Financial

Market
PM6
 Agenda

1 2 3 4 5
Founding Interest Return Loanable Inflation
Principles Fund Theory

2 Presentation title 20XX

Introduction
• If you want to understand what
something is worth today, look into
the future.
• Something is worth something today
is it generates future benefits

3
Founding
Principles
of Finance
 Principles of Finance
• Cash Flows
Cash left over that doesn’t need to be allocated
• Time Value of Money
The value of money today is worth more than its value tomorrow.
What something is worth today, is based on its ability to generate future
benefits
• Risk and Returns

5 Presentation title 20XX

• Cash flow is the movement of money in and out
of a company; inflows and outflows

• The cash flow statement is a financial statement

that reports a company's sources and use of
cash over time.

• Importance: to determine the liquidity and

solvency of the business: cash flow from
operating activities, cash flow from investing
activities and cash flow from financing activities

6 Presentation title 20XX

 • Would you rather receive
P100,000 today or the
promise that you’ll receive
it one year from now?

• Does receiving P100,000

now provide more value
than in the future? Why?

7 Presentation title 20XX

 Time Value of Money
• money can grow only through investing so a delayed
investment is a lost opportunity
• the impact of inflation will reduce the future value of
the same amount of money
• inflation has a negative impact on the time value of
money because your purchasing power decreases as
prices rise Uncertainty: Somethi
• the formula for computing the time value of money ng could happen to
the money before
considers the amount of money, its future value, the you’re scheduled to
amount it can earn, and the time frame receive it.
8 Presentation title 20XX
• If you know the money’s present value
(for instance, the amount you deposited
into your savings account today), you
can use the following formula to find its
future value after accruing interest:
• FV = PV x [ 1 + (i / n) ] (n x t)
if you know the money’s future value
(for instance, a sum that’s expected
three years from now), you can use
the following version of the formula
to solve for its present value:
PV = FV / [ 1 + (i / n) ] (n x t)
9 Presentation title 20XX
 Imagine you’re a key decision-maker in your organization
Exercise TVM
and two projects are proposed:
• Project A is predicted to bring in P2 million in one year.
• Project B is predicted to bring in P2 million in two
years.
Before running the calculation, you know that the time
value of money states the P2 million brought in by
Project A is worth more than the P2 million brought in by
Project B, simply because Project A’s earnings are
predicted to happen sooner.
BACK

10 Presentation title 20XX BACK

 Before borrowing money
from a friend, decide
which you need most.
Man vs Debt

11 Presentation title 20XX

Interest – cost of money or currency
Interest rate – interest of 1 currency for a year expressed in %

What four factors affect the level of interest rates?

1. Production opportunities
2. Time preferences for consumption
3. Risk
4. Expected inflation
13 Presentation title 20XX
15 Presentation title 20XX
Default Risk Premium – compensates investors for the business' likelihood of default.
Liquidity Premium – compensates investors for investing in less liquid securities such as
bonds.
Maturity Premium – compensates investors for the risk that bonds that mature many years
into the future inherently carry more risk.
16 Presentation title 20XX
17 Presentation title 20XX
 Interest
Rate (%)
15 Maturity risk premium

Hypothetical 10 Inflation premium

Yield Curve
5

Real risk-free rate

Years to
0 Maturity
1 10 20

18Presentation title 20XX

BACK

BACK
Return the minimum return an investor will
accept for owning a company's
Required Rate of Return stock, as compensation for a given
level of risk associated with holding
the stock.

The expected return is the amount

of profit or loss an investor can
Expected Rate of Return anticipate receiving on an
investment

is the gain or loss of an investment

over a certain period of time. In
other words, the rate of return is
Required Rate of Return the gain (or loss) compared to the
cost of an initial investment,
typically expressed in the form of a
percentage
 Bottomline
Req RoR Exp RoR Rel RoR
The required rate of return tells Expected return is an estimate of the The rate of return (ROR) is a simple to
investors whether to expand or take average return that an investment or calculate metric that shows the net
on new projects, venture into an portfolio investments should gain or loss of an investment or
investment, or buy the stocks of a generate over a certain period of project over a set period of time. RoR
company. The RRR determines the time. In general, riskier assets or is expressed as a percentage of the
inherent risks of an investment, and it securities demand a higher expected initial value. The internal rate of
can vary between investors with return to compensate for the return (IRR) also measures the
different risk tolerance levels. The additional risk. Expected return is not performance of investments or
RRR can be used as a benchmark of a guarantee, but rather a prediction projects, but while ROR shows the
minimum acceptable return when based on historical data and other total growth since the start of the
compared to the cost and returns of relevant factors. project, IRR shows the annual growth
other similar investment opportunities. rate.
 Exp RoR Req RoR Potential Decision

9% < 10% x invest

12% > 8% Invest

12% = 12% State of stability

BACK

22 Presentation title 20XX BACK

 Loanable Fund Theory
In economics, the loanable funds
doctrine is a theory of the market
interest rate.

According to this approach, the

interest rate is determined by the
demand for and supply of loanable
funds.

The term loanable funds includes all

forms of credit, such as loans,
bonds, or savings deposits.

23 Presentation title 20XX

DEMAND FOR LOANABLE FUNDS

• Households borrow for consumption (auto, mortgage, etc)

• Businesses borrow to invest in plant and machinery (capital assets)
• Governments borrow to cover budget deficits (arising from expenditure exceeding
revenues)
• Foreign governments and businesses borrow in larger, efficient financial markets, with
lower rates
• Government demand is interest inelastic, but all other demand curves (on aggregate)
slope downwards

24 Presentation title 20XX

SUPPLY OF LOANABLE FUNDS
• Households are the major suppliers of funds
• Households save from their income to increase future consumption
• Rate of savings depends on their preferences for current vs. future consumption, level of income,
amount of wealth, and interest rates
But is it always the case that higher interest rates lead to increased savings; Substitution Effect vs.
Income Effect
• Businesses also invest (loan) funds temporarily
But do interest rates influence the amount they save (retain)?
• Government (municipalities, agencies) may also supply funds temporarily
• Federal Reserve’s monetary policy may increase money supply - to lower interest rates and improve
economy
Does increasing money supply always cause lower rates?
• Foreign governments and households are net suppliers to the U.S. - induced by interest rate
differentials
• Overseas inflows are also influenced by expected changes in the exchange rate
25 Presentation title 20XX
 Equilibrium interest rate is that rate
at which the quantity of aggregate
loanable funds demanded is equal
to the aggregate supply of loanable
funds

Surplus and shortage conditions

impact on the equilibrium interest
rate

26 Presentation title 20XX

 OTHER FACTORS AFFECTING RATES

Changes in demand/supply of loanable funds due to level of

economic activity
1. Increase in demand by businesses due to optimistic economic
projections leads to increased interest rates if there is no
offsetting increase in supply
2. Economic slowdown leads to a decrease in demand for loanable
funds by firms => Supply may increase as workers save more in
expectation of worse times. Therefore, interest rates are likely to
fall => Supply may increase as workers save more in expectation
of worse times. Therefore, interest rates are likely to fall SUPPLY

27 Presentation title SUPPLY

20XX
Substitution and Income Effect
The income effect is the change in the consumption of goods by
consumers based on income and purchasing power.

The substitution effect occurs when consumers replace cheaper

goods with more expensive items due to price changes or an
improved financial condition, and vice versa.

28 Presentation title 20XX

29 Presentation title 20XX
 How Do Interest Rates
Influence Spending?
Interest rates influence spending by making spending more or
less expensive depending on the direction of interest rate
movements. For example, if interest rates go up, the cost of
borrowing goes up, meaning it is more expensive to buy goods,
so consumer spending decreases. When interest rates fall, the
cost of borrowing comes down, so it is cheaper to buy goods, so
spending increases.

30 Presentation title 20XX

Do High Interest Rates
Cause Saving?
High interest rates can cause an increase in savings. Because
high interest rates increase the cost of borrowing, making
goods more costly, individuals spend less, and thereby, save
more. In addition, the return on high-interest savings accounts
increases, making it more appealing for customers to deposit
their money in these accounts and earn a high interest on their
money.
 What Is the Connection
Between the Money Supply and
Interest Rates?
A nation's money supply and interest rates have an
inverse relationship. Interest rates should be lower if
there's a higher supply of money in a country's economy.
Rates should be higher if the money supply is lower.
BACK

32 Presentation title 20XX BACK

33Presentation title 20XX
 BACK

34 Presentation title 20XX BACK