Lec1 - lecture week 1 PDF

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lecture week 1...

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FIN222 Lecture 1 CH4: Time Value of Money: Valuing CF Streams CH5: Interest Rates

South Western Sydney Campus

Wollongong Campus

Learning Development Maths and Stats Support DR DAVID HARTLEY LEARNING DEVELOPMENT MATHS AND STATS COORDINATOR APPOINTMENTS (MONDAY-THURSDAY): RECEPTION, TOP FLOOR, BUILDING 11 (ABOVE UNISHOP) PHONE: 4221 3977

Maths and Stats Support SERVICES SUMMARY

• Topic introduction and reminder resources • Online modules • Maths workshops • One on one or small group consultations • Specialised stats lecturer FREE!!!!

Maths and Stats Support TOPIC RESOURCES

• Covers a range of topics • Brush up on your maths skills or supplement your own notes • Available at: – Printed resources on Level 2 of Building 11

– https://www.uow.edu.au/student/learning-co-op/

Maths and Stats Support ONLINE MODULES

• Self-enrol in online modules – Statistical Literacy (TCHR418_13) – Maths Refresher (TCHR541_15)

• Available through: – https://www.uow.edu.au/student/learning-co-op/ – Moodle: Login  All sites (scroll down)  Teaching resource  click relevant module

Maths and Stats Support WORKSHOPS

• Algebra skills for various maths & stats courses • Fractions • Order of Operations and Scientific Calculators • Logarithms • Hypothesis Testing • Register via the Learning Co-Op – https://www.uow.edu.au/student/learning-co-op/

• Programs also available at Level 2 Building 11 reception

Maths and Stats Support CONSULTATIONS – Wollongong

• Maths: David Hartley (Monday to Thursday) • Stats: Vicki Kendrick (Mon 11:30-2:30 & Wed 9:30-11:30) • Appointments through reception: – Level 2 (top floor) Building 11 (above the UniShop) – Phone: 4221 3977

Maths and Stats Support WORKSHOPS - Wollongong

Algebra for Level 2 Finance • — Day: Wednesday 11 March — Time: 12:30-1:30 — Location: 11-210 • — Solving equations — Rearranging formulae

1+𝐴 = 1+𝑋 1+𝐵 𝐴−𝐵 𝑋= 1+𝐵 𝐴 =𝑋+𝐵 𝐶−𝑋 𝐴 − 𝐵𝐶 𝑋= 1−𝐵

Maths and Stats Support WORKSHOPS - Wollongong

Logarithms with Applications to Finance — Day: Monday 16 March — Time: 12:30-1:30 — Location: 24.103 (TBC) — Introduction to logarithms — Logarithm laws — Solving finance equations using logs

•

Solve for investment term 𝑛 𝐹𝑉 = 𝑃𝑉 1 + 𝑟

Maths and Stats Support CONSULTATIONS – Batemans Bay

• Wendy Law • Appointments: via Wendy’s email [email protected] • Available: via appointment



Maths and Stats Support CONSULTATIONS – Shoalhaven

• Sheridan Reilly • Appointments: Reception, Ray Cleary building • Available: Tuesdays (TBC)

Maths and Stats Support CONSULTATIONS – South Western Sydney

• David Hartley • Appointments: phone 4221 3977 • Individual consultations via Skype/Webex/Zoom

Maths and Stats Support WORKSHOPS – South Western Sydney

Algebra for Level 2 Finance — Day: Monday 9 March — Time: 11:30-12:30 — Location: TBA and via webex — Solving equations — Rearranging formulae

•

•

1+𝐴 = 1+𝑋 1+𝐵 𝐴−𝐵 𝑋= 1+𝐵 𝐴 =𝑋+𝐵 𝐶−𝑋 𝐴 − 𝐵𝐶 𝑋= 1−𝐵

Register by emailing [email protected]

Maths and Stats Support WORKSHOPS – South Western Sydney

Logarithms with Applications to Finance — Day: Monday 16 March — Time: 11:30-12:30 — Location: TBA and via webex — Introduction to logarithms — Logarithm laws — Solving finance equations using logs

•

Solve for investment term 𝑛 𝐹𝑉 = 𝑃𝑉 1 + 𝑟

Register by emailing [email protected]



Maths and Stats Support CONSULTATIONS – Southern Highlands

• David Hartley • Appointments: phone 4221 3977 • Individual consultations via Skype/Webex/Zoom • Face to face group consultations available • Face to face workshops upon request

Maths and Stats Support CONSULTATIONS – Southern Sydney

• David Hartley • Appointments: phone 4221 3977 • Individual consultations via Skype/Webex/Zoom • Face to face workshops 17th March 3:30 – 5:30, register interest by emailing [email protected]

Subject Overview- Delivery mode • Lecture (2h) – Wed 5:30–7:30pm at 67.107 (Wollongong) – Thu 9:30-11:30am at SWS_1-38 (South Western Sydney) • Tutorial/Workshop (2h)

Expectation for workload A 6-credit point subject requires that students commit about 12 hours study a week including attendance at lectures and tutorials • 4 hours with teachers + 8 hours on your own per week and per subject

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Lecture • Attendance: Strongly encouraged • Lecture notes – Student version to be available by 5:30pm Tue on moodle.

• Please bring your calculator • Reading the chapter before you come is strongly recommended. • All lectures (including the revision lecture) will be recorded. You can access via ECHO360 on Moodle. • The full lecture note will be made available after the lecture on moodle.

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Tutorial (First-hour)

• Attendance Compulsory (starting next week) • Do I have homework to do? – Yes. Each week! The list of Questions in the subject outline. • Why is it important to do homework? – Your tutor, at their discretion, will collect your homework 5 times over the session. – The combined marks from 5 submissions will determine 10% of the total assessment marks. – It will help you keep up with the subject materials on a weekly basis. – You will learn better and more when you come knowing what you don’t know. • Solutions to tutorial questions will be available by Friday night each week. 21

Tutorial (First-hour)

Marking criterion for homework preparation

• Assessment will be based on the level of efforts put into the process of solving given problems and not on the correctness of the answers. • For each submission (worth 2 marks), two criteria will be applied. – i) [1 mark] the number of PARTS you have attempted – ii)[1 mark] the quality of preparation for attempted parts – The maximum you can obtain from criterion ii) varies depending on the portion of parts attempted. • Given the threshold values of 0, 0.25, 0.5, 0.65, 0.75, 0.85 and 1, the highest mark obtainable under ii) is the closest upper threshold value to marks obtained from i). • For example, if 7/9 (=0.78) from i), the maximum obtainable for ii) is 0.85. 22

Workshops (Second-hour) • Attendance Compulsory • What are the differences between Tutorial (T) and Workshop (W)? T

W

Do I have to prepare? The class is run based on Assessment attached? Personalised attention from teachers?

L

Solution will be available on Moodle?

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Assessment tasks • Homework preparation -10% – 5 random collections • Mid-Session Test -20% – During lecture time in Week 6 – No tutorial/workshop in Week 6 – 40 multiple choice questions for 100 minutes • Group Assignment -20% – Due on Thursday, 7 May 2020, Week 9 – The assignment manual will be available following Lecture 4. • Final Exam - 50% – Covers from Lecture 4 to the final lecture 24

Minimum Performance Requirements • Attend and participate in 80% of tutorials/ workshops; • Submit tutorial homework at least two times; • Attempt the mid-session exam in Week 6; • Submit the assignment in Week 9; • Pass the final exam (i.e. at least 50% in the final exam); • Obtain 50% overall in total marks

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Consultations – South Western Sydney • Professor Millicent Chang – Room 40.336 – Phone 4298-1169 – Email [email protected] • For consultations, please make an appointment.

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Consultations – Wollongong/Regional campuses • Aelee Jun – – – – – –

Wednesday 9:30-11:30 Thursday 10:00-12:00 Room 40.321 Phone 4221-5077 Email [email protected] For a meeting outside my consultation hours • Please make an appointment by emailing me.

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Text book • Berk, J, Demarzo, P, Harford, J, Ford, G, Mollica, V & Hull, J 2019, FIN222 Fundamentals of Corporate Finance, Custom edition for the University of Wollongong, Pearson

• You can use Berk’s 3rd edition. An additional “Option” chapter is available under library subject reading. • Registration instruction for Mylab finance access is on moodle. 28

Calculator

• Essential for this subject • Please carry one for all your classes including lectures • You can only use one of the APPROVED CALCULATORS. The list of eligible calculators can be found from https://www.uow.edu.au/student/exams/calculators/index.html

• Do you need a yellow sticker? Go to either Unishop or Student Central • Do you need to have a new model assessed? Go to https://www.uow.edu.au/student/exams/calcassess/index.html

• Do I have to buy a financial calculator? – No. Scientific calculator will work fine.

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Lecture 1 Reading 4.1 4.2 4.3 4.4 -Growing Perpetuity • 4.5 – Solving for the cash Flows - Rate of return - Solving for the number of periods • • • •

Lecture 2 Reading • 5.1 • 5.2 • 5.3 -Inflation and real vs nominal rates -Yield curve and Discount rates -Yield curve and The economy • 6.1 • 6.2 -Zero-coupon bond cash flows • 6.3 • 6.4 -Interest rate changes and bond prices -Interest rate risk and bond prices -Bond prices in practice • 6.5

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Learning Outcome 1 1.

Demonstrate an understanding of how financial system works and calculate the value of different types of cash flow streams including financial assets such as shares and bonds.

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Notations • • • • • • •

FV =Future Value PV = Present value r = Interest rate n = Number of periods m= Frequency of compounding g= growth rate k = the period where the first cash flow occurs (not in the text book)

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What comes to your mind?

Finance

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What does Oxford Dictionary say? • FINANCE is… – The money used or needed to support an activity, project – The management of money – The money available to a person, company or country

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What is ‘Corporate Finance’ about?

Quantitative Tools and Techniques financial managers can use to make optimal financial decisions in a way that maximises shareholders’ wealth (share price)

3 major decisions facing financial managers • Investment decision – What assets to buy – Real assets can be tangible or intangible. • Tangible assets: equipment, machinery, manufacturing facility, land, buildings • Intangible: patents, trademarks (intellectual properties)

• Financing decision – How to raise the needed cash to support investments – Two basic sources of funds: _____________

• Working capital management decision – How to manage ____________ and ___________

• Our Aim is to learn relevant quantitative tools and related concepts which will assist financial managers in making above decisions. 36

Role of Financial System • As you see in three areas of financial decision, it involves either access to funds or investment of funds. – Investment decision requires _________ of funds. – Financing decision requires ________ to funds. • Financial system consists of financial markets and financial institutions. • A critical role of the financial system in the economy is to gather money from people and businesses with surplus funds to invest and channel money to those who need it. – Channel money from _______ units to _____ units

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Financial System Have $ to invest

Need $

$

$

Goal of financial managers

• What is an appropriate goal of the financial manager? • To maximize the wealth of the owners, the shareholder (which is best measured by market value of the firm’s stock =current stock price). • To see whether an asset is fairly valued, we learn how to compute an intrinsic value (=fair value) of the asset. In the world of Finance, an intrinsic value is determined by three things! – Future cash flows – Timing of cash flows – Riskiness of the cash flows 39

Reminder Time value of money

A dollar today is worth more than a dollar tomorrow.

|_____| $1 > $1

Which one of these assets would you rather own? Asset 1

Asset 2

Year 0

1 2 3 4 5 6 7 8 |_____|_____|_____|_____|_____|_____|_____|_____| $100

Year 0

1 2 3 4 5 6 7 8 |_____|_____|_____|_____|_____|_____|_____|_____| $100 $105 5%

The interest rate plays a role of converting cash across time! 40

FV? when more than one compounding period is involved?

r=10%

FVn=C (1+r/m)mn

m =No of times per year that interest is compounded Rate per period Total No of periods

$1(1+0.1)1 =$1.1 2x1

$1(1+0.1/2) =$1.1025

10%

$1 0

1

5%

5%

$1

$1.1025

0

4x1

$1(1+0.1/4) =$1.1038

$1.1

1

0.5

2.5%

2.5%

2.5%

2.5% $1.1038

$1 0

0.25

0.5

0.75

1

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Example 1: Future Value • Your aunt is planning to invest in a bank deposit that will pay 7.5% per annum compounding semi-annually. If she has $5,000 to invest, how much will she have at the end of four years?

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Example 2: Present Value • Megan expects to need $50,000 as a down payment on a house in six years. How much does she need to invest today in an account paying 7.25% per annum compounding quarterly?

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How do we value an asset? • How to value future cash flows? – In finance, the value of asset is determined by future cash flows the firm can generate and the risk involved. – Then do we know how to value different type of future cash flows mathematically? Let’s learn today. How much is the asset worth TODAY? i.e) What is the maximum price you’re willing to pay today?

Year 0 1 2 3 4 5 6 7 8 |_____|_____|_____|_____|_____|_____|_____|_____| P=? $100 $100 $100 $100 $100 $100 $100 $100

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Let’s learn different type of CFs • A stream of equal cash flows arriving at a regular interval and ending after a specified period  Annuity – $500 paid each month for a year – $600 per week for 12 weeks – $20000 per annum for 10 years

• A stream of equal cash flows that occurs at regular intervals and lasts forever Perpetuity • A stream of cash flows that occurs at regular intervals and grows at a constant rate forever  Growing perpetuity 45

ANNUITIES PV and FV of an annuity x(1+r)n

FV

PV

C

C

C

C

0

1

2

3

n

PV =

PV = Rate per period

FV =

C

+

C

(1+ r) (1+ r)

C 1  1r  (1+ r)n 

2

+

C 3

(1+ r)

+⋅ ⋅ ⋅ +

C (1+ r)n

Total No of periods (payments)

C 1  C 1(1+r)n = (1+ r)n -1  n r  (1+r)  r

PV and FV of an annuity Example 3. If you can afford a $1000 monthly car payment for 2 years, how much car can you afford if interest rates are 12% compounded monthly?

PV =

C 1  1  r  (1+ r)n 

Example 4. Starting with his next monthly salary payment, Harold intends to save $200 each month. If the interest rate is 6% per annum, payable monthly, how much Harold have saved after 2 years?

FV =

C (1+ r)n -1 r

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Deferred Annuity PV =

PV1 (1 + r )1

0

PV1 =

C 1  1 r  (1+ r)n 

1

C

C

C

C

2 k

3

4

n

C 1  1=PVk-1 r  (1+r)n  PV = (1 + r) k−1

Example 5. What is the present value of an ordinary annuity consisting of 10 annual payments of $100 with an interest rate of 10% per annum, with the first payment occurring in 3 years time?

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Perpetuity

0

PV =

C

C

C

1

2

3

lim C 1-

1  n→∞ r  (1+ r)n 

=

C r

Example 6. A government security promises to pay $3 per annum from next year forever. If the interest rate is 8% per annum, how much is the security worth?

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Deferred Perpetuity PV =

PV1 (1 + r) 1

0

PV1 = 1

C r

C

C

C

2 k

3

4

C =PVk-1 r PV = (1 + r ) k −1 Example 7. You are considering an investment in venture capital that will return nothing in the first three years and $400,000 a year in perpetuity after that. What is the present value of the investment, given an interest rate of 10% p.a.?

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Growing Perpetuity C (1+g)

C

3

2

1

0

C (1+g)2

1st future cash flow

C PV = r-g

Example 8. The expected dividend next year is $1.30, and dividends are expected to grow at 5% forever. If the discount rate is 10%, what is the value of this promised dividend stream?

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Deferred Growing Perpetuity PV =

PV1 (1 + r) 1

0

PV1 =

1

C r-g

C 2 k

C(1+g) C(1+g)2 3

4

C =PVk-1 r-g PV = (1 + r ) k −1 Example 9. Company A will pay its first dividend of $3 in Year 3 and after that, it is expected to grow at a constant rate of 6%. The opportunity of cost of capital is 15%. What is the value of Company A?

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Solving for the number of periods (=n)

• How long will it take $50,000 placed in a term deposit at 10% interest to grow into $75,000?

FV = C(1 + r)n

• Natural logarithm (Ln(X)) is the logarithm to the base e of a number: Eg. Ln (2) ( easily solvable by a calculator!), Ln(2)=0.69314718......

75,000 = 50,000(1.1)n (1.1)n =

75,000 50,000

• Natural logarithm power rule: Ln (XY)=Y*Ln (X) Eg. Ln (28)=8*Ln2 =8*0.69314718 =5.545177

(1.1)n = 1.5 ln(1.1)n = ln(1.5) n × ln(1.1) = ln(1.5) n=

ln(1.5) = 4.2542years ln(1.1)

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Solving for rate of return • Suppose you have an investment opportunity that requires a $1000 investment today and will have a $2000 payoff in six years. What is the annual rate of return on the investment?

  / /

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Solving for the number of periods (=n)

Example 10. One of your customers is delinquent on their accounts payable balance. You have mutually agreed to a repayment schedule of $500 per month. You will charge 1% per month interest on the overdue balance. If the current balance is $13,000, how long will it take for the account to be paid off? 1  1  − (1 + r )n    500  1  $13,000 = 1− 0.01  (1.01)n  PV =

C r

1   $13,000 = 50,000 1 − (1.01)n   13,000  1  = 1− 50,000  (1.01)n   1  13,000  1 − (1.01)n  = 50,000   13,000 1 = 1− 50,000 (1.01)n 1 0.74 = (1.01) n 1 = (1.01)n 0.74 1.3514 = (1.01)n ln(1.3514) = ln(1.01)n ln(1.3514) = n ln(1.01) ln(1.3514) ln(1.01) n = 30.26 months n=

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Example 11 As winner of breakfast cer...