Introduction To Business Finance - Mauneel Desai

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In this PPT, you will learn about how you can value your money and relation between, risk and return.

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Presentation Transcript

Introduction To Business Finance:

1 Introduction To Business Finance

Slide 2:

2 It’s what we learn after we think we know it all that counts. - Mauneel Desai

Outline:

3 Outline Introduction Time value of money Safe dollars and risky dollars Relationship between risk and return

Introduction:

4 Introduction The occasional reading of basic material in your chosen field is an excellent philosophical exercise Do not be tempted to include that you “know it all ”

Time Value of Money:

5 Time Value of Money Introduction Present and future values Present and future value factors Compounding Growing income streams

Introduction:

6 Introduction Time has a value If we owe, we would prefer to pay money later If we are owed, we would prefer to receive money sooner The longer the term of a single-payment loan, the higher the amount the borrower must repay

Present and Future Values:

7 Present and Future Values Basic time value of money relationships:

Present and Future Values (cont’d):

8 Present and Future Values (cont’d) A present value is the discounted value of one or more future cash flows A future value is the compounded value of a present value The discount factor is the present value of a dollar invested in the future The compounding factor is the future value of a dollar invested today

Present and Future Values (cont’d):

9 Present and Future Values (cont’d) Why is a dollar today worth more than a dollar tomorrow? The discount factor: Decreases as time increases The farther away a cash flow is, the more we discount it Decreases as interest rates increase When interest rates are high, a dollar today is worth much more than that same dollar will be in the future

Present and Future Values (cont’d):

10 Present and Future Values (cont’d) Situations: Know the future value and the discount factor Like solving for the theoretical price of a bond Know the future value and present value Like finding the yield to maturity on a bond Know the present value and the discount rate Like solving for an account balance in the future

Present and Future Value Factors:

11 Present and Future Value Factors Single sum factors How we get present and future value tables Ordinary annuities and annuities due

How We Get Present and Future Value Tables:

12 How We Get Present and Future Value Tables Standard time value of money tables present factors for: Present value of a single sum Present value of an annuity Future value of a single sum Future value of an annuity

How We Get Present and Future Value Tables (cont’d):

13 How We Get Present and Future Value Tables (cont’d) Relationships: You can use the present value of a single sum to obtain: The present value of an annuity factor (a running total of the single sum factors) The future value of a single sum factor (the inverse of the present value of a single sum factor)

Ordinary Annuities and Annuities Due:

14 Ordinary Annuities and Annuities Due An annuity is a series of payments at equal time intervals An ordinary annuity assumes the first payment occurs at the end of the first year An annuity due assumes the first payment occurs at the beginning of the first year

Defining Risk:

15 Defining Risk Risk versus uncertainty Dispersion and chance of loss Types of risk

Risk Versus Uncertainty:

16 Risk Versus Uncertainty Uncertainty involves a doubtful outcome What you will get for your birthday If a particular horse will win at the track Risk involves the chance of loss If a particular horse will win at the track if you made a bet

Dispersion and Chance of Loss:

17 Dispersion and Chance of Loss There are two material factors we use in judging risk: The average outcome The scattering of the other possibilities around the average

Dispersion and Chance of Loss (cont’d):

18 Dispersion and Chance of Loss (cont’d) Investment A Investment B Time Investment value

Dispersion and Chance of Loss (cont’d):

19 Dispersion and Chance of Loss (cont’d) Investments A and B have the same arithmetic mean Investment B is riskier than Investment A

Types of Risk (cont’d):

20 Types of Risk (cont’d) Diversifiable risk can be removed by proper portfolio diversification The ups and down of individual securities due to company-specific events will cancel each other out The only return variability that remains will be due to economic events affecting all stocks

Relationship Between Risk and Return:

21 Relationship Between Risk and Return Direct relationship Concept of utility Diminishing marginal utility of money St. Petersburg paradox Fair bets The consumption decision Other considerations

Direct Relationship:

22 Direct Relationship The more risk someone bears, the higher the expected return The appropriate discount rate depends on the risk level of the investment The risk-less rate of interest can be earned without bearing any risk

Direct Relationship (cont’d):

23 Direct Relationship (cont’d) Risk Expected return R f 0

Psychic Return:

24 Psychic Return Psychic return comes from an individual disposition about something People get utility from more expensive things, even if the quality is not higher than cheaper alternatives E.g., Rolex watches, designer jeans

Price Risk Versus Convenience Risk:

25 Price Risk Versus Convenience Risk Price risk refers to the possibility of adverse changes in the value of an investment due to: A change in market conditions A change in the financial situation A change in public attitude E.g., rising interest rates and stock prices, a change in the price of gold and the value of the dollar

Price Risk Versus Convenience Risk (cont’d):

26 Price Risk Versus Convenience Risk (cont’d) Convenience risk refers to a loss of managerial time rather than a loss of dollars E.g., a bond’s call provision Allows the issuer to call in the debt early, meaning the investor has to look for other investments

Slide 27:

27 Thank You – Mauneel Desai