Finance 02?

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1.1. What does finance mean ?

Finance = f (money)

Money = anything that is generally accepted as payment for goods and services and repayment of debts

Meanings of “Finance”: - Financial Markets,

- Investments,

- Corporate and Public Finance,

- Insurance and Banks,

- Monetary and Fiscal Policy,

- Valuation of Tangible and Financial Assets,

- Business Valuation

Basic Finance – Basic Concepts in Finance

Finance = science of managing money matters, credit (loan), etc…

Finance = science of managing the issues related to Financial

Markets and Financial Systems

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Corporate Finance vs. Public Finance

Corporate finance is an area of finance dealing with the financial decisions made by corporations and the tools and analysis used to make these decisions.

* Investment = real investment/financial investment

Public finance is the field of economics that studies government activities and the alternative means of financing government expenditures.


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1.2. Financial Systems and Financial Markets

Financial Markets = the mechanisms that allow people and companies to easily trade financial securities, commodities

and other fungible items of value.

*Examples of financial securities: shares (stocks) and bonds

Financial System = the set of financial institutions and the relationships between these, which serve to money transfer between persons/ companies/institutions that have excess funds to the persons/ companies/institutions that have deficits of funds


EXCESS FUNDS

(CREDITORS / LENDERS)

DEFICIT OF FUNDS

(DEBTORS / BORRWERS)

FINANCIAL SYSTEM

FUNDSFUNDS

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Different financial systems

The Anglo-Saxon System, typical for UK and US, based on capital markets (Stock Exchanges). *stock exchange = a place where security trading is conducted on an organized system.

The Continental European System, typical for Germany and based on banks (commercial banks). *bank = a financial institution licensed as a receiver of deposits.

(Generally, there are two types of banks: commercial/retail banks - regulated by the Central Bank and investment banks – regulated by the Security and Exchange Commission)

*The Japanese System, representative for Japan and South Korea, based on entities known as keiretsu (in Japan) or chobol (in South Korea). *keiretsu = a powerful alliance of Japanese businesses often linked by cross-shareholding .


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Financial Markets

The money market, which refer to the short term financial market, related to banks and monetary instruments (money orders, cashier’s checks, traveller’s checks), including, exchange rate markets.

The capital market, which refer to the long term financial market, respectively the market of shares and bonds (primary securities).

By extension, in the capital market are included also futures and options contracts, even if these are on short term (derivative securities).*futures contract = a standardized contract to buy or sell a certain underlying instrument (usually primary security) at a certain date in the future, at a specified price.

*options are financial instruments that convey the right, but not the obligation, to engage in a future transaction on some underlying security, or in a futures contract.

The insurance market – ins. companies intermediate funds based on risk transfer

The real estate & other alternative investments markets (special markets): on this market traders act as investors, but also as consumers. (include investments in real estate, in platinum, gold, silver, etc.)


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Example (for Time Value of Money basic concept):

Mary Michael

Yearly Income (Y) € 100.000

Consumption (C) € 50.000

€ 100.000

Savings (S) € 50.000

€ 100.000 € 50.000

€ - 50.0001. - Opportunity cost (sacrifice of renouncing to consumption & any other alternative)

2. - Risks (incertitude of reimbursement, loss of purchasing power)

Year I

Year II

Loan reimbursement

(10% interest included)€ 55.000€ - 55.000

COMPENSATE

10 % interest rate (i)

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I. Time value of money Future value


0=present 1 2……………………….……………………….. n time (t)

FV(A0, i, n) = A0(1+i)n; i = interest rate

A0 A0(1+i) A0(1+i)2 A0(1+i)n

Present value (discounting) 0=present 1 2……………………….……………………….. n time (t)

AnAn

(1+i)n

PV = FV-1

PV(An, i, n) =

i = discount rate

An

(1+i)n

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II. Risk and Return

Return (rate) = classical measure of earningRT = (IF + Σ(Bi) - II) / II – holding period returnholding period return

Ry = (In + Bn – In-1) / In -1 – yearly return

Annualized return:(1+RA) = (1+RT)1/n

*example (E(R) - also for frequency series)

Risk = the probability that an investment's actual return will be different than expected.

σ(R) = [E (R - E (R))2] (1/2)

Risk = standard deviation of the historical returns from the average return

*example (also for frequency series)


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III. Price, Value and Valuation. Efficiency of the markets

Price = the amount of money paid for something.

(*Transaction => Price) Value = the utility of having something. *utility = measure of the relative satisfaction from consumption of various goods and services

I. Value 1. - utility

2. - value of exchange / rarity

II. Value = Cost of assets; Adam Smith (1776) - Objective Value Theory (theory of Work-based value).

III.Value = marginal utility - Subjective Value Theory

Value is a subjective variable. (Each person sets a value for assets, related to his or her own perceptions.)


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Fair market value = an estimate of what a willing buyer would pay to a willing seller, in a free market.

Fair market value = Price - conditions:

I. rational agents (which choose the project that will generate the higher level of satisfaction)

II. fair transaction:

- well informed buyer and seller (there is not an asymmetrical information)*;

- buyer and seller have equal ability in negotiation;

- buyer and seller are interested in that transaction.

*Informational Efficiency – features (EMH):

- the price equals the fair market value;

- nobody can obtain systematic abnormal earnings (abnormal returns). *

*Earnings are proportional with the risk took over by investor.


Finance 02?

Business

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