Sunteți pe pagina 1din 23

# Financial management

## Time value of money, Risk

and return, Valuation

Objectives of Financial
management

Profit maximisation/EPS

## Ambiguity, quality of benefits/risk, timing of benefits

Wealth maximisation

## Capitalisation/discount rate that reflects risk and time preferences

After tax operational profits of a firm less the cost of funds used to
finance investments

Focus on stakeholders

## Employees, customers, suppliers, creditors, owners and others

who have direct link with the firm

## Time value of money

I will gladly pay you Tuesday for a hamburger I
can eat today - Wimpie, from the Popeye cartoon

Learning Objectives
Explain the meaning of the time value of money and the
importance of the timing of cash flows in making financial
decisions
Calculate the future value and present value of cash flows for
one period and multiple periods
Solve for the interest rate implied by a given set of present
value and future value cash flows
Apply time value of money techniques to solve basic problems
facing financial managers
Use a calculator/excel sheet to solve time value of money
problems

## Central concepts in finance

risk only if they anticipate higher return.
Time value of money value of a unit of money is
different in different time periods
A rupee available today is worth more than a rupee
available at a future date.
This is because a rupee today can be invested to earn a
return.

Techniques

## Compound interest is the interest earned on a

given deposit/principal that has become a part of
the principal at the end of a specified period

amount

future amount

## Return actual income received plus any

change in the market price of an asset /
investment
Calculation of expected return single period
Risk variability of actual return from the
expected return associated with a given asset

Measurement of risk

## Behavioural point of view

Sensitivity analysis

Probability distribution

## Quantitative/statistical point of view

Standard deviation

Co-efficient of variation

## Portfolio combination of two or more

securities/assets

## Portfolio expected return

Portfolio risk

Correlation/covariance

Diversification

Systematic risk

## Caused by factors that affect the overall market/all

securities

Non diversifiable/unavoidable

Unsystematic risk

## Unique to particular company/industry/security

Diversifiable/ avoidable

CAPM

## Model that describes the relationship/tradeoff

between risk and expected/required rate of return
Explains the behaviour of security prices and
provides a mechanism to assess the impact of
proposed security investment on investors overall
portfolio risk and return
Provides a framework for basic risk return trade off in
portfolio management
Enables drawing certain implications about the risk
and size of risk premium necessary to compensate
for bearing risk

Efficiency of market

Assumptions

## Expectations are based on one year holding period

Investor preferences

## Prefer to invest in securities with the highest return for a given

level of risk or lowest risk for a given level of return

## Return a risk measured in terms of expected value and standard

deviation respectively

Measure of risk

## Beta coefficient is an index of the degree of

responsiveness/comovement of security return with
market return

## Beta coefficient represents the change in excess

return on the individual security over changes in
excess return on market portfolio
Beta of market portfolio is equal to 1
Index of systematic risk of individual security relative
to that of market portfolio

## Beta of a security and CAPM

formula
The CAPM formula is: ra = rrf + Ba (rm-rrf)
Required Return = Risk free rate + (Market return Risk free rate) *
Beta
Portfolio Beta = (the sum of) {weight of security X Beta of security}

## Valuation of long term securities

Valuation of bonds/debentures

## Bond long term debt instrument used by

government, government agencies and
business enterprises to raise a large sum of
money
Par value value on the face of the bond
Coupon rate specified interest rate available
on security
Maturity period number of years after which
the par/specified value is payable to the

Illustration

## A firm has issued a 10 percent coupon interest

rate, 10 year bond with a Rs. 1000 par value
that pays interest semi-annually. A bond
holder would have contractual right to

## Annual interest of Rs 100 i.e., coupon interest rate

* par value (.10*1000) paid as Rs 50 at the end of
every 6 months

## Present value of contractual payments its issuer (corporate) is

obliged to make from the beginning till maturity
Appropriate discount rate would be the required return
commensurate risk and prevailing interest rate
When the required return is equal to the coupon rate, the
bond value equals the par value

values

Time to maturity

RR

Bond value

Constant RR

Changing RR

## The shorter the time to maturity, the smaller the

impact on bond value caused by a given change in
the required return

Yield to maturity

## Rate of return investors earn if they buy a

bond at a specific price and hold it till maturity
Illustration

## Expected return is the return that is expected

to be earned on a given security over an
infinite time horizon