Introduction to Finance

Question 1

What are the three financial decisions?

Answer 1

Investment Decisions Dividend decisions Financing decisions

Question 2

What is the main objectives in financial management?

Answer 2

Maximise shareholder wealth

Question 3

How do you determine value of cashflow?

Answer 3

Amount Timing Risk

Question 4

Explain time value of money

Answer 4

Cash flows can only be compared at the same point in time

Question 5

What is a NPV?

Answer 5

Net present value = PV (benefits) - PV (Costs) The objective is to maximize NPV

Question 6

Advantages of shareholder wealth Maximization?

Answer 6

• explicitly considers time and risk of expected benefits - can determine whether decision consistent with objective - provides a impersonal objective

Question 7

Limitations of profit maximization objective?

Answer 7

• Does not consider timing of expected benefits - Does not consider risk

Question 8

What are some constraints?

Answer 8

CSR - considering the interest of all stakeholders - Ethical practices - Agency problems - Agency costs

Question 9

Three forms of business organsiation

Answer 9

• Sole proprietorship - Partnership - Corporation

Question 10

What is the multi disciplinary approach?

Answer 10

• Primary disciplines (Accounting, Macro, Micro) - Other Related (MKTG, Production, HR)

Question 11

Draw the Financial System

Answer 11

Question 12

Market Efficiency - No arbitrage condition

Answer 12

A no arbitrage condition

Security prices instantaneously and fully reflect all risk and economically relevant information about a security’s prospective returns

Question 13

What are some implication of market efficiency?

Answer 13

• Timing or Gambling
• An expected NPV of zero
• Expensive and unnecessary corporate diversification
• Security price adjustment

Question 14

What is Holding Period Return?

Answer 14

• Return to investor for holding asset over period of time
• Calculated for any time period - limited basis for meaningful comparison

Question 15

Time value of money matters?

Answer 15

three factors need to be considered

• Amount
• Risk
• Timing

Question 16

What is interest?

Answer 16

• Compensation for gorgoing current consumption or alternative investment opportunities
• Nominal versus real interest rates
• Simple v Compound
• Nominal V effective interest

Question 17

What is the difference between nominal and real interest rate?

Answer 17

Real interest rate is ex-inflation

(1+ Nominal) =(1+real)(1+inflation)

Question 18

Simple v Compound Interest

Answer 18

• Interest calculated on principal amount only (Simple)
• INterest calculated on current balance at time of interest calculation (i.e. principal amount plus prior interest earned by not withdrawn)

INTEREST ON INTEREST (Compound)

Question 19

How to calc a Future Value Single Sum

Answer 19

Year 1: FV1 = PV0(1+i)

Year 2: FV2= PV0(1+i)(1+i)=PV0(1+i)^2

Year 3: FV3 = PV0(1+i)(1+i)(1+i)=PV0(1+i)^3

Question 20

What is the formula for PV Single Sum

Answer 20

Question 21

Explain compounding frequency

Answer 21

If the interest calculated more frequenctly than once per year effective annual rate greater than nominal rates p.a. rate

• If interest calcualted once a year, effective and nominal rates equal
• The greater the compounding frequency, the higher the effective annual rate

Question 22

What are some effective interest rate examples?

Answer 22

10% compounded pa = 10%

10% Compounded quartly = 10.38% effective

10%pa compounded monthly = 10.47% effective

Question 23

How to solve for N?

Answer 23

N = the number of compounding periods over life of financial asset/security

Compounding frequency affects the return estimates

Question 24

What is value additivity?

Answer 24

• Can only add or subtract cashflows if they are valued at the same point in time
• Extention of rule that you can only compare cash flows if they are valued at the same point in time
• Multiple cash flows - Multi calculations

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