L1 Introduction to FAIS Finance

1. Organization
2. Intro. Corporate finance
3. Time value of money
4. Discounted cash flows
5. Chp1,4,5
 What is Finance?

How business How money

generates money generates money

Value

Why to study Finance at all?

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 Learning objectives
• F1: Describe the scope of financial management and
the interaction between the firm and its (international)
financial environment; (Chap 1)
• F2: Apply the concept of the time value of money in
valuing the two key financial securities: stocks and
bonds; (Chap 4,5,6,7)
• F3: Make and evaluate capital investment decisions;
(Chap 8, 9,10,13)
• F4: Compute risk and return, and explain their
relationship. (Chap 11,12)

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 Organization
• Lectures, tutorials and self-study
– 5 Lectures
– 5 Tutorials: exercises from end-of chapter
questions and problems are posted in advance (you
shall at least think about how to solve the exercises
before class, simple ones will be skipped)
– Self study: self-test problems of textbook.
• Assessment: Remindo exam 100% (test on computer
on campus)
• Office hour: Mondays 12:45-13:30 (Canvas
conference)
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Literature
• Hillier, D., Clacher, I., Ross, S.,
Westerfield, R., & Jordan, B.
(2017). Fundamentals of
Corporate Finance, 3rd
European Edition (digital access
to Connect, see registration
details on Canvas )
• This book will also be used in
FENSI (2nd year elective
module

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 Chapter 1
• Slide 7-10 on what is corporate finance to watch
https://www.youtube.com/watch?v=uCVCfSGMi-k
• Slide 11 on goal of financial management to watch
https://www.youtube.com/watch?v=pRcu8po7tC0

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 What is Corporate Finance?
Investment
• What long term investments will you make?

Financing
• Where will you get long-term financing for your
long term projects?

Liquidity
• How will you manage your everyday activities?

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 Financial Management Decision 1
Capital The process of planning and managing a
Budgeting firm’s long-term investments.

Identify investment opportunities that

are worth more to the firm than they
cost to acquire

Financial managers must be concerned

not only with how much cash they
expect to receive, but also with when
and how likely they are to receive it.
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 Financial Management Decision 2
Capital The mixture of long-term debt (borrowing)
Structure and equity (owners’ investment) maintained
by a firm.

1. How much should the firm borrow?

2. What are the least expensive sources of
funds for the firm?

The financial manager also has to decide

exactly how and where to raise the money.

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 Financial Management Decision 3
Working The management of a firm’s short-term
Capital assets and liabilities.
Manage-
ment
How much cash and inventory should we
keep on hand?
Should we sell on credit? If so, what terms
will we offer, and to whom will we extend
them?
How will we obtain any needed short-term
financing?
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The Goal of Financial Management

Maximise
Manage profit
Risk

Avoid
Financial
Distress

Maximise Value of Owner’s

Equity

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 Corporate and financial markets
A financial market is a market where securities are issued
and traded.

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 Primary vs. Secondary Markets
Primary Markets Secondary Markets

Securities are created Securities are traded among

and sold to investors investors

Money raised goes to Money change hands

issuing firm between investors

IPO and SEO Share Prices

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 Stock Exchanges and listing
Securities that trade on an organized exchange are said to be listed on that exchange.

New York
London Stock
Stock Euronext
Exchange
Exchange

Shanghai
Tokyo Stock
Stock
Exchange
Exchange

Financial regulators:
http://en.wikipedia.org/wiki/List_of_financial_regulatory_authorities_by_co
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untry#U-Z
Chapter 4

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Let’s take a poll:
A. You will get 1000 euro today.
B. You will get 1020 euro a year later.

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 Money travels along the timeline

Future value (FV) Present value (PV)

and Compounding and discounting

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Future Value and Compounding

Future value (FV)

The amount an
investment is worth after
one or more periods.

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 Investing for a Single Period

Year 0 • You invest €100 at 10%

• Your money grows to

Year 1 €100 + 10% of €100
= €110

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 Investing for a Single Period
• In general:

V1 V0 (1 + r )
=
Where V1 is the value at time t; r is the interest rate

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Investing for More than One Period
• Invest
Year 0 €100 at
10%

Year 1 • €100×(1.1)
= €110

• €110×(1.1)
Year 2 • = €121
• =100×(1.12)
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 Investing for multiple periods
• In general:

Vt =V0(1+r) t

• where Vt is the value at time t; r is the interest

rate
• V0 *r*t is simple interest

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 Some Terminology
Principal
• The amount of money you invest or borrow; V0.

Simple interest
• Interest earned only on the original principal amount invested; V0 ×r × t.

Interest on Interest/interest from compounding

• Interest earned on the reinvestment of previous interest payments; Vt - V0
×r ×t .
Compounding
• The process of accumulating interest on an investment over time to earn
more interest.
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Future Value Interest Factors

Vt = V0(1+r)t

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Present Value: The Single Period Case

• Receive €1,
Year 1 interest rate is
10%

• V0 = €1/1.1 = £0.909
• Year 0 equivalent value

Year 0 of €1 received in Year 1

is 90.9 cent.
• PV of €1 received in
Year 1 is 90.9 cent.
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 Some More Terminology

Present Value
• The current value of future cash flows
discounted at the appropriate discount
rate.
Discount
• Calculate the present value of some future
amount.
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 Present Value: A Generalisation

Vt
PV= V=
0 t
(1 + r )
Where Vt is the value at time t;
r is the interest rate

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 Table 4.3
Present Value Interest Factors
V0 = Vt/(1+r)t

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 Tying it all Together

PV × (1 + r ) = FVt
t

PV = FVt / (1 + r ) t

= FVt × [1 / (1 + r ) ] t

= FVt × (1 + r ) −t

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 Spreadsheet Strategies
• FV
• PV
• RATE
• NPER
• Goal seek
• Solver

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Chapter 5

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 Future Value with Multiple Cash Flows
• Suppose you deposit €100 today in an account paying
8 per cent. In one year, you will deposit another €100.
How much will you have in two years?

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Present Value with Multiple Cash Flows

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 Multiple Cash Flows
Important Amount of cash flow
Points

In PV and FV problems, cash flow timing is

critically important.

In all the formulas we have discussed, we assume

that cash flows occur at the end of each period,
unless you are explicitly told.
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 Valuing Level Cash Flows: Annuities
and Perpetuities

Annuity Perpetuity
A level stream
A level stream
of cash flows
of cash flows
for a fixed
forever.
period of time.

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Present Value for Annuity Cash Flows
Suppose we were examining an asset that promised to
pay £500 at the end of each of the next three years.
The cash flows from this asset are in the form of a
three-year, £500 annuity. If interest rate is 10 per cent,
how much would we offer for this annuity?

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 PV of an Annuity (equation 5.1)
The present value of an annuity of €C (or any other
currency) per period for t periods when the rate of
return or interest rate is r is given by:

 1 − Present value factor 

Annuity present value = C ⁄× 
 r 
1 − [1 / (1 + r )t ] 
= C× 
 r 
1 1 
=C ×  − t 
 r r (1 + r )  37
Future Value of Annuities (equation 5.2)

Annuity FV factor = (Future value factor − 1) / r

= [(1 + r )t − 1] / r
t
(1 + r ) 1
= −
r r

 (1 + r ) 1  t
FV of=
Annuity C  − 
 r r

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 Perpetuities

PV for a perpetuity
= C/r

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 Comparing Rates
Nominal interest rate
The interest rate expressed in terms of the interest payment made
each period. Also known as the state or quoted interest rate.
Not sufficient information if compounding frequency is not given;
e.g. nominal rate of 10% compounded once in a period
≠
nominal rate of 10% compounded twice in a period

Effective annual percentage rate (EAR)

The interest rate expressed as if it were compounded once per year.
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 Comparing Rates

How to convert all rates to EAR?

EAR = [1 + (Quoted rate/m)] m −1

m is the number of times the interest is
compounded during a year, i.e.
compounding frequency
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 Example 5.7 What’s the EAR?

A bank is offering 12 per cent

compounded quarterly. If you put €100
in an account, how much will you have
at the end of one year? What’s the
EAR? How much will you have at the
end of two years?

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 Example 5.7
What’s the EAR and future values?

Method 2 to get future value:

The bank is effectively offering 12%/4 = 3%
every period. If you invest £100 for 8 periods at 3
per cent per period,
future value =100 × 1.038 = 100 × 1.2668 =
126.68

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 Continuous Compounding

Quoted rate is 10%

EAR = [1 + (Quoted rate/m)]m − 1 44
Continuous Compounding Formula

EAR = e q −1

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 Types of financial management
decisions
Goal of financial management

Recap of Relation with financial market

Chapter Compute FV and PV of single and

1,4,5 multiple cash flows (annuity, perpetuity)
Compare rates of different
compounding frequency
Terminology

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 Tutorial 1 chapter 1,4,5
Ch1: Corporate finance and financial market:

• 1.3, 1.7, 1.13;

Ch4&5: Interest rates, PV and FV:
• 4.1, 4.10, 4.16
• 5.13, 5.14, 5.18
Please prepare before the class and I will
discuss those you find difficult. 47
Thank you!

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