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What is finance? (Define (Cost of capital (How much % needs to be paid for…
What is finance?
Define
Cost of capital
How much % needs to be paid for debt and equity
WACC
Weighted Average Cost of Capital
WACC=[Debt/(Debt+Equity) x Kd]
[Equity/(Debt+Equity) x Ke]
Required Rate of Return
Minimum % needed to be earned in capital investment
Expected Rate of Return
Forecasted % earned on assets
Basis point
Percentage change
1 basis point = 0.01%
Flow of Funds
Capital is transferred from surplus units to deficit units
Efficient growth in economy
Capital is not mispriced
Value as a buying price would go below value
Surplus and deficit units have liquidity
Depth of financial markets
Indirect transfer: Financial intermediation
Surplus units
Asset transformation
Asset security
Liquidity transformation
Direct Financing
Advantages
Saves on the cost of intermediation
Access to non-standard products
Deficit units can issue finance that is unique
level of financial sophistication
Market reputation
Deficit units and surplus
Disadvantages
Difficulty in matching preferences between units
Higher risk of liquidity
Higher search and transaction costs
Difficulty in assessing risk
Indirect transfer: Investment bank
Finance
Raising Capital
Investments
Raising equity
Existing funds of owners
Sharing ownership
Raising debt
Borrow money
Rate of Return
Risk-free interest rate
Government debt= risk-free
All risky assets should earn E(R)>Risk-free rate of return
Risk premium= E(R) Asset- Rf=
The rate of return for bearing risk
Total premium of all risks taken