P Finance

Personal Finance
Pankaj Mathpal,CFP,CWM,CIWM
4/3/2014
Brief Overview To
Financial Markets
4/3/2014
Financial Markets
A Market is a place where buyers

and sellers come together to
exchange something
Financial
Financial Markets are where
financial Instruments/products are
exchanged.
A Financial Market is known by
type of product traded in it
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Different Financial
Markets
FINANCIAL MARKET
Money
Market
Debt
Market
Forex
Market
Capital
Market
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Money
y Market
Markets for short term

Borrowing
Lending
Primarily used by Banks

Typical Financial Instruments
Bankers Acceptance
Certificate
C tifi t off Deposit
D
it (CD)
Treasury Bills
Repos
R
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Debt Market
Debt
Contract
OnePartylendstoanotherParty
One Party lends to another Party
Predetermined
InterestRatesandTerm
Participants
Banks
FinancialInstitutions
MutualFunds
InsuranceCompaniesetc.
Instruments
I t
t
GovernmentSecurities(GSecs)
PublicSectorUnitsBonds
CorporateSecurities
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Foreign Exchange
Market
Foreign Goods
Payments in Foreign Currency
Forex Market
Participants
Government
Payments
y
for Imports
p
Repayment of Loans
Importers
Exchange Rates One Currency in terms of other (Eg.

(Eg 1 US
Dollar = 62 Rupees)
Bid Rate
Offer
Off R
Rate
t
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Capital
Cap
a Market
a e
Long Term Funds
Raised by
Government
Corporates
Trading Instruments used

Shares
Derivatives
Units of Mutual Funds
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Financial Markets
Primary Market
Instruments issued for first time
Used by
Government/Corporates/PSUs
IPO
Initial Public Offering
FPO (Follow on Public offer)

Right Issues
Secondary Market
Trading of already issued
Stocks
Bonds
Stock Exchange
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10
IIntroduction
t d ti
To
T Debt
D bt
Management
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11
Introduction
DEBT MANAGEMENT:
P
Process
off involving
i
l i
a designated
d i
t d thi
third
d party
t
assisting a debtor with repayment of his/her
debt
2 types of third party companies: Fee charges
Free or low cost services
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12
Importance Of Debt
M
Management
t
Helps the borrowers to manage the huge debts

It helps in :
-debt negotiation
-debt
debt consolidation
-debt elimination
Helps in enhancing personal financial stability
Helps the debtors to remove the pressure from creditors
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13
Types Of Public Debt
Government loans are of different kinds, they may differ in respect of time of
repayment, the purpose, conditions of repayment, method of covering liability etc. The
kinds are:
Productive and Unproductive debts

The debts which are productive for the economy are known as productive
productive, similarly the
debts which do not benefit the economy are unproductive.
Voluntary and Compulsory Debt

Generally the debts taken are voluntary, on the part of the government, known as
voluntary debts whereas in times of wars or crisis there is a mandatory loan taken by the
government known as compulsory debt. It is a rare phenomenon.
Internal and External Debt
Internal debt refers to public debt floated within the country; While external debt refers
loans floated outside the country.
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14
Short-Term, Medium-Term & Long-Term Debts
The debts maybe
y
for short, medium or long
g periods.
p
Redeemable and Irredeemable Debts
The debts which the government promises to pay at a future date
are known as redeemable and Irredeemable is vice-versa. It does
not have a maturity period.
Funded and Unfunded
f
Debts
The funded debts are those which are paid after a long period of
time with a fixed rate of interest.
Unfunded debts are incurred to meet the temporary needs of the
government. They are of a comparatively short period say a year.
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15
Personal Financial
Statement Analysis
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Net Worth
16
The amount by which assets exceed liabilities. Net worth is a

concept applicable to individuals and businesses as a key
measure of how much an entity is worth.
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Cash Flow
17
A revenue or expense stream that changes a cash account over

a given period. Cash inflows usually arise from one of three
activities - financing, operations or investing - although this also
occurs as a result of donations or gifts in the case of personal
finance. Cash outflows result from expenses or investments. This
holds true for both business and personal finance.
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Budget
18
An
A estimation
ti
ti
off th
the revenue and
d expenses over a specified
ifi d
future period of time. A budget can be made for a person,
family, group of people, business, government, country,
multinational organization or just about anything else that
makes and spends money. A budget is a microeconomic
concept that shows the tradeoff made when one good is
exchanged for another.
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C l l ti
Calculation
off R
Returns
t
19
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20
Holding Period Return

Holding-Period
Yield to maturity is a measure of return if a bond is held
to maturity, and all interest income is reinvested at the
yield to maturity
The holding-period return measures return for a shorter
period of time
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21

Holding-Period
Ending
gp
price Beginning
g
gp
price + Coupon
p
Holding - period Return =
Beginning price
For a single period

P1 P0 + C
HPR =
P0
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22

Holding-Period
The holding-period return can be decomposed into

two parts
Holding - period Return =
Ending price Beginning price

Coupon
Beginning price
Beginning price
P1 P0 C
HPR =
+
P0
P0
HPR = Percent capital gain (loss) + Current yield
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Total Return
23
Like the holding-period return, the total return on a

bond is a measure of the bonds yield over a shorter
period of time than until maturity
The total return incorporates an explicit assumption
about the reinvestment rate
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24
Computing the Total Return

for a Bond
Step 1 Compute the total coupon payments plus the
interest on interest based on the assumed
reinvestment rate (use the equation for the future
value of an annuity)
Step 2 Determine the projected sale price at the end
planned investment horizon
of the p
Step 3 The total future dollars that will be received
from the investment, given the reinvestment rate and
the p
projected
j
required
q
y
yield at the end of the
investment horizon is the sum of Steps 1 and 2
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25
Computing the Total Return

for a Bond (cont)
Step 4 Obtain the semiannual total
return
Total future dollars
Purchase p
price
of
bond
1h
Step 5 As interest is assumed to be

paid semiannually,
p
y double the
interest rate in Step 4 the result is the
total return for the investment horizon
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26
IRR
The discount rate often used in capital budgeting that
makes the net present value of all cash flows from a
particular project equal to zero. Generally speaking, the
higher a project's
project s internal rate of return
return, the more
desirable it is to undertake the project. As such, IRR can
be used to rank several prospective projects a firm is
considering. Assuming all other factors are equal among
the various projects, the project with the highest IRR
would probably be considered the best and undertaken
first.
IRR is sometimes referred to as "economic rate of return
(ERR)."
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Returns
27
XIRR
Used to calculate internal rate returns with irregular cash
flow.
flow
4/3/2014
Example
28
An investor bought 1,000 units in the dividend payout

option of a scheme, on January 15, 2011, when the
NAV was Rs.
Rs 14 per unit.
unit On July 1,
1 2011 the scheme
distributed a dividend of Rs. 2 per unit. Another dividend
of Rs. 1.50 per unit was distributed on December 10,
2011 The investor exited the scheme on February 1,
2011.
1
2012, when the NAV was Rs. 15 per unit. The applicable
exit load was 1%.
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29
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30
Suppose the investor bought another 500

units on September
p
15, 2011 at Rs. 13 p
per
unit. The investor sold only 1,000 units on
February 1,
1 2013.
2013
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31
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32
Compounded Annual
Growth Rate (CAGR)
The year-over-year growth rate of an investment over a
specified period of time.
The compound annual growth rate is calculated by
taking the nth root of the total percentage growth
rate, where n is the number of years in the period
b i
being
considered.
id
d
This can be written as follows:
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33
Compounded Annual
Growth Rate (CAGR)
The year-over-year growth rate of an investment over a
specified period of time.
The
Th compound
d annuall growth
th rate
t is
i calculated
l l t d by
b
taking the nth root of the total percentage growth rate,
where n is the number of years in the period being
considered.
considered
This can be written as follows:
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34
An investor bought 1,000 units in the dividend payout

option of a scheme, on January 15, 2011, when the
NAV was Rs. 14 per unit. On July 1, 2011 the scheme
distributed a dividend of Rs. 2 per unit. Another dividend
of Rs. 1.50 per unit was distributed on December 10,
2011. The investor exited the scheme on February 1,
2012, when the NAV was Rs. 15 per unit. The applicable
exit
it load
l d was 1%
1%. SSuppose th
the ex-dividend
di id d NAV after
ft
dividend distribution was Rs. 12.50 per unit on July 1,
2011 and Rs.
Rs 13.594
13 594 per unit on December 10,
10 2011.
2011
4/3/2014
35
4/3/2014
Absolute Return
36
The return that an asset achieves over a certain period of

time. This measure looks at the appreciation or
depreciation (expressed as a percentage) that an asset usually a stock or a mutual fund - achieves over a given
period of time.
Absolute return differs from relative return because it is
concerned with the return of a particular asset and does
not compare it to any other measure or benchmark.
4/3/2014
Annualized Return
37
The average amount of money earned by an

investment each year over a given time period. An
annualized total return provides only a snapshot of an
investment's performance and does not give investors
any indication of its volatility. Annualized total return
merely provides a geometric average, rather than an
arithmetic average.
A mutual fund could earn returns varying from 3 to 5%

each
h year and
dh
have an annualized
li d ttotal
t l return
t
off
3.995%. On the other hand, a fund could also be
much more volatile, losing 3% in one year, earning 12%
in another and have an annualized total return of
4 23% The
4.23%.
Th difference
diff
iis th
the first
fi t fund
f d would
ld offer
ff
steady returns while the second would offer widely
fluctuating returns.
(1/ )
Annualized
i
Return = [(1+R
(
) (
) (
) ^ (1/n)
1)*(1+R
2)...*(1+R
n)]
Where R = annual return for a given year
4/3/2014
Arithmetic vs
vs. Geometric
mean
38
Arithmetic Mean:
Always greater than geometric mean.
Superior statistical properties. * Best "estimator" or

"forecast" of "true" return.
Mean return components sum to the mean total return
Most widely used in forecasts & portfolio analysis.
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39
Arithmetic vs
vs. Geometric
mean (contd)
Geometric Mean:
Reflects compounding ("chain-linking") of returns:
* Earning of "return
return on return"
return .
Mean return components do not sum to mean total
return * Cross-product is left out.
Most widely used in performance evaluation.
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40
Arithmetic vs
vs. Geometric
mean (contd)
The two are more similar:
-
The less volatility

y in returns across time
The more frequent the return interval
(Note: "continuously compounded" returns (log

differences) side-steps around this issue. (There is only
one continuously-compounded mean annual rate:
arithmetic & geometric distinctions do not exist).
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41
Time Value Of Money
4/3/2014
Time Value of Money

42
Theideaisthatmoneyavailableat
thepresentisworthmorethanthesameamountin
the future due to its potential earning capacity
thefutureduetoitspotentialearningcapacity.
Moneyissubjecttoinflation,eatingaway
M
i
bj
i fl i
i
atthespendingpowerofthe currency
overtime,makingitworthlessinthe
future.
future
4/3/2014
43
PresentValue:tellsyouthecurrentworthofa
y
futuresumofmoney
FutureValue:givesyou thefuturevalueofcashthat
you have now
youhavenow
NetPresentValue: valueastreamoffuture
p y
paymentsintoonelumpsumtoday
p
y
DiscountRate:Theinterestrateusedindetermining
thepresentvalueoffuturecashflows.
IRR:TheIRRisadiscountratewherethepresent
valueoffuturecashflowsofaninvestmentisequal
tothecostoftheinvestment.
4/3/2014
44
Inflation
Inflation
Inflationisdefinedasasustainedincreaseinthe
is defined as a sustained increase in the
generallevelofpricesforgoodsandservices.
subsequently,purchasingpowerofRupeefalls.
Itismeasuredasanannualpercentageincrease.
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45
Calculation Of Loan
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46
Calculation of Loan
EMI Calculation
Principal repaid during a particular period
Total interest paid during a particular period
Calculating outstanding balance
4/3/2014
47
Total Assets, Net Worth And

Fi
Financial
i lR
Ratios
ti
4/3/2014
Total Assets
48
The sum of current and long-term assets

owned
d by
b a person, company, or other
th
entity.
4/3/2014
49
Total Assets
Non
Financial
Assets
Financial
Assets
Equity
Debt
Commodity
Real Estate
4/3/2014
Net Worth
50
Net worth (sometimes called net ) is the total assets

minus total outside liabilities of an individual or a
company.
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51
Personal Financial
St t
Statement
t Ratio
R ti
On The Basis of Liquidity
Basic Liquidity Ratio = Liquid assets / Monthly expenses
Expanded Liquidity Ratio = Liquid Assets and Other
Financial Assets / Monthly Expenses
On The Basis of Debt
Liquid Asset Coverage Ratio = liquid assets / total debt
Solvency Ratio = liquid and other financial assets / total
debt
Current Ratio = liquid assets / non-mortgage debt
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52
Personal Financial
St t
Statement
t Ratio
R ti
On The Basis of Risk Exposure

Life Insurance Coverage Ratio = Net Worth + Death Benefits of
P i i l Wage
Principal
W
Earner
E
/ Salary
S l
off Principal
P i i l Wage
W
Earner
E
On The Basis of Tax Burden
Effective Income Tax Ratio = Income Tax Liability / Total Realized
Increases in Net Worth
On The Basis of Inflation Protection
Inflation Hedge Ratio= equity, tangible and personal assets / net
worth
4/3/2014
53
Personal Financial
St t
Statement
t Ratio
R ti
On The Basis of Net Worth
Net Cash Flow Ratio =
1 -Realized Decreases in Net Worth /
Realized Increases in Net Worth)
Net Worth Growth Ratio = Net Increase in Net Worth / Net
Worth at Beginning of the Year
4/3/2014
54
4/3/2014
55
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Personal Finance

A Market is a place where buyers

Markets for short term

Primarily used by Banks

Exchange Rates One Currency in terms of other (Eg.

Trading Instruments used

FPO (Follow on Public offer)

Helps the borrowers to manage the huge debts

Types Of Public Debt

Productive and Unproductive debts

Voluntary and Compulsory Debt

The amount by which assets exceed liabilities. Net worth is a

A revenue or expense stream that changes a cash account over

Holding Period Return

Holding Period Return

For a single period

Holding Period Return

The holding-period return can be decomposed into

Holding - period Return =

Ending price Beginning price

Like the holding-period return, the total return on a

Computing the Total Return

Computing the Total Return

Step 5 As interest is assumed to be

An investor bought 1,000 units in the dividend payout

Suppose the investor bought another 500

An investor bought 1,000 units in the dividend payout

The return that an asset achieves over a certain period of

The average amount of money earned by an

A mutual fund could earn returns varying from 3 to 5%

Where R = annual return for a given year

Always greater than geometric mean.

Superior statistical properties. * Best "estimator" or

Mean return components sum to the mean total return

Most widely used in forecasts & portfolio analysis.

The less volatility

The more frequent the return interval

(Note: "continuously compounded" returns (log

Time Value Of Money

Time Value of Money

Total Assets, Net Worth And

The sum of current and long-term assets

Net worth (sometimes called net ) is the total assets

On The Basis of Risk Exposure

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