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BFF1001-the foundation of finance - Coggle Diagram
BFF1001-the foundation of finance
Week 1- what is finance?
Financial system- defination- Comprises financial institutions, instruments and markets; facilitates the flow of funds between deficit units and surplus unit through the interaction of its three components.
Financial Institutions:
These include banks and non-banks financial institutions. The Non Banks includes : insurance firms,venture capitalists, currency exchanges, some microloan organizations, and pawn shops.
Financial markets
: a variety of financial instruments which can be broadly classified according to the markets they are traded in, how they are issued(debt,equity,derivatives) and their maturity ( shrot term or long term, also known as money and capital market instruments respertively.
Public offerings Verus Private placements
Public offering: a security offering in which all investors have the opportunity to acquire a portion of the financial claim being sold.
a security offering limited to a small number of potential investors
Primary markets(initial issue) Versus Secondary markets
This is a market in which new issues of a securities are sold to the initial buyers.This is the only time the issuing firm ever gets any money for the securities. The first time a company issues its securities is referred IPO(initial public offering).
This is the market in which previously issued securities are traded.
The money market Versus the capital market
The money market is the trade in short-term debt. It is a constant flow of cash between governments, corporations, banks, and financial institutions, borrowing and lending for a term as short as overnight and no longer than a year.
The capital market encompasses the trade in both stocks and bonds. These are long-term assets bought by financial institutions, professional brokers, and individual investors.
Stock exchanges: organized security exchanges verus over the counter markets
The organized securities exchanges
are tangible entities and financial instruments are traded on its premises.
Over the Counter or OTC
is a decentralized dealer market wherein brokers and dealers transact directly via computer networks and phone.
The benefits of stock exchange: 1.provides a continuous market 2.establishes and publicizes fair securities prices 3.help business raise new capital
Financial instruments
: These provide a forum for the creation and exchange of financial instruments. Financial markets can be classified as primary VS secondary markets, money VS capital market, or as equity(share) markets,debt markets,dervatives markets, foreign exchange markets if classified according to the instruments traded in these markets.
Surplus units
lend to other 2. increase their net assets 3. issue financial claims
Deficit units
1.borrow from others 2. run down their net assets 3.take on financial obligations
Investment decision VS Finance decision
We only make an investment decision If: The asset bought must earn an Expected Return E(R) that is greater than Required Rate of return(RROR).
The 1st critical thinking concept learnt in foundation of finance: E(R)Assets > RROR Capital
The understand of one of financial principle:1. Money has a time value.
A dollar received today is worth more than a dollar received in the future. Tips: The Same amount of money in different time can not be calculated together.
Direct or indirect financing
Direct financing
The transfer of funds from ultimate savers to ultimate borrowers without an intermediary. Surplus units and deficit units deal directly with each other.
Advantages
: 1. avoids costs of intermediation 2. increases access to diverse range of markets 3. greater flexibility in range of securities users can issue for different financing needs
Disadvantages
:1. matching of preferences 2. liquidity and marketetability of security 3.search and transaction costs 4. assessment of risk,especially default risk
Indirect financing
*
Involves the transfer of funds between ultimate savers and ultimate borrowers via deposit taking institutions or other financial institutions. Two or more than two financial assets are created in the process.
Advantages:
1.asset transformation 2.maturity transformation 3.credit risk diversification and transformation 4. liquidity transformation 5. economics of scale.
Rates of return in the financial markets
Terms that required to remember
Opportunity cost- rate of return on next best investment alternative to the investor
Standar deviation- dispersion or variability around the mean rate of return in the finanacial markets.
Real return – return earned above the rate of inflation
Maturity-risk premium- addional return required by investors in long-term securities to compensate for greater risk of price fluctuations on those securities caused by interest rate changes
Liquidity-risk premium-addional return required by investors in securities that cannot be quickly converted into cash at a reasonably predictable price.
Interest rate determinants
Nominal interest rate=real risk-free rate + inflation premium + default-risk premium + maturity-risk premium + liquidity-risk premium
Thus the nominal rate or quoted rate for securities is driven by all of the above risk premium factors. Such knowledge is critical when companies set an interest rate for their issues. Review the example in text.
Real and nominal rates
Real risk-free interest rate= risk-free rate – inflation premium
Nominal interest rate =(约等于)real rate of interest + inflation risk premium
The real rate of interest is the nominal (quoted ) rate of interest less any loss in purchasing power of the dollar during the time of the investment.
The differences between rates
Risk-free interest rate=real risk-free interest rate + inflation premium
Real risk-free interest rate=risk-free interest rate - inflation premium
The term risk free indicates there is no compensation for default risk,maturity risk,or liquidity risk.
The real rate of interest includes the compensations except the inflation premium.
Nominal interst rate=(约等于)real rate of interst+ inflation premuim.
