Money and Banking

Course Syllabus

Hour Ry
University of South East Asia
McGrawHill/Irwin

Copyright2013byTheMcGrawHillCompanies,Inc.Allrightsreserved.

Course Objective
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Hour Ry
of South East Asia

University

Course Description

Hour Ry
University of South East Asia
McGrawHill/Irwin

Copyright2013byTheMcGrawHillCompanies,Inc.Allrightsreserved.

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General History of International

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Hour Ry
of South East Asia

University

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INTRODUCTION TO SUBJECT
Suppose you intend to start a business.
Three up-front questions that hit you
think are:
- What type of investments(asset) do we need?
- Where the money will come from?
- How we will finance our day to day
monetary matters (like purchase of raw
materials and payment of salaries etc)?
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The Balance-Sheet Model of the Firm

Total Value of Assets:

Total Firm Value to Investors:

Current
Liabilities

Current Assets

Long-Term
Debt

Fixed Assets
1 Tangible

Shareholders
Equity

2 Intangible
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The Balance-Sheet Model of the Firm

The Capital Budgeting Decision
Current
Liabilities

Current Assets

Long-Term
Debt

Fixed Assets
1 Tangible
2 Intangible
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of South East Asia

What type of
asset do we
need?

University

Shareholders
Equity
6

The Balance-Sheet Model of the Firm

The Capital Structure Decision
Current
Liabilities

Current Assets

Fixed Assets
1 Tangible
2 Intangible

How can the

firm raise the
money for the
required
investments?

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Long-Term
Debt

Shareholders
Equity
7

The Balance-Sheet Model of the Firm

The Net Working Capital Investment Decision
Current
Liabilities

Current Assets
Net
Working
Capital

Fixed Assets
1 Tangible
2 Intangible

How much
short-term cash
flow does a
company need
to pay its bills?

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Long-Term
Debt

Shareholders
Equity
8

To answer these questions

to find out:
What is corporate finance
The scope of the subject

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1- Capital budgeting
Capital budgeting is the planning and
control of cash outflows in the
expectation of receiving future cash
inflows from investments in non-current
assets.
Involves evaluating the:
size of future cash flows
timing of future cash flows
risk of future cash flows.
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10

2.Capital Structure
Should we use debt or equity?
The value of the firm can be
thought of as a pie.
70%50%30%
25%
DebtDebt
Equity

The goal of the manager is to

increase the size of the pie.

50%
75%
Equity

The Capital Structure decision

can be viewed as how best to
slice up the pie.

If how you slice the pie affects the size of the pie, then
the capital structure decision matters.
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11

3- Working Capital
Management
How much cash and inventory should
be kept on hand?
Should we extend credit terms for
customers? If so, what are the
conditions?
How is short-term financing acquired?
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12

II- Forms of Business

Organization
Three major forms in the United
States
Sole Proprietorship
Partnership
General
Limited

Corporation

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13

Sole Proprietorship
Advantages
Easiest to start
Least regulated
Single owner keeps
all the profits
Taxed once as
personal income

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South East Asia

Disadvantages
Limited to life of
owner
Equity capital
limited to owners
personal wealth
Unlimited liability
Difficult to sell
ownership interest

University of

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Partnership
Advantages
Two or more
owners
More capital
available
Relatively easy to
start
Income taxed once
as personal income

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South East Asia

Disadvantages
Unlimited liability
General partnership
Limited partnership

Partnership
dissolves when one
partner dies or
wishes to sell
Difficult to transfer
ownership
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Corporation
Advantages
Limited liability
Unlimited life
Separation of
ownership and
management
Transfer of
ownership is easy
Easier to raise
capital
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South East Asia

Disadvantages
Separation of
ownership and
management
Double taxation
(income taxed at
the corporate rate
and then dividends
taxed at the
personal rate)
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III- In case of a Corporation

1- Corporate structure

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Organization Chart
Board of Directors
Chairman of the Board and
Chief Executive Officer (CEO)
President and Chief
Operating Officer (COO)
Vice President Finance

Treasurer

Controller

Cash Manager

Tax Manager
Data Processing
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18

2- The Agency Problem

Agency relationship
Principal hires an agent to represent
his/her interests
Stockholders (principals) hire managers
(agents) to run the company

Agency problem
Conflict of interest between principal and
agent

Management goals and agency costs

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19

3-Financial Markets and the

corporation
Firm
Invests
in assets
(B)

Financial
markets

Retained
cash flows (D)
Short-term debt
Cash flow
from firm (C)

Dividends and
debt payments (F)

Ultimately, the firm must

be a cash generating
activity.

Government

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Long-term debt
Equity shares

Taxes (E)

Current assets
Fixed assets

Firm issues securities (A)

University

The cash flows from the

firm must exceed the
cash flows from the
financial markets. 20

Financial Markets and the corporation

Primary versus Secondary Markets
Primary Market

When a corporation issues securities, cash flows from

investors to the firm.
Usually an underwriter is involved

Secondary Markets

Involve the sale of used securities from one investor

to another.
Securities may be exchange traded or trade over-thecounter in a dealer market.
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21
University

Financial Markets
Firms

Stocks and
Bonds
Money

Investors
securities
Bob

Sue
money

Primary Market
Secondary Market

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22

Quick Quiz
What are the three types of financial
management decisions and what questions
are they designed to answer?
What are the three major forms of business
organization?
What are agency problems and why do they
exist within a corporation?
What is the difference between a primary
market and a secondary market?

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23

Review
The time value of money

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1- Future value: Compound

Interest
FV PV 1 r

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Future value: Simple Interest

FV PV 1 rt

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2- Present Value

PV

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of South East Asia

FV

1 r

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3- Multiple Cash Flows

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University of South East Asia

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3-1 Future value Multiple Cash Flows

You plan to deposit each year, $5,000 at
year 1, $6,000 at year 2, $4,000 at year 3,
and $8,000 at year 4. How much is your
money at the end of year 4? If the bank
provides 10% annual interest rate.
0 r = 10%1

$5,000 $6,000 $4,000

4
$8,000
FV
?

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University of South East Asia

37

3-2 Present value multiple cash

flow

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PV of Multiple Cash Flows

Example
Your auto dealer gives you the choice to pay $15,500
cash now, or make three payments: $8,000 now and
$4,000 at the end of the following two years. If your
cost of money is 8%, which do you prefer?
Immediate payment

8,000.00

PV1

4 , 000
(1.08 )1

3,703.70

PV2

4 , 000
(1.08 ) 2

3,429.36

Total PV

$15,133.06

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University of South East Asia

PV of Multiple Cash Flows

PVs can be added together to
evaluate multiple cash flows.

PV

C1
(1 r )

(1 r ) 2 ....
C2

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4- Perpetuities & Annuities

Perpetuity
An equal cash flow that never ends.
Annuity
Equally cash flows for a limited period
of time.

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University of South East Asia

Perpetuities & Annuities

PV of Perpetuity Formula

PV

C
r

C = cash payment
r = interest rate
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Perpetuities & Annuities

Example - Perpetuity
You pays $100,000 per year, forever, how
much money must be set aside today in
the rate of interest is 10%?

PV

100 , 000
.10

$1,000,000

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Perpetuities & Annuities

Example - continued
If the first perpetuity payment will not be
received until three years from today, how
much money needs to be set aside today?

PV

1, 000 , 000
(1 .10 ) 3

$751,315

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Perpetuities & Annuities

Example - Annuity
You are purchasing a car. You are
scheduled to make 3 annual installments
of $4,000 per year. Given a rate of interest
of 10%, what is the price you are paying
for the car (i.e. what is the PV)?

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University of South East Asia

4-3 FV annuity
You plan to save $3,000 every
year for 4 years. Given a 10%
rate of interest, what will be the
FV of this amount?

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5- Inflation
Inflation - Rate at which prices as a whole
are increasing.

Nominal Interest Rate - Rate at which money

invested grows.
Real Interest Rate - Rate at which the
purchasing power of an investment
increases.
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University of South East Asia

Real rate Vs nominal rate

Real int. rate nominal int. rate - inflation rate
1 Nominal Interest Rate
1 Real Interest Rate
1 Inflation Rate

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Inflation

Example
If the interest rate on one year govt. bonds is
5.0% and the inflation rate is 2.2%, what is the
real interest rate?

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Effective Annual Rates

Effective Annual Interest Rate (EAR) Interest rate that is real from compound
interest.

Annual Percentage Rate (APR)

Annual interest rate using simple
interest.
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50

6- Effective Annual Rates

example
Given a monthly rate of 1%, what is the
Effective Annual Rate(EAR)? What is the
Annual Percentage Rate (APR)?

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End of Chapter

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of South East Asia

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