Week 1 - Introduction to Financial Decision Flashcards
(17 cards)
Understand what finance is and how to make financial decisions.
→ Finance is about how individuals and firms raise and invest money to maximise wealth inc. personal and business wealth
→ Includes the financial decision investors and firms and how they use the financial system to implement their decisions
→ Price is determined by supply and demand - the market price reflects the price of the most recent transaction
→ When benefits exceed cost = wealth increasing decision
→ We estimate asset values (time value of money with the benefit recieved) in the face of uncertainty by discounting cash flows at required rate of return (interest rate)
Valuation Principle
→ Shows how to make the costs and benefits (must be measured in current $) of a decision comparable so that we can weigh them appropriate
→ NPV = net present value = time value of money + risk
Time Value of Money Concept: it states that $1 in the future is not equivalent to $1 in the future
Real Assets
productive assets –> assets that can be put to productive to generate cash flows
Separated into tangible assets and intangible assets
Financial Assets
= claim on the cash flow –> assets that represent a claim to a series of cash flows against an economic unit
Three Types of Financial Assets:
- Shares
- A claim against a company
- Cash flows = dividends and sales price
2. Bonds - A claim against the bond issuer (e.g government)
- Cash flows = interest and principal
3. Bank Account - A claim against a bank
Cash Flows = interest and principal
Who are investors
Investors are individuals and households
opportunity cost
= value of the next best alternative (MUST BE SUBTRACTED FROM ALL INVESTMENT DECISIONS)
Consumption and Savings decisions:
- How much to spend of consumption and how much of current income should be saved for the future?
- What is the opportunity cost of trading off consumption today for consumption in the future?
Investment decisions:
- How should they invest the money saved? E.g bank account, bonds, shares, managed fund, ETF
- Investment Decision = recoginising you must spend money to make money
Financing Decisions
How and when should individuals use other peoples’ money to implement their consumption and investment plans?
Firms
are any business owned by a sole trader or partnership & shareholders, with the primary purpose to produce goods and services.
The Investment Decision
→ Firms invest in real assets to produce goods and services
→ The basic unit of account is the investment project (set of cash flows)
→ Projects with have a set of cash flows - usually a cash outflow up front (the cost) and cash inflows (benefits) over the life of the project
The Financing Decision
→ Firms pay for their real assets by selling (issue) financial assets, which are claims on the cash flows generated by the real assets
→ Bonds and shares (debt and equity) are examples of the financial assets issued by firms
→ Buying a bond from a firm = lending money to the firm
Buying a share from a firm = owning part of the firm
Lean Startup and Minimum Viable Product
aim to minimise risks in financing and investment decisions
The financial system includes (flow of money from investors to firms):
- Financial Institutions e.g banks, credit unions, fund managers
- Financial Markets e.g money market, bond market, FEM
The financial system there allows:
- Investors to trade off current consumption and future consumption
- Firms to raise finance to fund their investment projects and generate returns for their investors
The financial system provides a mechanism for investors to channel their savings into the productive opportunities of firms that generate returns for investors
