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1、,chapter 1&3Scope and environment of financial management,Development of Financial Management,Early 20th century:Concentrated on reporting to outsiders.,Early 21st century:Insiders managing and controlling the firms financial operations.,At the turn of the twentieth century financial topics focused
2、on the formation of new companies and their legal regulation and the process of raising funds in the capital markets.The companys secretary was in charge of raising funds and producing the annual reports,as well as the accounting function.,Business failures during the Great Depression of the 1930s h
3、elped change the focus of finance.Increased emphasis was placed on bankruptcy,liquidity management and avoidance of financial problems.,After World War the emphasis of corporate finance switched from financial accounting and external reporting to cost accounting and reporting and financial analysis
4、on behalf of the firms managers.That is,the perspective of finance changed from reporting only to outsiders to that of an insider charged with the management and control of the firms financial operations.,Capital budgeting became a major topic in finance.This led to an increased interest in related
5、topics,most notably firm valuation.Interest in these topics grew and in turn spurred interest in security analysis,portfolio theory and capital structure theory.,Typical Finance Structure,Chief accountant is also called financial controller,whose responsibilities include financial reporting to outsi
6、ders as well as cost and managerial accounting and financial analysis on behalf of the firms managers.Corporate treasurer is in charge of raising funds,managing liquidity and banking relationships and controlling risks.,Financial Goal of the Firm,Profit maximisation?,In microeconomics courses profit
7、 maximisation is frequently given as the financial goal of the firm.Profit maximisation functions largely as a theoretical goal.,Problems:UNCERTAINTY of returns TIMING of returns,Shareholder wealthmaximisation?,Same as:Maximising firm valueMaximising share values,It takes into account uncertainty or
8、 risk,time,and other factors that are important to the owners.But many things affect share prices.,Difficulty:The agency problem,Agency problem,The agency problem refers to the fact that a firms managers will not work to maximise benefits to the firms owners unless it is in the managers interest to
9、do so.This problem is the result of a separation of the management and ownership of the firm.,Agency Costs,The costs,such as reduced share price,associated with potential conflict between managers and investors when these two groups are not the same.,In order to lessen the agency problem,some compan
10、ies have adopted practices such as issuing stock options(share options)to their executives.,Financial Decisions and Risk-return Relationships,Almost all financial decisions involve some sort of risk-return trade-off.The more risk the firm is willing to assume,the higher the expected return from a gi
11、ven course of action.,Risk and Returns,Why Prices Reflect Value,Efficient Markets,Markets in which the values of all assets and securities at any instant in time fully reflect all available information.,Assumption,Organisational Forms,Sole proprietorshipsPartnershipsCompanies,Nature of the organisat
12、ional forms,Sole proprietorshipOwned by a single individualAbsence of any formal legal business structureThe owner maintains title to the assets and is personally responsible,generally without limitation,for the liabilities incurred.The proprietor is entitled to the profits from the business but als
13、o absorb any losses.,PartnershipThe primary difference between a partnership and a sole proprietorship is that the partnership has more than one owner.Each partner is jointly and severally responsible for the liabilities incurred by the partnership.,CompanyA company may operate a business in its own
14、 right.That is,this entity functions separately and apart from its owners.The owners elect a board of directors,whose members in turn select individuals to serve as corporate officers,including the manager and the company secretary.The shareholders liability is generally limited to the amount of his
15、 or her investment in the company.,Limited company(Ltd)and proprietary limited company(Pty Ltd)Ltd companies are generally public companies whose shares may be listed on a stock exchange,ownership in such shares being transferable by public sale through the exchange.Pty Ltd companies are basically p
16、rivate entities,as the shares can only be transferred privately.,Comparison of Organisational forms,Organisation requirements and costsLiability of ownersContinuity of businessTransferability of ownershipManagement controlEase of capital raisingIncome taxes,The flow of funds,Savings deficit unitsSav
17、ings surplus unitsFinancial markets facilitate transfers of funds from surplus to deficit unitsDirect flows of findsIndirect flows of funds,Direct transfer of funds,savers,firms,Types of securities,Treasury Bills and Treasury BondsCorporate BondsPreferred SharesOrdinary Shares,Risk?,High Returns?,Re
18、lationship?,Broking&investment banking,How do brokers/investment bankers help firms issue securities?Advising the firmUnderwriting the issueDistributing the issueEnhancing Credibility,Indirect transfer of funds,financialintermediary,firms,savers,Components of financial markets,Primary and secondary
19、marketsCapital and money marketsForeign-exchange marketsDerivatives marketsStock exchange markets,Primary andsecondary markets,Primary marketsSelling of new securitiesFunds raised by governments and businessesSecondary marketsReselling of existing securitiesAdds marketability and liquidity to primar
20、y marketsReduces risk on primary issuesFunds raised by existing security holders,Capital&money markets,Capital marketsMarkets in long-term financial instrumentsBy convention:terms greater than one yearLong-term debt and equity marketsBonds,shares,leases,convertiblesMoney marketsMarkets in short-term
21、 financial instrumentsBy convention:terms less than one yearTreasury notes,certificates of deposit,commercial bills,promissory notes,Reviews,Introduce the history of financial managementUnderstand the financial goal of decision-makingUnderstand the limitations of a goal of profit maximisationIntrodu
22、ce risk-return trade-off of decisionsIntroduce market efficiencyDistinguish between the forms of business organisationsUnderstand the financial market,End of Chapter 1,Chapter 4:Mathematics of Finance,The Time Value of Money,Compounding and Discounting:Single sums,We know that receiving$1 today is w
23、orth more than$1 in the future.This is due to OPPORTUNITY COSTS.The opportunity cost of receiving$1 in the future is the interest we could have earned if we had received the$1 sooner.,we can MEASURE this opportunity cost by:,Translate$1 today into its equivalent in the future(COMPOUNDING).Translate$
24、1 in the future into its equivalent today(DISCOUNTING).,?,?,Note:,Its easiest to use your financial functions on your calculator to solve time value problems.However,you will need a lot of practice to eliminate mistakes.,Future Value,Future Value-single sumsIf you deposit$100 in an account earning 6
25、%,how much would you have in the account after 1 year?,Mathematical Solution:FV1=PV(1+i)1=100(1.06)1=$106,0 1,PV=-100 FV=?,Future Value-single sumsIf you deposit$100 in an account earning 6%,how much would you have in the account after 2 year?,Mathematical Solution:FV2=FV1(1+i)1=PV(1+i)2=100(1.06)2=
26、$112.4,0 2,PV=-100 FV=?,Future Value-single sumsIf you deposit$100 in an account earning 6%,how much would you have in the account after 3 year?,Mathematical Solution:FV3=FV2(1+i)1=PV(1+i)3=100(1.06)3=$119.1,0 3,PV=-100 FV=?,Future Value-single sumsIf you deposit$100 in an account earning 6%,how muc
27、h would you have in the account after 4 year?,Mathematical Solution:FV4=FV3(1+i)1=PV(1+i)4=100(1.06)4=$126.2,0 4,PV=-100 FV=?,Future Value-single sumsIf you deposit$100 in an account earning 6%,how much would you have in the account after 5 years?,Mathematical Solution:FV5=FV4(1+i)1=PV(1+i)5=100(1.0
28、6)5=$133.82,0 5,PV=-100 FV=?,Future Value-single sumsIf you deposit$100 in an account earning i,how much would you have in the account after n years?,Mathematical Solution:FVn=PV(1+i)n=PV(FVIF i,n),0 n,PV=-100 FV=?,Example 4.1Example 4.2Example 4.3Example 4.4,Until now it has assumed that the compou
29、nding period is always annual.But interest can be compounded on a quarterly,monthly or daily basis,and even continuously.Example 4.5,Future Value-single sumsIf you deposit$100 in an account earning 6%with quarterly compounding,how much would you have in the account after 5 years?,Mathematical Soluti
30、on:FV=PV(FVIF i,n)FV=100(FVIF.015,20)(cant use FVIF table)FV=PV(1+I/m)m x NFV=100(1.015)20=$134.68,0 20,PV=-100 FV=?,Present Value,In compounding we talked about the compound interest rate and initial investment;In determining the present value we will talk about the discount rate and present value.
31、The discount rate is simply the interest rate that converts a future value to the present value.,Example 4.7Example 4.8,Present Value-single sumsIf you will receive$100 5 years from now,what is the PV of that$100 if your opportunity cost is 6%?,Mathematical Solution:PV=FV/(1+i)n=100/(1.06)5=$74.73PV
32、=FV(PVIF i,n)=100(PVIF.06,5)(use PVIF table)=$74.73,0 5,PV=?FV=100,Present Value-single sumsIf you sold land for$11,933 that you bought 5 years ago for$5,000,what is your annual rate of return?,Mathematical Solution:PV=FV(PVIF i,n)5,000=11,933(PVIF?,5)PV=FV/(1+i)n 5,000=11,933/(1+i)5.419=(1/(1+i)5)2
33、.3866=(1+i)5(2.3866)1/5=(1+i)i=0.19,Example 4.9,The Time Value of Money,Compounding and DiscountingCash Flow Streams,Annuities,Annuity:a sequence of equal cash flows,occurring at the end of each period.,Examples of Annuities:,If you buy a bond,you will receive equal coupon interest payments over the
34、 life of the bond.If you borrow money to buy a house or a car,you will pay a stream of equal payments.,Future Value-annuityIf you invest$1,000 at the end of the next 3 years,at 8%,how much would you have after 3 years?,10001000 1000,Mathematical Solution:FV=PMT(FVIFA i,n)FV=1,000(FVIFA.08,3)(use FVI
35、FA table,or)FV=PMT(1+i)n-1 iFV=1,000(1.08)3-1=$3246.40 0.08,Example 4.11,Present Value-annuityWhat is the PV of$1,000 at the end of each of the next 3 years,if the opportunity cost is 8%?,10001000 1000,Mathematical Solution:PV=PMT(PVIFA i,n)PV=1,000(PVIFA.08,3)(use PVIFA table,or)1PV=PMT 1-(1+i)n i
36、1PV=1000 1-(1.08)3=$2,577.10.08,Example 4.12,Interpolation within financial tables:finding missing table values,Example 1:PV=1000(PVIFA2.5%,6)Example 2:1000=100(PVIFA?%,12 months),Perpetuities,Suppose you will receive a fixed payment every period(month,year,etc.)forever.This is an example of a perpe
37、tuity.You can think of a perpetuity as an annuity that goes on forever.,Present Value of a Perpetuity,When we find the PV of an annuity,we think of the following relationship:,PV=PMT(PVIFA i,n),Mathematically,(PVIFA i,n)=We said that a perpetuity is an annuity where n=infinity.What happens to this f
38、ormula when n gets very,very large?,When n gets very large,1were left with PVIFA=i,So,the PV of a perpetuity is very simple to find:PV=PMT/i,Present Value of a Perpetuity,What should you be willing to pay in order to receive$10,000 annually forever,if you require 8%per year on the investment?,=$125,
39、000,Example 4.13,Other Cash Flow Patterns,Ordinary Annuity versus Due Annuity,Earlier,we examined this“ordinary”annuity:,Using an interest rate of 8%,we find that:The Future Value(at 3)is$3,246.40.The Present Value(at 0)is$2,577.10.,10001000 1000,What about this annuity?,Same 3-year time line,Same 3
40、$1000 cash flows,butThe cash flows occur at the beginning of each year,rather than at the end of each year.This is an“annuity due.”,1000 1000 1000,0 1 2 3,-1000-1000-1000,Future Value-annuity due If you invest$1,000 at the beginning of each of the next 3 years at 8%,how much would you have at the en
41、d of year 3?,Mathematical Solution:Simply compound the FV of the ordinary annuity one more period:FV=PMT(FVIFA i,n)(1+i)FV=1,000(FVIFA.08,3)(1.08)(use FVIFA table,or)FV=PMT(1+i)n 1(1+i)i FV=1,000(1.08)3-1(1.08)=$3,506.11 0.08,0 1 2 3,1000 1000 1000,Present Value-annuity due What is the PV of$1,000 a
42、t the beginning of each of the next 3 years,if your opportunity cost is 8%?,Mathematical Solution:Simply compound the FV of the ordinary annuity one more period:PV=PMT(PVIFA i,n)(1+i)PV=1,000(PVIFA.08,3)(1.08)(use PVIFA table,or)1PV=PMT 1-(1+i)n(1+i)i 1PV=1000 1-(1.08)3(1.08)=2,783.26 0.08,Is this a
43、n annuity?How do we find the PV of a cash flow stream when all of the cash flows are different?(Use a 10%discount rate).,Uneven Cash Flows,Uneven Cash Flows,Sorry!Theres no quickie for this one.We have to discount each cash flow back separately.,period CF PV(CF)0-10,000-10,000.00 1 2,000 1,818.18 2
44、4,000 3,305.79 3 6,000 4,507.89 4 7,000 4,781.09PV of Cash Flow Stream:$4,412.95,Retirement Example,After graduation,you plan to invest$400 per month in the stock market.If you earn 12%per year on your stocks,how much will you have accumulated when you retire in 30 years?,Mathematical Solution:FV=PM
45、T(FVIFA i,n)FV=400(FVIFA.01,360)(cant use FVIFA table)FV=PMT(1+i)n-1 i FV=400(1.01)360-1=$1,397,985.65.01,House Payment Example,If you borrow$100,000 at 7%fixed interest for 30 years in order to buy a house,what will be your monthly house payment?,Mathematical Solution:PV=PMT(PVIFA i,n)100,000=PMT(P
46、VIFA.005833,360)(cant use PVIFA table)1PV=PMT 1-(1+i)n i 1100,000=PMT 1-(1.005833)360 PMT=$665.30 0.005833,Calculating Present and Future Valuesfor single cash flowsfor an uneven stream of cash flowsfor annuities and perpetuitiesFor each problem identify:i,n,PMT,PV and FV,Summary,chapter 9Risk and r
47、ates of return,In financial markets,firms seek financing for their investments and shareholders of a company achieve much of their wealth through share price movements.Involvement with financial markets is risky.The degree of risk varies from one financial security to another.,Important principle,Al
48、most always true:The greater the expected return,the greater the risk,1926-1999：the annual rates of return in American financial market,Rates of return,Historical returnThe return that an asset has already produced over a specified period of timeExpected returnThe return that an asset is expected to
49、 produce over some future period of timeRequired returnThe return that an investor requires an asset to produce if he/she is to be a future investor in that asset,Rates of return,NominalThe actual rate of return paid or earned without making any allowance for inflationRealThe nominal rate of return
50、adjusted for the effect of inflationEffectiveThe nominal rate of return adjusted for more frequent calculation(or compounding)than once per annum,When an interest rate is quoted in financial markets it is generally expressed as a nominal rate.For example,if a bank advertises that it will pay interes
