FINANCE
Principles and Applications
A Comprehensive Guide to Financial Management
Published: September 2025
TABLE OF CONTENTS
Chapter 1: Financial Markets and Institutions 3
Chapter 2: Time Value of Money 4
Chapter 3: Investment Analysis and Portfolio Theory 5
Chapter 4: Corporate Finance and Valuation 6
Chapter 5: Financial Statement Analysis 7
Chapter 1: Financial Markets and Institutions
1.1 Financial System Overview
The financial system consists of markets, institutions, and instruments that facilitate the
transfer of funds from savers to borrowers. Primary markets involve new securities issuance,
while secondary markets trade existing securities. Financial intermediaries like banks,
insurance companies, and investment funds connect surplus and deficit units efficiently.
1.2 Money and Capital Markets
Money markets deal with short-term debt securities (less than one year) like Treasury bills,
commercial paper, and certificates of deposit. Capital markets handle long-term securities
including stocks and bonds. Interest rates in these markets are determined by supply and
demand, monetary policy, and economic conditions.
1.3 Financial Institutions and Regulation
Commercial banks, investment banks, insurance companies, and mutual funds serve different
roles in the financial system. Regulatory bodies like the Federal Reserve, SEC, and FDIC
ensure stability and protect investors. Understanding regulatory frameworks is crucial for
financial professionals and investors.
Chapter 2: Time Value of Money
2.1 Present and Future Value Concepts
The time value of money principle states that money available today is worth more than the
same amount in the future due to earning potential. Future value FV = PV(1+r)^n calculates
growth over time, while present value PV = FV/(1+r)^n determines current worth of future
cash flows.
2.2 Annuities and Perpetuities
Annuities involve regular payments over specified periods. Ordinary annuities have payments
at period end, while annuities due have payments at period beginning. Perpetuities are
annuities with infinite payment periods. These concepts are fundamental for loan calculations,
retirement planning, and investment valuation.
2.3 Compound Interest and Effective Rates
Compound interest involves earning interest on both principal and previously earned interest.
Different compounding frequencies (annual, semi-annual, monthly, daily) affect returns. The
effective annual rate (EAR) allows comparison of investments with different compounding
periods.
Chapter 3: Investment Analysis and Portfolio Theory
3.1 Risk and Return Fundamentals
Investment returns consist of income (dividends, interest) and capital gains. Risk measures
include standard deviation, beta, and value at risk (VaR). The risk-return tradeoff suggests
higher returns require accepting higher risk. Diversification can reduce portfolio risk without
sacrificing expected returns.
3.2 Modern Portfolio Theory
Harry Markowitz's modern portfolio theory demonstrates how to construct efficient portfolios
that maximize return for given risk levels. The efficient frontier shows optimal risk-return
combinations. Correlation between assets affects portfolio risk - lower correlation provides
better diversification benefits.
3.3 Capital Asset Pricing Model
The CAPM establishes the relationship between systematic risk and expected return: E(R) =
Rf + β(E(Rm) - Rf). Beta measures sensitivity to market movements. The security market line
shows required returns for different risk levels. CAPM helps in investment decisions and cost
of capital calculations.
Chapter 4: Corporate Finance and Valuation
4.1 Capital Budgeting Techniques
Capital budgeting evaluates long-term investment projects using net present value (NPV),
internal rate of return (IRR), and payback period methods. NPV measures value creation,
while IRR provides the discount rate that makes NPV zero. These techniques help managers
allocate capital efficiently.
4.2 Cost of Capital and Capital Structure
The weighted average cost of capital (WACC) represents the firm's financing costs from debt
and equity sources. Capital structure decisions involve the optimal mix of debt and equity
financing. The Modigliani-Miller theorem provides theoretical foundations, while practical
considerations include taxes and financial distress costs.
4.3 Dividend Policy and Share Repurchases
Dividend policy determines how much of earnings to distribute versus retain for reinvestment.
Factors influencing dividend decisions include growth opportunities, tax considerations, and
signaling effects. Share repurchases provide an alternative method for returning cash to
shareholders while potentially increasing earnings per share.
Chapter 5: Financial Statement Analysis
5.1 Financial Statement Components
Financial statements include the balance sheet (financial position), income statement
(profitability), cash flow statement (cash movements), and statement of equity changes.
These statements follow accounting standards (GAAP/IFRS) and provide information for
investment, credit, and management decisions.
5.2 Ratio Analysis and Interpretation
Financial ratios analyze liquidity (current ratio), efficiency (asset turnover), leverage
(debt-to-equity), and profitability (ROE, ROA). Trend analysis examines changes over time,
while cross-sectional analysis compares firms within industries. Ratios help identify strengths,
weaknesses, and potential problems.
5.3 Cash Flow Analysis
Cash flow analysis examines operating, investing, and financing activities. Operating cash
flow indicates business sustainability, investing cash flow shows capital allocation, and
financing cash flow reveals funding sources. Free cash flow measures cash available for
distribution to investors after necessary reinvestments.
