Week 1
Finance is a discipline concerned with determining value
(what something is worth today) and making decisions
based on that value assessment. The finance function
allocates resources, including the acquiring, investing, and
managing of resources.
Government finance, corporate/business finance,
personal finance.
Main areas of finance: investments, financial markets
and intermediaries, international finance, fintech,
corporate/business finance.
Forms of business organisations:
1. Sole proprietorship
2. Partnership
3. Corporation – split into private and public companies
2 main sources of external financing:
Debt: lenders, relationship determined by contract,
security and seniority
Equity: shareholders’ ownership rights, shareholders’
payoffs (dividends, capital gain)
The goal of financial management is to maximise the market
value of existing owners’ equity. For a publicly-listed
corporation, same as maximising the current stock price.
Role and decisions of a financial manager: capital budgeting
decision, capital structure decision, working capital
management decision.
Agency problem: Conflicts of interest between principal and
agent as managers are naturally inclined to act in their own
best interests. (Direct and indirect agency costs)
Good corporate governance requires you to view
organisations as a web of relationships between and among
various stakeholders and to manage their interests in a
responsible manner.
Financial markets:
Primary vs Secondary markets / Money vs Capital markets
Week 2
The annual report is a report issued annually by a
corporation to its stockholders.
Book values are determined by IFRS/GAAP while market
values are determined by current trading values in the
market.
Market value of shareholders’ equity = market capitalisation
= share price x number of outstanding shares
Enterprise value of a firm assesses the value of the
underlying business assets (however financed) while
excluding the value of any non-operating assets.
Market value of equity + debt – excess cash
Operating working capital = current assets – current
liabilities
Exclude non-operating working capital such as notes
payable.
Free cash flows (Cash flow from assets) = operating cash
flow – net capital spending – net operating working capital
FCF + interest tax shield = cash flow to creditors + cash flow
to stockholders
Operating cash flow = EBIT x (1 – tax rate) + depreciation
Net capital spending = ending net fixed assets – beginning
net fixed assets + depreciation
Change in net operating working capital = ending NOWC –
beginning NOWC
Cash flow to creditors = interest paid – net new borrowing
(LT debt and notes payable)
Cash flow to stockholders = dividends paid – net new equity
raised
Liquidity is the ability to convert assets to cash quickly
without a significant loss in value.
Current ratio = CA/CL
Quick ratio = (CA – inventory)/CL
Cash ratio = Cash/CL
NWC to total assets = NWC/TA = CA-CL/TA
Interval measure = CA/avg daily oprtg cost = CA/(COGS/365)
Long term solvency ratio also known as financial leverage
ratios relates to the extent that a firm relies on debt
financing rather than equity.
Total debt ratio = (TA-TE)/TA
Debt/equity ratio = (TA-TE)/TE
Equity multiplier = TA/TE = 1 + debt/equity ratio
LT debt ratio = LT debt/(LT debt + TE)
Times interest earned ratio = EBIT/interest
Cash coverage ratio = (EBIT + depreciation)/interest
Asset management ratios also known as activity ratios
measure how effectively the firms’ assets are being
managed.
Inventory turnover = COGS/Inventory
Days’ sales in inventory = 365/Inventory turnover
Receivables turnover = Credit sales/Receivables
Days’ sales outstanding = 365/Receivables turnover
FA turnover = Sales/Net fixed assets
TA turnover = Sales/TA
Profitability ratios measure how successfully a business
earns a return on its investment.
Profit margin = Net income/sales
Basic earning power = EBIT/TA
Return on assets = Net income/TA
Return on equity = Net income/total common equity
Market value ratios are a set of ratios that relate the firm’s
stock price to its earnings, cash flows and book value per
share.
P/E ratio = price per share/earnings per share
M/B ratio = market value per share/book value per share
Du Pont identity
ROE = NI/Sales x Sales/TA x TA/TE = PM x TATO x EM
Week 3
Discounting is the translation of a value that comes at some
point in the future to its value in the present.
Compounding if the translation of a value to the future.
Principal is the original amount invested or borrowed.
Interest is the compensation for the opportunity cost of
funds and the risk borne on the amount invested or
borrowed.
Interest rate can be referred to as discount rate, cost of
capital, required return.
Simple interest is the interest earned only on the original
investment while compound interest is interest that is also
earned on top of the interest previously received (on the
original investment).
FV = PV(1+i)^n
Example 1: PV = -10, I = 5.5%, n = 200
PV = FV/(1+i)^n
Example 2: FV = 19671.51, I = 7%, n = 10
For multiple cash flows, calculate the FV/PV of each cash
flow.
Annuity is a series of cash flows in which an equal cash flow
(PMT) takes place over regular intervals for a set number of
periods.
Ordinary annuity: first cash flow occurs one period from
now.
Annuity due: first cash flow occurs immediately
Growing annuity: a set of payments which grow at a
constant rate each period and continue for a set number of
periods, with the first cash flow occurring at the end of
period 1.
Example 3: PMT = 100, n = 3, I = 10%
Perpetuity: series of equal payments over regular intervals
that are paid forever, with the first payment at the end of
period 1. PV = PMT/i
Growing perpetuity: a set of payments over regular intervals
which grow at a constant rate each period and continue
forever, with the first payment at the end of period 1.
PV = C/(I - g)
Week 4
Implied discount rate:
Example: n = 5, PV = -1000, FV = 1200
Number of periods:
Example: I = 5, PV = -15000, FV = 20800
Effective annual rate: actual rate paid after taking into
consideration any compounding that might occur within the
year.
Annual percentage rate = period rate x number of periods
per year
Using calculator, input ICONV function.
Greater compounding frequency, the higher the EAR.
Types of loans: Pure discount, interest only, “flat”, amortised
loan with fixed principal paid down, amortised loan with
fixed instalment payments
Amortised loan calculation:
PV = 1000000, n = 30 x 12,
I = 2.4%/12, PMT = -3899.41,
input AMORT function.
BAL = remaining principal
PRN = sum of principal paid
INT = sum of interest paid
Week 5
Investment returns measure the financial results of an
investment. Returns may be historical or prospective.
Dividend yield = dividend/initial share price,
Capital gains yield = capital gain/initial share price,
Total percentage return = dividend yield + CG yield
1 + real return = 1 + nominal return/1 = inflation rate
Approximation: real return approximately equals to nominal
return – expected inflation
Expected return =
Geometric mean is what the investor
actually earned per year on average compounded annually.
Holding period return =
Geometric average return =
Arithmetic mean is what the investor earned in a
typical/average year.
Arithmetic average return =
To evaluate whether an investment is good, compare the
expected return to a benchmark which is the required rate
of return, which depends on the risk of the investment.
Risk is the uncertainty associated with future possible
outcomes.
In general, higher returns
will mean higher risk.
Risk measured by variance/
standard deviation of the possible returns.
Stand-alone risk is the
risk an investor would
face if he held only this
one asset.
Coefficient of variation is a standardized
measure of dispersion about the expected
value, that shows the risk per unit of return.
Risk aversion assumes investors dislike risk and therefore
require higher rates of return to encourage them to hold
riskier securities. The “extra” return earned for taking on
risk is referred to as risk premium.
The volatility of a portfolio is the total risk of the portfolio,
as measured by the portfolio standard deviation.
Week 6
Total risk = diversifiable risk + non-diversifiable risk
DR: company-specific, unsystematic risk
UDR: market, systematic risk, cannot be diversified away
For a well-diversified portfolio, total risk measure =
systematic risk.
Beta measures the responsiveness of a security to
movements in the market portfolio.
Slope of the regression line of the
asset’s excess returns over the risk-free rate on the
market portfolio’s excess returns over the risk-free rate.
Measures the sensitivity of a stock’s return to the
return on the market portfolio.
Beta = 1: asset has same systematic risk as the overall
market.
Beta <1: less systematic risk than the overall market.
Beta >1: more systematic risk than the overall market.
Portfolio systematic risk measure:
Capital Asset Pricing Model (CAPM)
The CAPM assumes that all investors.
try to maximise economic utilities, are rational and riskaverse, are fully diversified across a range of investments,
are price takes and hence cannot influence prices, can lend
and borrow unlimited amounts at the risk-free rate of
interest, trade without transaction or taxation costs, all
securities are highly divisible into small parcels, all
information is available at the same time to all investors, the
standard deviation of past returns is a perfect proxy for the
future risk associated with a given security.
ER > RR, underpriced, ER above SML, ER < RR, overpriced, ER
under SML, ER = RR, fairly priced, ER on SML. If underpriced,
demand increases which drives up market prices leading to
a decrease in expected return and hence establishing eqm.
Inflation causes a translation of SML upwards.
Increase in risk aversion of investors causes the steepening
of the slope of the SML
Efficient frontier: minimum variance portfolio onwards
Capital market line is the steepest line from RFS to EF.