Introduction to IFM and Time Value of Money Flashcards
What are the functions of financial markets?
- matching supply and demand for funding
- benchmarking/information
- flexibility for both parties
- efficiency (lower transaction costs)
- a well-functioning market reduces risk for investors
- lower risk means lower cost of capital
What is traded on financial markets?
Financial titles:
- equities
- debts
- derivatives
- foreign currency
What is a financial title?
A title involves a contract between two parties - specifies how and when cash flows are paid and how risk is allocated.
Why is direct matching inefficient?
- savings are too small to cover the firm’s needs
- liquidity preferences
- risk concentration
- information asymmetry
Which side has the informational advantage?
The demand side.
Why do we need banks as intermediaries?
- pooling of funds and economies of scale
- maturity transformation - access to checking accounts
- risk diversification
- production of information
What are the 2 problems caused by information asymmetry?
- Ex ante - adverse selection
- Ex post - moral hazard
What is the moral hazard problem?
A change in the behaviour after the transaction has taken place.
Who has direct access to financial markets?
Large firms
What is the role of banks in the information asymmetry problem?
Banks perform screening (to prevent adverse selection) and monitoring (to prevent a moral hazard).
Why is money today more valuable than money tomorrow?
Due to:
- inflation
- risk
- patience
Future Value of a Single Amount
FV = S*(1+r)^n
Future Value of Annuity
FV = A * [(1+r)^n - 1] / r
Present Value of Single Amount
PV = S/(1+r)^n
Present Value of Annuity
PV = A * [1-1/(1+r)^n] / r
