High-Q Financial Basics. Skills & Knowlwdge for Today's man

By J.M. Lacarte

Highly convenient for those who:
- Already know about these matters, but they would like to get it refreshed and keep a consulting tool with them
- Need to master financial concepts in order to enhance their professional or academic performance
- Want to really know what their money & investments are worth. Here is the rationale.

The book starts at a basic level for inexpert readers and then moves into the key matters of finance that it is necessary to master. It deals with basic questions on the value over time of money, a correct valuation of different structures of bonds, the discounting and capitalization of different cash flows, methods for NPV (Net present Value), IRR (internal Rate of Return), Pay-back, etc. and the reasoning behind all of them. The book explains how to deal correctly with inflation when making any analysis. The author has explained the basic concepts in some exercises and cases so that the reader can master them.

CONTENTS
-The Value of Money Over Time
-Measuring The Profitability of Investments
-Solved Exercises on Basic Concepts
-Determination of Relevant Flows to Make a Business Decision Case
-FINALTERNA Case
-The FERSA Case

• Language: English
• Publisher: J.M. Lacarte
• Release date: Aug 17, 2012
• ISBN: 9781476291291

Book preview

THE TIME FACTOR. THE CONCEPT OF COMPOUND INTEREST

Money does not have the same value today as it can have tomorrow. The time factor plays a decisive role when it comes to fixing the value of the capital invested. It is not the same to have $ 10,000 now or to receive it one year in to the future. The value of money changes as a consequence of:

1) Inflation.

2) the opportunity to invest money in some activity, protecting it from inflation while at the same time giving a return.

3) credit risk.

If we have the alternative option of receiving $ 10,000 at the end of the year, that is waiting one year, we could accept on the condition that we receive an additional sum to compensate us for the three factors set out above. Having said this, we are stating that money makes more money, or perhaps it is better to say: Money produces wealth.

Financial problems normally require the use of compound interest, rather than simple interest. Compound interest assumes that the amounts of interest already earned are reinvested with the original capital and therefore earn a return at the same interest rate.

This effect is achieved by the action of CAPITALIZATION of the interest generated. Each time they fall due, and therefore are calculated, the interests generated is taken to the capital account. This means that they are now earning interest at the rate agreed, as they are now capital invested (this is not because the borrower has not complied with the contract but because it was agreed like this).

This way of dealing with interest is much more in line with the time value of money than using simple interest. Under the latter, the amounts earned as interest cannot generate more interest even if the interest is paid over a long time before all the original investment is paid back.

In this explanation, we will try to keep a lot of mathematics out of the subject, avoiding working with equations and formulas. The quantitative concepts used are illustrated in the numerical examples as simply as possible.

ELEMENTS

The elements that intervene in all financial situations are:

- TIME (time the business takes or the period during which the interest is capitalized).

- THE INTEREST rate applied to the period.

- the FLOWS OF FUNDS or CASH FLOWS which take place at different moments.

TIME

Normally the time a business lasts is divided into PERIODS (days, months, years, etc.) or intervals, corresponding to the type of capitalization agreed.

So that the return or cost of each period is equivalent, in principle they should be of equal length, though in some cases models are designed with periods of different lengths but here this is not dealt with as we don’t believe it occurs often.

GRAPHS usually provide us with a great deal of help in analyzing business situations. Time is represented on one axis, broken down into the periods, (períod 0-1 or period 1, period 1-2 or period 2, etc.):

THE INTEREST RATE

The interest rate represents the cost of being lent the capital necessary for the business during a certain time period. Normally it is represented by the letter i, and it is stated as a percentage for a given time period.

The interest rate is applied to the PERÍOD of COMPOSITION, this is the period during which interest is earned, or must be paid. It is important to note that this interest rate is called the periodic interest rate, and the period for which it is applied must be the same as the periods into which the business Project is divided (years, months, days, etc.)

The periodic interest rate can be applied at the beginning of the period or once the period is over, as is stipulated in the contract. It is vital to identify with which interest rate we are working. The equivalence developed in later examples use the (over)due interest rate and therefore if the original interest