PRINCIPLES OF FINANCE
Structure of the Course
• Chapter 1: Introduction to Finance
• Chapter 2: Time Value of Money
• Chapter 3: Financial Markets
• Chapter 4: Risk and Return
• Chapter 5: Corporate Finance
Materials
ü Keown, A., Martin, J. and Petty, J. (2019). Foundations of
Finance, Global Edition, (10th ed.), Pearson
ü Bodie Z., Merton R.C. and Cleeton D.L. (2009). Financial
Economics, Pearson Prentice Hall, Upper Saddle River
ü Ross, S. A., Westerfield, R. W., and Jordan, B. D.
(2022). Fundamentals of corporate finance (13th ed.).
McGraw-Hill Professional.
Assessment
1. Class Participation (10%)
Random attendance check.
2. Mid-term Assessment (30%)
Closed book writing exam (short answer & computational).
3. Final Exam (60%)
Closed book writing exam (multiple choice & essay).
Chapter 1: Introduction to Finance
1. The concept of Finance
2. The Financial system
3. Five core principles of Finance
1. The Concept of Finance
v Definition:
Finance is the study of how people allocate scarce resources
over time (Bodie and Merton).
- Financial allocation decisions:
+ The cost and benefit of Financial decisions spread out over time
+ The cost and benefit of Financial decisions are usually not known in
advance, even by the decision makers or anybody else.
1. The Concept of Finance
Transfer of economic
benefits
Distribution/Allocation
2. The Financial System
v Definition:
Financial system is the set of markets and other institutions used
for financial contracting and the exchange of assets and risks.
2. The Financial System
v Market participants:
- Households
- Business firms
- Government
- Foreign sectors
2. The Financial System
v Components of Financial System:
• Surplus Spending Unit (SSU):
- Has more cash income flow than expenditure on consumption
and real investments in a period of time.
- Other terms for surplus unit: saver, lender, buyer of financial
assets, financial investor, supplier of loanable funds, buyer of
securities.
- The household and foreign sectors are usually a surplus sector.
2. The Financial System
v Components of Financial System:
• Deficit Spending Unit (DSU):
- Has more expenditures on consumption and real goods
(investment) in the real sector than income during a period of
time.
- Other terms for deficit expending unit are borrower, demander
of loanable funds, and seller of securities.
- The business firms and government are usually a deficit sector.
2. The Financial System
v Components of Financial System:
• Other participants:
- Market intermediaries simply help make markets work:
Investment dealers, Brokers,….
- Financial institutions (banks, insurance companies,…)
- Financial service firms (financial advisory firms)
- Regulatory bodies (the government)
2. The Financial System
2. The Financial System
v Financial Transactions:
$$$
A B
Financial Assets
- Properties:
• Spread out through space and over time
• Risk – Return trade off
• Assets used for the transactions is either cash or financial
assets.
2. The Financial System
v Financial Assets:
- Asset: Any possession that has value in an exchange
• A real asset is used to produce goods and services and thereby
generate cash flow.
E.g: machine, building, equipment, land/real estate, …
• A financial asset is a claim against a firm, government or
individual for future expected cash flows.
E.g: bonds, preferred stocks and common stocks.
2. The Financial System
v Financial Assets:
- Properties:
• Rate of Return : expected return
• Risk: credit risk, market risk
• Liquidity: Easy convertibility into cash with little or no loss
of value
2. The Financial System
v Financial Assets:
- Classifications:
• Fixed-income securities
• Equity securities
• Derivative securites
2. The Financial System
v The Flow of Funds:
- Funds may flow from the surplus unit to the deficit
unit in three ways:
• Directly meet
• Through markets
• Through intermediaries
2. The Financial System
v The Flow of Funds Diagram:
2. The Financial System
v The Flow of Funds:
- Funds may flow from the surplus unit to the deficit
unit in three ways:
• Directly meet
• Through markets
• Through intermediaries
2. The Financial System
v The Flow of Funds:
- Directly meet:
Funds
Surplus Units Deficit Units
Financial Claims
2. The Financial System
v The Flow of Funds:
- Funds flow via Markets:
2. The Financial System
v The Flow of Funds:
- Funds flow via Intermediaries:
2. The Financial System
v The Flow of Funds:
- Funds flow via Intermediaries and Markets:
2. The Financial System
v The Flow of Funds:
- Funds flow via Markets and Intermediaries:
3. Five Core Principles of Finance
Principle 1: Cash Flows is what matters
Principle 2: Money has a time value
Principle 3: Risk requires a reward
Principle 4: Market prices are generally right
Principle 5: Conflicts of interest cause agency problem
