Finance 1

Question 1

what are the two main things the existence of financial markets allow

Answer 1

• inter-temporal exchange
• exchange of risk

Question 2

what are the 5 main categories of financial markets

Answer 2

• the stock market
• the bond market
• the money market
• the foreign exchange market
• the hedging market

Question 3

what is the primary function of the stock market

Answer 3

• to raise permanent capital in the form of new shares being sold to equity investors
• whether in an IPO or an SEO

Question 4

what differentiates a treasury bill, note and bond

Answer 4

• the time to maturity of the bond
• if the time to maturity is short-term like less than 1 year, its a bill
• if the time to maturity is medium-term between 1 to 10 years, its a note
• if the time to maturity is long-term like over 10 years, its a bond

Question 5

what is the money market

Answer 5

• the money market is a market for debt securities that will pay off in the very short-term
• usually overnight or a couple of days
• they are comprised of a series of closely connected wholesale OTC short-term financial markets

Question 6

what is the forex market

Answer 6

• the forex market is where foreign exchange currencies are bought and sold
• its a market for the exchange of purchasing power from one currency to another

Question 7

what is the hedging market mainly used for

Answer 7

• the hedging market is mainly used for the management of risk
• like buying and selling of risk through derivatives products
• such as options, futures and forwards

Question 8

what is the difference between a primary and secondary market

Answer 8

• primary markets are where governments and corps initially sell securities or do an IPO
• secondary markets are where they are traded from one investor to another (after debt and equity securities are originally sold)

Question 9

what is the first principle of finance

Answer 9

• the time value of money
• the fact that “a pound today is worth more than a pound tomorrow”
• because you can invest the pound today and start earning interest immediately

Question 10

what is the generic formula for future value, FV

Answer 10

• FV = C*(1+r)^t
• C = cash flow
• r = interest rate
• t = time

Question 11

what is the generic formula for the present value, PV

Answer 11

• PV = C / (1+r)^t
• RHS = the discount factor

Question 12

what is perpetuity and what is the formula for the PV of a perpetuity

Answer 12

• perpetuity is a constant stream of payments
• PV = C_1 / r
• C_1 = cash flow in the next period
• r = discount rate

Question 13

what is the formula for the PV of a growing perpetuity

Answer 13

• PV of a growing perpetuity = C_1 / (r-g)
• g = growth rate

Question 14

what is an annuity

Answer 14

• an annuity is a level stream of regular payments that lasts for a fixed number of periods

Question 15

what is the formula for the PV of an annuity

Answer 15

• PV of an annuity = C*(1/r - 1/r(1+r)^t)

Question 16

what is growing annuity

Answer 16

• growing annuity is a stream of growing cash flows that occur at regular intervals and eventually come to an end

Question 17

what is the formula for the PV of growing annuity

Answer 17

• PV of growing annuity = C/(r-g)*[1 - (1+g/1+r)^t]