FUNDAMENTAL PRINCIPLES OF FINANCE

Question 1

the study of how individuals, institutions, governments, and businesses acquire, spend, and manage money and other financial assets

Answer 1

Finance

Question 2

provide the framework that govern the study of finance.

Answer 2

fundamental principles of finance

Question 3

“money in hand today is worth more than the

promise of receiving the same amount in the future.”

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time value of money

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“a peso today is worth

more than a peso tomorrow.”

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time value of money

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the longer the time period that it takes to receive a sum of money in the future, the riskier it is.

Answer 5

time value of money

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“a bird in the hand is worth two in the bush”

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time value of money

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that the purchasing power of the peso, even when its value is held constant, diminishes the farther away into the future it is held because of the effects of inflation and other factors.

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time value of money

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This concept is highly useful in the study of capital budgeting which evaluates investment projects decisions by comparing the cash outlay foregone today as investment for the project with the present value of the cash flows to be received in the future in connection with the project.

Answer 8

time value of money

Question 9

This principle of finance recognizes that all things in the world involve a certain trade-off or palitan, in that in every situation there will always something which we will have to forego or trade in order to achieve something else.

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risk-return trade off

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uncertainty about the outcome or payoff of an investment in the
future.

Answer 10

risk

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underscores the cost-benefit relationship which states that “in every undertaking, the benefits to be derived should always exceed the costs”.

Answer 11

risk-return trade off

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also recognizes the importance of the concept of opportunity cost, which is the value of the benefit foregone by choosing one alternative over the other.

Answer 12

risk-return trade off

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“the higher the risk, the higher the return.”

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risk-return trade off

Question 14

rational investors would consider investing in a risky investment only if they feel that the
expected return would be high enough to justify the greater risk involved.

Answer 14

risk-return trade off

Question 15

This principle of finance recognizes that while higher returns are expected for taking on more risk, all investment risk is not the same since some risk can be removed or “diversified” by investing in several different assets or securities.

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diversification of risk

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relevant to managing a portfolio of investments rather than choosing only one particular type of investment since when investing in a portfolio, the loss incurred by one investment could be offset or cancelled by gains earned in another investment.

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diversification of risk

Question 17

“do not put all your eggs in one basket”.

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diversification of risk

Question 18

It is said to be information efficient if at any point the prices of securities reflect all the information available to the public.

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financial markets

Question 19

This means that the price of any security in the market should reflect the real value or worth of the item.

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financial markets pricing efficiency

Question 20

reasons why it’s hard to find exceptionally profitable projects.

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market competition

Question 21

In this principle, extremely large profits cannot exist for very long because of competition moving in to exploit those large profits.

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market competition

Question 22

profitable projects can only be found if the market is made less competitive, either through product differentiation or by achieving a cost advantage.

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market competition

Question 23

It’s only what changes that counts. In making business decisions, we will only concern ourselves with what happens as a result of that decision.

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incremental cash flows

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“cash is the only liquid asset which can be used for buying goods and paying expenses.”

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cash is king

Question 25

This principle of finance relates to the fact that the objectives of management may differ from the objectives of the owners of the business.

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agency problem

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managers may seek to setting up objectives that may benefit them instead of benefitting the owners and investors, in which case owner returns may suffer as a result of the objectives of management.

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agency problem

Question 27

to maximize shareholders’ wealth, emphasizing on generating the best return on the investment of the owners, rather than profit maximization.

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agency problem

Question 28

Business owners should always consider the tax effects, if any, of any decision that the make in line with their business.

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tax bias decision making

Question 29

Every decision relating to investment should be done after seeing its tax effect, such as how much tax will be paid to the government if any new project is to be undertaken.

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tax bias decision making

Question 30

This principle of finance relates to ethical behavior, which is how an individual or organization treats others legally, fairly, and honestly.

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ethics and reputation

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This relates to the avoidance of perpetrating fraudulent activities at the expense of the good name of the firm, illegal and unethical behavior aimed at competing against other firms, and the like.

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ethics and reputation

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A high reputation is the product of high-quality ethical behavior, which is ideal not only for businesses but to individuals as well.

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ethics and reputation

Question 33

reasons for studying finance

Answer 33

To make informed economic decisions. To make informed personal and business decisions. To make informed career decisions.