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Risk-Return Tradeoff & Fundamantal Principle of Finance

The document discusses the fundamental principle of finance and the risk-return tradeoff. The fundamental principle is that a business proposal only raises firm value if the present value of future cash flows exceeds initial costs. Higher risk investments generally provide higher returns. Financial decisions involve balancing expected return with risk exposure. Markets allow suppliers and demanders of funds to exchange securities and loans.

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vivekchabbra
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31 views8 pages

Risk-Return Tradeoff & Fundamantal Principle of Finance

The document discusses the fundamental principle of finance and the risk-return tradeoff. The fundamental principle is that a business proposal only raises firm value if the present value of future cash flows exceeds initial costs. Higher risk investments generally provide higher returns. Financial decisions involve balancing expected return with risk exposure. Markets allow suppliers and demanders of funds to exchange securities and loans.

Uploaded by

vivekchabbra
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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RISK- RETURN TRADEOFF & FUNDAMANTAL PRINCIPLE OF FINANCE

FUNDAMENTAL PRINCIPLE
A business proposal regardless of whether it is a new investment or acquisition of another company or a restructuring initiative- raises

the value of the firm only if the present value of the future stream of net cash benefits expected from the proposal is greater than the initial outlay required to implement the proposal.

Net present value (NPV)= present value of future cash flows initial outlay
Investors shareholders lenders
Investors provide the initial cash reqd

The business proposal

to finance the business proposal

The proposal generates

cash returns to the investors

RISK-RETURN TRADEOFF
The financial decisions often involve alternative courses of action
The expected return

The risk exposure

HIGHER THE RISK HIGHER THE RETURN

Capital budgeting decision Return Capital structure decision Dividend decision Risk Working capital decisions Market value Of the Firm

The Financial System


Funds Deposits/shares
Financial Institutions

Banks Mutual funds Insurance

Funds Loans

Suppliers of funds Individuals Businesses Government

Demanders of funds Individuals Businesses Government

Funds
Securities

Financial markets Money market Capital market

Funds
Securities

CLASSIFICATION OF FINANCIAL MARKETS


Debt Market
Nature of Claim Equity Market

Money market
Maturity of Claim Capital Market Primary Market Seasoning of Claim Secondary Market

Cash or Spot Market


Timing of Delivery Forward or Futures Market

Exchange Traded Market


Organizational Structure Over the Counter Market

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