Principles of Finance

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Principles of Finance

• Bartek Kubicki
• City University, Trencin
• February 28th, 2009

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GROUP PROJECT

• COMMODITIES AN INTERESTING ASSET CLASS?

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Objectives of the course

• Global financial markets
• Financial statements
• Time value of money
• Bonds valuation
• Stocks valuation
• Capital markets efficiency
• Cost of capital
• Capital budgeting
• Derivatives
• Investors psychology

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THE ULTIMATE OBJECTIVE

• Understand the financial markets

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Objectives of todays session

• Introduction to global financial markets
• Financial instruments
• Financial statements
• Time value of money

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FINANCE INTRODUCTION

• Finance a field concerned with acquiring,
  investing and managing capital
• Areas of finance
• Corporate finance create and maintain value
• Investments investors outside the firm
• Capital markets where financial securities are
  bought and sold

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INVESTMENTS IN GLOBAL MARKETS

• Money markets instruments T-bills, Commercial
  Papers, Certificate of Deposits, Bankers
  Acceptance.
• Bonds T-notes, T-bonds, US Agency Securities,
  Municipal Bonds, Commercial Bonds, International
  Bonds (Eurobonds, International Domestic Bonds).
• Stocks Preferred and Common Stocks.
• Derivatives Options, Forwards, Futures, Swaps

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INVESTMENTS IN GLOBAL MARKETS

• Investment Funds (Mutual Funds) Money Market
  Funds, Bond Funds, Equity Funds, Balanced Funds,
  130/30 Funds, Fund of Funds
• Alternative Investments Private Equity, Hedge
  Funds, Real Estate, Commodities, Infrastructure,
  ILS, Art and Antiques

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FINANCIAL MARKETS ORGANIZATION

• Primary vs. Secondary markets
• Third and Fourth Markets
• OTC vs. Standardized Markets
• Initial Public Offerings (IPOs), Seasoned Issues
  (SPOs)
• Bid vs. Ask

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TYPES OF ORDERS

• Market Orders buy or sell at the best price
  available
• Limit Orders buy or sell away from the current
  market price (buy below, sell above)
• Short Sale Order a trader borrows stock, sells
  it, and then purchase the stock later to return
  the stock back to the original owner
• Stop Loss Order are used to prevent loss or
  protect profits

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TYPES OF MARKETS

• Pure auction market (price-driven market) is an
  exchange system where buyers and sellers submit
  their bid and ask prices to a central location
  and transactions are matched by brokers who to
  not have a position in the stock (NYSE, AMEX, TSE
  first section)
• Order driven market (dealer market) buyers and
  sellers submit their orders to dealers, who
  either buy the stock for their own inventory or
  sell the stock from their own inventory (LSE, TSE
  2nd section, NASDAQ)

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TYPES OF MARKETS

• Call market the stock is only traded at specific
  times (smaller markets, opening/closing price in
  major markets)
• Continuous market trades occur at any time the
  market is open. The price is set by either the
  auction process or by dealer bid-ask quotes

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MARKETS PERFORMANCE
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MARKETS PERFORMANCE
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MARKETS PERFORMANCE
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MARKETS PERFORMANCE
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MARKETS PERFORMANCE
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MARKETS PERFORMANCE
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ASSET ALLOCATION
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FINANCIAL STATEMENTS

• Balance Sheet
• Income Statement
• Statement of Cash Flows
• Statement of Stockholders Equity
• Notes

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BALANCE SHEET

• Assets Liabilities Shareholders Equity

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ASSETS

• 1. Current assets
• Cash
• Short-term investments
• Accounts receivable
• Notes receivable
• Inventory
• Prepaid expenses
• 2. Long-term assets
• Investments
• Property, plant and equipment
• Intangible assets

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LIABILITIES

• 1. Current liabilities
• Accounts payable
• Wages, rent, taxes and other payables
• Notes payable
• Dividends payable
• Current portion of long-term debt
• 2. Long-term liabilities
• Notes payable
• Bonds payable
• Bank credit

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SHAREHOLDERS EQUITY

• 1. Contributed capital (paid-in capital)
• 2. Common stock
• 3. Other paid-in capital
• 4. Retained earnings
• 5. Effects of recognition or valuation of certain
  assets or liabilities
• 6. Treasury stock

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INCOME STATEMENT

• Revenues from sales of goods and services
• - Operating expenses
• operating income from continuing operations
• Other income, revenues and expenses
• Recurring income before interest and taxes from
  continuing operations
• / - Financial revenues/ financial costs
• Recurring (pretax) income from continuing
  operations
• - Income tax expense
• Net income from continuing operations
• /- Income from discontinued operations (reported
  net of tax)
• /- Extraordinary items (reported net of tax)
• /- Cumulative effects of accounting changes (net
  of tax)
• NET INCOME

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STATEMENT OF CASH FLOWS

• CFO operating cash flow represents changes in
  working capital accounts and all the items that
  flow through the income statement
• CFI cash flow from investing represents the
  purchase or sale of productive assets (physical
  assets and investments) for cash
• CFF cash flow from financing represents
  acquiring and dispensing ownership funds and
  borrowing

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STATEMENT OF STOCKHOLDERS EQUITY

• Reports the amounts and sources of changes in
  equity from transactions with owners and may
  include the following
• Preferred shares
• Common shares at par
• Additional paid-in capital
• Retained earnings
• Treasury shares
• Employee stock adjustments
• Minimum pension liability
• Valuation allowance for marketable securities
• Cumulative foreign currency translation
  adjustment

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NOTES

• Disclose the significant accounting policies used
  to prepare the financial statements

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TIME VALUE OF MONEY

• Cash Flows Ending
  Value Beginning Value
• Rate of Return Beginning
  Value

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TIME VALUE OF MONEY

• FUTURE VALUE is a value at the end of a given
  period. It is the amount to which a current
  deposit will grow over time when it is placed in
  an account paying interest.
• FV PV (1r)n
• FV future value
• PV amount of money invested today
• n number of compounding periods
• r rate of return per compounding period

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TIME VALUE OF MONEY

• Calculate the future value of 300 investment at
  the end of 10 years if it earns an annual
  compounded rate of return of 8.
• Calculate also the future value of the investment
  if the interest is not capitalized
• FV 647.68
• FV 540.00

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TIME VALUE OF MONEY

• PRESENT VALUE is an amount invested today at the
  rate of r per period that would provide a given
  future value at time n
• The interest rata used in the discounting process
  is commonly referred to as the discount rate but
  may also be referred to as the opportunity cost,
  required rate of return, the cost of capital.
• FV
• PV (1r)n
  

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TIME VALUE OF MONEY

• Given a discount rate of 9 percent, calculate the
  present value of a 1,000 cash flow that will be
  received in five years.
• PV 649.93

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TIME VALUE OF MONEY

• EFFECTIVE ANNUAL RATE (EAR) represents the
  annual rate of return actually being earned after
  adjustment have been made for different
  compounding periods.
• EAR (1 periodic rate)m -
  1
• Periodic rate - nominal rate / m
• m the number of compunding periods per year
  

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TIME VALUE OF MONEY

• Using a stated rate of 6, compute the effective
  annual rate for semiannual, quarterly, monthly
  and daily compounding.
• Semiannual 6.090
• Quarterly 6.136
• Monthly 6.168
• Daily 6.183
• Compute the FV of a single 2,000 cash flow at
  the end of five years using an interest rate of
  12 ,compounded quarterly.
• FV 3,612.22

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TIME VALUE OF MONEY

• ANNUITY is a stream of equal cash flows that
  occur at equal intervals over a given period.
• Ordinary annuity is characterized by a cash
  flows that occur at the end of each compounding
  period.
• Annuity due the payments or receipts occur at
  the beginning of each period

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TIME VALUE OF MONEY

• What is the present value of a 3-year annuity
  that pays 100 each year a) at the beginning of
  the period, b) at the end of the period
• What is the future value of a 3-year annuity that
  pays 100 each year a) at the beginning of the
  period, b) at the end of the period
• The discount rate is 10
• 273.55
• 248.69
• 364.10
• 331.00

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TIME VALUE OF MONEY

• PERPETUITY it is a financial instrument that
  pays a fixed amount of money at set intervals
  over an infinite period of time. In essence, a
  perpetuity is a perpetual annuity.
• British console bonds and most preferred stocks
  are examples of perpetuities since they make
  fixed interest or dividend payment ad infinitum.
• payment
• PVperpetuity discount rate

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TIME VALUE OF MONEY

• What is the value of company X preferred stock,
  if it is to pay 10 annual dividend and plans to
  follow the dividend policy forever? The rate of
  return is given to be 8
• 125
• Calculate the future and present value of uneven
  cash flows at the end of the 5th year, where the
  cash flows at the end of each year are as
  follows 1 -1000, 2 -500, 3 200, 4 1500,
  5 1000. The rate of return equals 10
• Future 762.4
• Present 473.39