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BASIC FINANCIAL CONCEPTS - Coggle Diagram
BASIC FINANCIAL CONCEPTS
Time Value of Money
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Interest Rates: It allows us to adjust the value of cash flows whenever they occur at a particular point in time.
The interest rate accrued or charged is the ratio of interest accrued to principal, in the unit of time. Unless otherwise stated, the agreed time unit is one year.
The exact simple interest is calculated based on the 365-day year (366) in leap years). Ordinary simple interest is calculated based on a 360-day year. Using the 360-day year simplifies some calculations, however it increases the interest charged by the creditor.
The value of a debt, on a date prior to its maturity, is known as the present value of the debt on that date.
Risk, Return and Value
The return on holding an investment for some period, say a year, is equal to any cash payment received due to the property, plus the change in market price, divided by the initial price.
If we define risk as the variability in expected returns, the Treasury bond would be a risk-free security, while the common stock would be a risky security.
We can use the ratio of an individual's certainty equivalent to the expected monetary value of a risky investment (or opportunity) to define his risk attitude.
In general, if the .. • certainty equivalent <expected value, risk aversion is present • certainty equivalent = expected value, risk indifference is present. • certainty equivalent> expected value, risk preference is present.
For risk-averse individuals, the difference between the certainty equivalent and the expected value of an investment constitutes a risk premium; This is the additional expected return that the risky investment must offer to the investor for this individual to accept the risky investment.
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Financial appeceament
Operating or operating leverage is present whenever a company has fixed operating expenses - regardless of volume.
One of the most drastic examples of operating leverage is found in the aviation industry, where a large portion of total costs are fixed.
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An interesting potential effect caused by the presence of fixed operating costs (operating leverage) is that a change in sales volume results in a more than proportional change in operating profit (or loss).
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A quantitative measure of this sensitivity of a company's operating profit to a change in the company's sales is called the degree of operating leverage (DOL).
Investment decision: This is the most important of the three main decisions of the company. It begins with determining the total amount of assets needed to maintain the business.
Financing decision: The second main decision of the company is financing, here the financial manager is interested in the composition of the liabilities of the balance sheet.
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Financial management is interested in acquiring, financing and managing assets, with an overall goal in mind.