Financial Management (FTX2024S)
Module 1 – Summary and Highlights
Chapter 1 (Financial Overview) – The five main (focus) areas are as follows:
1. The role of the financial manager – making decisions that create firm value or shareholder value/wealth.
This is achieved when operating cash inflows exceed operating cash outflows – resulting in residual cash
flows (which can be distributed to owners as dividends or re-invested in the firm). Note the focus on cash
flows in value/wealth creation and determining the value of a firm or any asset.
2. The three fundamental decisions taken by finance managers – Note: (a) what each decision entails or
means and provide examples of such decisions; (b) reasons why the capital budgeting decision is often
considered the most important of the three; (c) the potential of the other two decisions to destroy value;
and (d) the effect of each of the three decisions on the five sections of the SOFP.
3. The forms of business organizations – Know: (a) the nature, advantages, and disadvantages of operating a
business as a sole proprietorship, partnership, or company (including private, public, listed and unlisted
companies); (b) the difference between an incorporated business (company) and an unincorporated
business (sole proprietorship or partnership) and its implication on the perpetual succession of the business,
limited liability of owners, and the taxation of business income; and (c) the role and reporting structure of
the board of directors, the CEO, CFO, audit committee, the internal and external auditors in large
companies.
4. The goal of financial management (FM) – Know: (a) the reasons why profit maximization is not an
appropriate goal for FM; (b) the reasons why maximizing firm/shareholder value is an appropriate goal for
FM and what this means for a listed firm and for an unlisted firm; and (c) some of the internal and external
factors that affect share prices.
5. The agency problem/conflicts – Know: (a) what is meant by the agency relationship and agency problem
and how they arise; (b) examples of direct and indirect agency costs; and mechanisms of minimizing the
agency problem – internal ones (management compensation, board mechanisms, external auditors) and
external mechanisms (threat of takeover by corporate raiders/market for corporate control, managerial
labour markets, and large institutional shareholders).
Chapter 2 (Financial Markets) – The three main (focus) areas are as follows:
1. The nature and the role of a financial system in an economy: - Know (a) the main components of a financial
system; (b) the role of a financial system – transferring funds from saver-lenders to borrower-spenders
either directly via financial markets or indirectly via financial institutions (or intermediaries); and (c)
examples of financial institutions.
2. Classifications of financial markets: Know the differences between the following categories or
classifications of financial markets:
a. Primary markets vs secondary markets (including the role of brokers and dealers in secondary markets).
b. Money markets vs capital markets (including the nature and examples of financial instruments traded in
each market segment).
c. Formal markets vs over-the-counter markets (including examples of formal markets and of over-thecounter transactions).
d. Public markets vs private markets: Note that public markets are akin (similar) to formal and capital
markets, while private markets are akin to money and over-the-counter markets.
e. Spot vs derivative markets – Note: (a) the use of derivatives in managing financial risk; and (b) the
differences between exchange-traded derivatives (share options, futures, and warrants) and nonexchange traded derivatives (forward foreign exchange contracts, forward interest rate agreements,
interest rates swaps).
3. Real and nominal interest rates – Know the differences between these two.
Financial Management (FTX2024S)
Summary and Highlights – Module 3 (Time Value of Money, DCFs and Valuations)
Chapter 5 – Time Value of Money
The following conceptual issues are important:
1. Time value of money (TVM) – Know: (a) the meaning of the TVM concept; (b) the factors that support it; and
(c) why the concept is important in Financial Management or Finance.
2. Present value (PV) and future value (FV) of a lump-sum – Know: (a) the PV and FV concepts of a lump-sum;
and (b) that the difference between the PV and FV of a lump-sum is total interest.
3. Simple interest and compound interest – Know: (a) the meaning of each; (b) the difference between the two;
and (c) the assumption that underlie each of them.

With regards to calculations, the focus is on this equation: FV = PV ( 1 + i/m)nm
•
•

The above equation is for a lump-sum received today (PV) or on a future date (FV).
The key variables in the above equation are: PV, FV, i, and n. Given any three of these four variables, you
should be able to manipulate this equation and solve for the fourth (missing) variable as in Tutorial
Questions 2, 3, and 6. About 90% of the marks on this chapter would be computational (calculations).
Chapter 6 – Discounted Cash Flows and Valuations
The following conceptual issues are important:
1. Understand the meaning and difference between: (a) an annuity and a perpetuity; (b) an ordinary annuity and
an annuity due; and (c) a perpetuity and a growing perpetuity.
2. Understand the difference between the APR and the EAR. When are the two the same, and when are they
different? Which one is used to compare loans or investments with different compounding periods?
Computational Issues: Be able to calculate the PV of a perpetuity and a growing perpetuity. The focus is on
annuities (their future or present values). Be able to calculate the PVA, FVA , and the PMT (or I) for an ordinary
annuity or an annuity due, using one of the following formulas:
Ordinary Annuity Formulas
(
Annuity Due Formulas
)
(
)
 1 − (1/(1 + i/m)nm ) 
PVA = I 

i/m


 1 − (1/(1 + i/m)nm ) 
PVA = I 
 x (1 + i/m)
i/m


 (1 + i/m )nm − 1 
FVA = I 

i/m


 (1 + i/m )nm − 1 
FVA = I 
 x (1 + i/m)
i/m


Three common areas of application:
1. Loan repayments:
• Always use the PVA formula (either for an ordinary annuity or annuity due) to calculate: (a) the PMT (or I);
or (b) the loan account balance on a given date (being the present value of future payments). See Tutorial
Questions 1 & 8, and Practice Question 1 in the Lecture Slides.
• Sometimes there is a balloon payment at the end (which is common with vehicle loans) and you are
required to calculate either the PMT or loan account balance – See the Practical Tutorial Question.
2. Withdrawing cash from a retirement fund (in the post retirement period):
• Always use the PVA formula (either for an ordinary annuity or annuity due) to calculate: (a) the PMT (or I);
or (b) the amount in the retirement fund at the beginning of the retirement period.
3. Investing (or saving) for retirement (or other financial objective) – The pre-retirement period:
• Always use the FVA formula (either for an ordinary annuity or annuity due) to calculate: (a) the PMT (or I);
or (b) the amount in the retirement fund at end of the investing period (which is the same as the beginning
of the retirement period). Refer to Tutorial Questions 4 and 5 as well as Practice Question 2 in Lecture
Slides. Note that long questions on retirement often combine the pre-retirement (investing) period and the
post retirement period, whereas MCQs would deal with only one of the two periods.
FINANCIAL MANAGEMENT FTX2024
SUMMARY AND HIGHLIGHTS – MODULE 4
CHAPTER 7RISK, RETURN, AND PORTFOLIO MANAGEMENT
The Following conceptual issues are important
1. Holding Period return
We invest in an asset in the hope of achieving a return (a profit on investment) which could
come in the form of capital appreciation and cash flow from the investment
Calculating an annual investment return:• A cash flow from the investment, such as a dividend or interest received. We call this
a realised gain because the cash flow has been paid to us and is safely in our bank
account.
• A change in the value of the investment. The asset has appreciated or decreased in
value.
• Both a cash flow and a change in the value of the investment – also called a total holding
period return.
NOTE: Know the difference between a regular stream of income while we own the asset and
an increase in the value of the asset leading to a profit when we eventually sell it.
You might be asked to calculate the cash flow only, or the capital appreciation only, or the total
holding period.
2. Calculating risk metrics with historical data and Forecast data
We have calculated the return but what is the risk associated with achieving that return? The
risk comes from the volatility of the investment returns (the actual result might differ from the
expected result). To answer this question and calculate the risk metrics, we use statistical
measures i.e. variance, standard deviation, and coefficient of variation.
• Historical data
For historical data the expected return or mean is a simple arithmetic average, we add the return
and divide by the number of observations (n).
• Forecast data
For historical data and expected returns, we are given several different economic outcomes and
each outcome has an expected probability of happening expressed as a percentage. We multiply
the probability by the projected return to get the expected return (RxP).
NOTE: Take note of the different equations used to calculate variance and standard deviations
for historical and forecast data.
3. Risk and the normal distribution graph.
We get a very good idea of how risky a share is by looking at the normal distribution graph.
• If the graph is flatter and one standard deviation seems bigger (further from the mean),
this share is considered to be riskier because there is a bigger change/probability that
you might not achieve a return equal to at least the mean
• If the graph is steeper and the standard deviations seem smaller (closer to the mean)
this share is thought to be less risky because the chance of deviating from the mean is
smaller.
NOTE: You would not be expected to draw a graph in a test or examination but you might be
given the images and be asked to interpret the results
4. Confidence intervals
Computing the lowest and the highest range
NOTE: You will be given a return and standard deviation and you will be expected to calculate
the lower and the upper ranges.
5. Coefficient of variation (CV) and Z-Score
Know the situations where CV and Z-score are used.
NOTE: Test or exam questions might be presented in a form of a graph (returns and variances
between multiple shares) and be asked to comment
6. The portfolio concept
The goal of portfolio management is to diversity (spread) our risk. There are two additional
metrics to measure risk in a portfolio: - Covariance and Correlation coefficient.
• Covariance
Measures the extent to which the return of two shares in a portfolio moves together in response
to market conditions. The covariance metric is difficult to interpret so we standardize the
covariance to the standard deviation of the two shares and this is the correlation coefficient.
• Correlation coefficient
It converts the covariance into a standard value ranging from -1 to +1, this enables a better
understanding of the covariance of the two shares. A value of +1 means the two shares are
highly positively correlated and that they move together in response to the market conditions.
A value of -1 means that two shares are highly negatively correlated and that they do not move
together in response to the market conditions.
NOTE: More importantly, know how to interpret the results. Interpretation is important as the
calculation.
7. Constructing portfolios
The next step is putting two shares into a portfolio in different weightings that will give us the
best return for the lowest risk
In tests and exams, I will specify the weighting of each share/investment.
•
The portfolio return is simply the sum of the return on each share multiplied by its
weight in the portfolio (W x R).
• We can calculate the portfolio variance and standard deviation in two ways, using the
Covariance and Correlation Coefficient.
NOTE: Know how to calculate the portfolio return. Know how to calculate the variance and
standard deviation using:- i. covariance ii. Correlation coefficient
8. BETA
Only unsystematic risk can be diversified away. The only risk that an investor should be
rewarded for, is the systematic risk/market risk attached to a share. The measure used to
evaluate the risk of one company relative to the whole of the market is described as Beta.
Take note of the risk premium: E(Rm)– Rrf . Sometimes you will be given the risk premium
NOTE: Know the definition and interpretation of Beta. Example: Beta equal to one ( = 1.0)
means the asset has the same systematic risk as the market.
Be able to calculate the RRR and interpret the results. (When Beta is high the RRR becomes
high as well and Vice versa)
FINANCIAL MANAGEMENT FTX2024
SUMMARY AND HIGHLIGHTS – MODULE 6
CHAPTER 8&9 BASIC VALUATION
The Following conceptual issues are important
1. VALUATIONS FOR INVESTMENT DECISION
The valuation process assists the investor in determining whether an asset is overvalued or
undervalued by the market
Be able to identify overvalued and undervalued assets.
Know when it is good to buy or sell the asset, especially when you a given a scenario
2. BOND VALUATION
Features of the bond: Face Value, Coupon rate, Time to maturity, Yield to maturity, Price of
the bond
Understand the features of the bond
After understanding the bond features, Know how to calculate the bond price
Know the theory around Yield to Maturity.
2.1 Non-redeemable and Redeemable bonds
Understand the difference; know the formulas that are used to calculate these bonds.
Know how to calculate the bond price that pays annual coupons and semi-annual compounding
coupons
2.2 Relationship between YTM and bond price: Inverse relationship
The value of the new bond is dependent on its coupon rate compared to the market interest rate
for similar bonds.
• Coupon rate is the same as the YTM = bond is selling at par
• Coupon rate is greater than the TYM = bond is selling at a premium
• Coupon rate is less than the YTM = bond is selling at a discount
Know and understand the inverse relationship between TYM and the bond price.
You may be asked to interpret your bond price calculation.
3. PREFERENCE SHARES
3.1 Non-redeemable and Redeemable preference shares
Understand the difference.
Know the formulas that are used to calculate these bonds.
4. ORDINARY SHARES
Based on the DDM, the share price should equal the present value of all expected future
dividends to perpetuity.
Understand different models that are used to calculate the share price
4.1 Zero growth model
Shares can pay the same dividend forever.
Understand the formula and know how to calculate the share price
4.2 Constant growth model
Many companies increase their dividend each financial year. Remember that the formula needs
D1
D1 R−g
, so if we have D0, we must grow this dividend by the growth rate of D0 (1 +g). It is a
fatal mistake to use D0 in the calculation.
Write down the formula first (it is easy to make a mistake, especially confusing D0 with D1)
Know how to calculate D1 (the next dividend / the expected future dividend in period 1).
You might not be given D1 therefore use D0 to calculate D1.
Be aware of the questions which give you the “next dividend” or tell you what the dividend
will be next year- that is D1. In this case, it again can be a fatal error to multiply by (1+g)
Curve balls for the constant growth model
Companies go through life cycles and as a result exhibit different dividend patterns over time.
• Dividend Grow at a constant growth (+ve) - 1 + g; r-g.
• Dividend reduction (-ve). - Be careful when you substitute the equation: 1- g, r-(-g)
• Calculation of dividend growth rate. Use PV and FV to calculate g
4.3 The two-stage dividend growth model
The company experienced the 1st stage of mixed/abnormal dividend growth and the 2nd stage
of stable growth rate.
In this case, we analyze and present the value of each stage independently. The sum of each of
these stages represents the value of the share.
P0 = PV (Mixed/abnormal dividend growth) + PV (Constant dividend growth)
Let us use the lecture example 12:
Share Price
= the sum of the dividends for years 1 to 3
individually present valued using the
required rate of return
+
The value of the share at year 3
(P3) with constant growth in future
dividends.
Determine the dividends over the abnormal period- D1 to D3.
In most cases, the focus period dividends (mixed-growth) are given, but sometime you might
have to calculate them/are
Determine the value of the dividends after the abnormal growth – D4.
You need this calculation to calculate P3
Discount the cash flows and sum them
Note: P3 is at time period 3 that is why the discounting factor is 3
The perpetuity value (constant growth) assumes that the dividend will grow forever. The
growth starts on day 1 of the second stage (Y4), but since we work at year ends, we call this
the end of year 3 so we value this at P3. This must also be present valued
Know how to calculate the share price when you are given a two-stage problem.
SHOW ALL YOUR WORKINGS.