Unit 2 Flashcards
perfect symmetry
mode = median = mean
positive skew
mode < median < mean
negative skew
mean < median < mode
normal distribution: 1sigma, 1.96sigma
1s = 68%, 1.96s = 95%
why calculate future and present values
future flows are less certain (risk)
greater purchasing power (inflation)
greater flexibility if received today
- investors require additional return to compensate for delayed receipt
why calculate future and present values
future flows are less certain (risk)
greater purchasing power (inflation)
greater flexibility if received today
- investors require additional return to compensate for delayed receipt
Future value formula
FV = CF x (1+r)^n CF = cash flow r = growth n = time period
Single cash flow discount factor
PV (present value_ = cash flow at t_n /(1+r)^n
Single cash flow discount factor
PV (present value_ = cash flow at t_n /(1+r)^n
Present value of an annuity
PV = 1/r x [1-1/(1+r)^n]
perpetuity
infinite number of equal cash flows
PV at Time 0 = CF * 1/r
Continuous compounding
FV = CF * e^(rt)
Net present value (NPV)
present value of cash inflows - present value of cash outflows
+VE? worthwhile investment
-VE? not worthwhile
demand curve: the price effect
as price falls, leads to increase in quantity demanded
other influences on demand
Other influence (not price) leads to an inc in quantity demanded = shift in demand
price of other goods: substitutes (e.g. tea more demand when coffee price inc), complements (e.g. cream with strawberries)
income: normal goods, superior goods (buy more $$$ things when income increases), inferior goods
supply driven by
profitability. change in price moves us along the existing curve.
What shifts supply
costs, technology, natural factors, political factors or taxes
price mechanism
supply = demand: equilibrium
Elasticity measures
Relative change in quantity demanded
- Price elasticity - Cross elasticity - Income elasticity
elastic vs inelastic
elastic: demand changes more than price (-1 -> -5 ->): luxuries, non-essential goods and services
inelastic: demand changes less than price (-1 -> 0): food, household, personal care (necessities)
unitory elasticity of demand
when elasticity = -1
Cross elasticity
change in quantity demanded/change in price of another good (substitute/complementary)
+ve = substitute goods
-ve = complemetary goods
Income elasticity of demand
Price/income
Normal goods e.g. cars/TVs: positive
Saturated goods e.g. toothpaste: nil/zero
Inferior goods: negative
Revenue
Costs
Profits
Revenue = sales: amount a firm earns from selling its output (price x quantity)
Costs: outgoings associated with production of goods for sale
Profits: revenue minus costs. economists assume firms make decisions to maximise profits
marginal revenue
additional revenue gained by selling one additional item
change in revenue/change in quantity
average revenue
price of one item. total revenue/quantity
factors of production
land and raw materials: rent
labour: wages
capital: interest rates
entrepreneurship: director salaries
average total cost
average fixed cost + average variable cost
average fixed cost vs average variable cost
average fixed cost: constantly declines in price as quantity dec
average variable cost: cost declines and then increases as quantity inc
when maximise profitability
when marginal revenue and marginal cost equal each other
marginal cost curve cuts average total cost curve where
at a minimum point of ATC curve and from below
minimum efficient scale
there’s a quantity which will minimise ?
equilibrium condition
output = income = expenditure
leakage and injections in equilibrium
leakage: savings, taxation, imports
injections: investment, government expenditure, exports
classical economics
believe in power of free markets: invisible hand
economy tends to equilibrium without intervention. says law: production creats it’s own demand
natural equilibrium: full employment
government: no major role in enconomy
interwar period effect on classical economics
supply creating its own demand was not working:
mass unemployment
falling wages, falling prices and falling demand
keysian economics
no one single equilibrium for an economy
equil level of activity in economy determined by level of aggregate demand
role of government manage the appropriate level of demand: demand-management econ, pump-prime the economy
- demand too high = inflation
- demand too low = unemployment
- in between is full employment equilibrium
fiscal policy
taxation + government spending
expansionary fiscal policy: increase government spending, reduce taxation
restrictive fiscal policy: increase taxation, reduce government spending
monetary policy
money supply and interest rates
expansionary: increase money supply, reduce interest rates
restrictive: increase interest rates, reduce money supply
problems of economic management
- fiscal policy decisions difficult to time due to: info lags, reaction lags and response lags
- crowding out effect
- automatic stabilisation policies
- stagflation
crowding out effect
increased Government spending, increased through borrowing, leads to higher interest rates, leading to lower private sector investment levels
automatic stabilisation policies
automatically apply as economy grows or contracts
will increase the Government’s budget deficit during a recession
will reduce the budget deficit or create a budget surplus during peak economic periods
stagflation
where both higher unemployment and high inflation levels exist simultaneously
therefore the trade-off is temporary and not permanent
phillips curve short run + long run
short run: recognises a trade-off between unemployment and inflation
long run: recognises existence of natural rate of unemployment
monetarist agenda
priority is to control inflation therefore control money supply to control inflation
(too much money in supply -> excessive spending)
MPC responsible for setting interest rates
2% inflation target based on CPI measure. if inflation > 1% in either direction from 2%, MPC must explain
quantity theory of money
(total expenditure) money supply * velocity = prices * level of transactions (nominal output)
change M + change V = change P = change Y
foreign exchange: spot market
market for immediate currency transactions: buying or selling currency today at the today’s exchange rate. settlement is T+2
currency quotations
single unit of one currency: fixed/base currency
number of units of another currency: variable currency
in fx markets, by convention one of these would be the $
currency quotations
single unit of one currency: fixed/base currency
number of units of another currency: variable currency
in fx markets, by convention one of these would be the $
forward exchange contract
agreement to undertake a future FX deal at a rate and date agreed today.
Forward rates quoted against spot rates at either a premium or discount
(premium: subtracted from spot to calculate forward rate. discount added to spot)
UK balance of payments made up of
current account and capital account (inc UK investment abroad and foreign investment into UK)
objectives of accounting
record and summarise an organisation’s transaction for benefit of management
report to company’s owners, the shareholders
enable analysis and assessment by other interested parties
auditor’s report
adequate accounting records
‘true and fair’ opinion
‘clear’ or ‘qualified’ report
EU audit directive and regulation provisions
- audit firms of public interest entities to rotate after a period of 10 years
- audit committees must include at least one member with competence in accounting and/or auditing
required annual statements delivered annually to registrar of companies
- balance sheet (aka statement of financial position)
- comprehensive income statement (profit and loss account)
- director’s report
- auditor’s report
- cash flow statement
- statement of changes in equity
small and medium sized company exempt from __. but what do they need to satisfy
preparing and delivering full annual financial statements to registrar of companies need to satisfy 2/3 of: revenue: sm <10.2m md <36m balance sheet total: sm <5.1m <18m avg no. of employees sm <50 md <250
public limited company
min issued share capital of 50k
at least 25% paid-up
registered as public company
adv: ability to offer shares to public and access to greater amounts of capital
private limited company
any other company that’s not a plc
close company
defined in income and corporation taxes act is a company under control of 5 or less
balance sheet (statement of financial position)
company’s financial position at a particular point in time.
cumulative since inception of company
assets, liabilities and shareholders’ funds (share capital and reserves)
comprehensive income statement
company’s performance over a specified period of time, covering a one year trading period
more detailed analysis of the retained income (as shown in the reserves in the balance sheet)
cash flow statement
summary of cash movements during trading period
cash flows from: operating activities, investing activities and financing activities
balance sheet: net assets and capital employed
net assets = non-current assets + current assets - non current liabilities - current liabilities = shareholders’ funds (equities)
capital employed = non current assets + current assets - current liabilities = shareholder funds + net current liabilities
current assets
inventories: raw materials, work in progress, finished goods
trade receivables (debtors): amount the company is owed by 3rd parties on balance sheet date
available-for-sale: held for short term and sold within 12 months
cash: held at bank and cash-in-hand, not overdraft as this is current liability
current liabilities
current liabilities: paid within 12 months
bank overdraft and loans with less than 12 months to repayment, loan capital with less than 12 month until redemption, trade payables, corporation tax payable, accruals and deferred income
non current liabilities
payable after more than 12 months
bank loans, corporate bonds (loan capital), debentures and unsecured loan stock
contingent liability
potential liability but not specifically predictable to warrant specific provision in the financial statements
share capital
nominal value (aka par) of shares in issue (not shares authorised to be issued)
retained earnings reserve
profit made by company not yet distributed as dividends
capital reserves
share premium (amount shares were issued for above the nominal value) + revaluation reserve (upward valuation of non current assets
minority interests (non controlling interests)
portion of net assets belonging to the minority shareholders in subsidiaries
inventory valued at
the lower of cost and net realisable value
inventory valuation cost
FIFO: assumes oldest items sold first, newest items remain in inventory
LIFO: assumes newest items sold first, inventory may contain old items
Weighted average cost method
main 3 headings in cash flow statement
operating activity cash flows: cash from operations and tax paid
investing activity cash flows: capital expenditure, acquisitions/disposals
financing activity cash flows: raising and repayment of capital
main 3 headings in cash flow statement
operating activity cash flows: cash from operations and tax paid
investing activity cash flows: capital expenditure, acquisitions/disposals
financing activity cash flows: raising and repayment of capital
associate undertaking: company A owns 31% of company b
balance sheet: A owns 31% of net assets
income statement: A owns 31% of profits
return on capital employed
operating profit/capital employed (or profit margin x sales/capital employed
capital employed: share capital+reserves+long term borrowing OR equity + debt OR NCA + CA - CL
return on equity
measures amount of profits generated in relation to equity book value
= net income(less preference dividends)/total equity
operational gearing
measures sensitivity of profits to changes in sales revenue. high fixed costs can become a burden in less profitable years
(operating profit + fixed costs)/operating profit or (sales revenue - variable costs)/operating profit
can company meet its shorter term liabilities? current ratio: current assets/current liabilities
> 1 is good, as company is solvent.
gearing: measure extent company is financed by debt
if level of debt too high: equity returns potentially more volatile, risk of corporate collapse
