqudty transfrmatn Shrt-term debt (depsts) used t fund lng-term assets (lans) Ecnmes f scale The larger banks are, the cheaper ntermedatn becmes - 2 -

6 Drect Fnancng: Where defct and surplus unts seek each ther ut and enact the flw f funds between them wthut the use f an ntermedary. Key benefts: Saves n the cst f ntermedatn Allws access t nn-standard/unque prducts nt ffered by ntermedares Defct unts can ssue fnance that s unque t ther specfc fundng requrements nstead f relyng n a "cke-cutter" prduct allws fr greater flexblty n fundng Dsadvantages: Dffculty n matchng preferences between surplus and defct unts Hgher rsk f lqudty and marketablty f drect fnance nstruments Hgher search and transactn csts Dffculty n assessng rsk Fnancal Markets Prmary market: Where fnancal securtes are created. Secndary market: Where fnancal securtes are traded after creatn. Publc market: A central marketplace pen t the publc where buyers and sellers meet t trade. Prvate market: Where buyers and sellers transact wthut pen advertsement and nclusn f the publc. Mney market: Shrt term fnancal nstruments (<12 mnths). Captal market: Lng term fnancal nstruments (>12 mnths). Whlesale market: A drect and prvate market where large fund flw transactns ccur between gvernment/nsttutnal/crprate surplus and defct unts. Retal market: Prmarly an ntermedary market where surplus and defct unts are ndvduals, husehlds and small busnesses nvlve small transactns. Rates f Return Rate f return: The percentage earned n the captal nvested. Needs t be quantfed ver a tme perd - 3 -

7 Rsk-free and rsky All rsky assets shuld earn E(R) > rsk-free E(R) Opprtunty cst f funds: The rate f return n the next-best nvestment alternatve t the nvestr. Nmnal nterest rate: The quted nterest rate and nterest rate pad n debt securtes wthut an adjustment fr any lss n purchasng pwer. Real rsk-free nterest rate: The nterest rate n a fxed-ncme securty that has n rsk n an ecnmc envrnment f zer nflatn. Premum: A rate f return abve a benchmark. Inflatn premum: Rate f return added t cmpensate fr nflatn. Hgher nflatn = hgher nflatn premum Rsk premum: The rate f return fr bearng rsk ttal premum fr all rsks taken. Rsk Premum = E(R) Asset R f Default-rsk premum: Rate f return added t cmpensate fr default-rsk (rsk f brrwer defaultng nt makng debt repayments). Hgher default-rsk = Hgher default-rsk premum Maturty-rsk premum: Rate f return added t cmpensate fr assets that have lnger terms t maturty. The lnger t takes t receve mney back, the mre rsky the nvestment s Lqudty-rsk premum: Rate f return added t cmpensate fr assets that cannt be quckly cnverted nt cash at a reasnably predctable prce. Expected Rate f Return: What s frecasted t be earned (%) n assets. Requred Rate f Return (Hurdle Rate): Mnmum percentage needed t be earned n captal nvested

8 Value, Tme and Mney (Annuty Fnancal Math) Annutes Annuty: Any fnancal cntract that calls fr equally spaced and level cash flws ver a fnte number f perds. When valung annutes, rather than dscuntng/cmpundng each cash flw ndvdually, a sngle frmula can be appled fr ease f understandng and calculatn (as each cash flw s the same and equally spaced ver tme) Ordnary Annutes Ordnary Annuty: An annuty structured s that cash payments are pad r receved at the end f each perd. Mst annutes are rdnary annutes Als called Annuty n Arrears r a Deferred Annuty Assume rdnary annuty unless therwse stated 1 st cash flw ccurs 1 perd after the start f the annuty A fxed amunt f mney s pad/receved at fxed ntervals f tme fr a fxed perd f tme Valuatn f Ordnary Annutes PV = PMT n PMT FV = 1 + n 1 FV = Future value f the annuty PV = Present value f the annuty PMT = Cash flw receved/pad under the annuty n = Number f payments/perds = Per-perd dscunt rate (PV) r cmpund rate (FV) PV f Ordnary Annutes s fr tme perd befre the 1 st payment

9 Annuty Dues Annuty Due: An annuty structured s that cash payments are pad r receved at the start f each perd. Als called an Annuty n Advance 1 st cash flw ccurs at the start f the annuty Valuatn f Annuty Dues PV = PMT n (1 + ) FV = PMT 1 + n 1 (1 + ) FV = Future value f the annuty PV = Present value f the annuty PMT = Cash flw receved/pad under the annuty n = Number f payments/perds = Per-perd nterest rate PV f Annuty Dues s fr tme perd f the 1 st payment Annuty Applcatns Deferred Annutes Deferred Annuty: An annuty that des nt start n Y 0 but n the future. Equvalent Annual Annutes Equvalent Annuty: Used t evaluate annutes wth uneven lves. Calculatng Equvalent Annual Amunts (EAAs): Ordnary Grwth Annuty: EAA = PV Annuty n Grwth Annuty Due: EAA = PV Annuty n (17)

10 PVAnnuty = Present value f annuty = Interest rate per perd n = Number f payments/perds Grwth Annutes Grwth Annuty: An annuty structured s that the cash flw ncreases each perd at a cnstant grwth rate. Grwth Annuty Frmulae: Ordnary Grwth Annuty: PV = CF 0 17g (5g) 1 17g 17 n Grwth Annuty Due: PV = CF 0 + CF g 16g n< g CF0 = Cash flw n Perd 0 = Interest rate per perd g = Cnstant grwth rate per perd n = Number f payments/perds Perpetutes Perpetuty: An annuty where the cash flw cntnues fr an ndefnte perd. n = Perpetuty Frmulae: Ordnary Perpetuty: PV = PMT Perpetuty Due: PV = PMT + PMT PMT = Cash flw per perd = Interest rate per perd

11 As wth annutes, the rdnary perpetutes frmula establshes PV ne perd befre the frst cash flw, whle the perpetuty due frmula establshes PV at the same perd as the frst cash flw As wth annutes, perpetutes can als be deferred Grwth Perpetutes Grwth Perpetuty: A perpetuty s where the cash flw ncreases each perd at a cnstant rate fr nfnty. Grwth Perpetuty Frmulae: Ordnary Grwth Perpetuty: PV = CF 0 17g (5g) Grwth Perpetuty Due: PV = CF 0 17g (5g) 1 + CF0 = Cash flw n Perd 0 nte CF g = CF 1 = Interest rate per perd g = Cnstant grwth rate per perd Annuty Learnng Map