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Principle of Finance

A financial system allows for the exchange of funds between borrowers, lenders, and investors. It includes institutions like banks and stock exchanges, as well as the rules and practices used to determine which projects get financed. The theoretical framework discusses key concepts like financial assets, instruments, and markets. It also covers topics such as the time value of money, annuities, interest rates, and how interest rates are influenced by factors like expected returns, inflation, and the level of economic activity. Sample problems apply these concepts to calculate monthly savings amounts needed to finance education costs in the future and to analyze how interest rates may change based on shifts in bond demand and supply or the money supply.

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39 views2 pages

Principle of Finance

A financial system allows for the exchange of funds between borrowers, lenders, and investors. It includes institutions like banks and stock exchanges, as well as the rules and practices used to determine which projects get financed. The theoretical framework discusses key concepts like financial assets, instruments, and markets. It also covers topics such as the time value of money, annuities, interest rates, and how interest rates are influenced by factors like expected returns, inflation, and the level of economic activity. Sample problems apply these concepts to calculate monthly savings amounts needed to finance education costs in the future and to analyze how interest rates may change based on shifts in bond demand and supply or the money supply.

Uploaded by

Trần Phùng Trung
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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A.

Theoretical framework
1. A financial system is a set of institutions, such as banks, insurance
companies, and stock exchanges, that permit the exchange of funds. Financial
systems exist on firm, regional, and global levels. Borrowers, lenders, and investors
exchange current funds to finance projects, either for consumption or productive
investments, and to pursue a return on their financial assets. The financial system
also includes sets of rules and practices that borrowers and lenders use to decide
which projects get financed, who finances projects, and terms of financial deals.

2. Concepts of financial assets vs financial instruments vs securities

3. Financial market and its components (Money Market vs Capital Market)

4. Securities traded in Money Markets and Capital Markets

5. The nature of time value of money => Present value vs Future Value

6. Concepts of Annuities and Perpetuities and their applications in life

7. Interest rates classification and its application: Interbank offered rates,


real vs nominal, simple vs compounded interest rate, foreign interest rate vs
domestic rates, discount basis, Annual effective rate (AER) vs annual
percentage rate (APR), interest rate vs rate of return

8. Interest rates’ behaviors:

a) Loanable framework and its application (Bond Demand and Supply


Equilibrium => Considering Bond as an Asset => Theory of Asset Demand
(Wealth, Expected Return, Risk, Liquidity).

Supply Bond (Expected profitability of investment opportunities, Expected


inflation, Government budget)

Capable to explain how interest rate behaves due to a business cycle


expansion/contraction (recession)

b) The liquidity preference framework (Money supply and demand


approach)

9. Risk structure of interest rates (default risk, Liquidity, Income taxe) and
term structure of interest rates (Expectation theory, Segmented market
theory, and Liquidity Premium Theory)

B. Problem application
1.Suppose that you are getting enrolment in a MBA course abroad in 2 year later
(said year 2023) that cost you a total amount of VND 1 billion for 1 year. Your payments are
requested and taken initially. If your parents save money from now on, how much do they
have to save monthly if the prevailing interest rate is 5% per year?

Assume that the monthly savings amount is VND A

Tn=A/r *[(1+r)n+1-1] à 1=A/0.05*[(1+0.05)24-1] à A=0.02247


Conclusion: If my parents save money from now on, they have to save VND 22.47
million monthly

2.
2.1. More willing because bonds have become more liquid and more
desirable - increases demand, increases price, lowers interest rate on bond
2.2. More willing because the expected return on the bonds have risen
relative to stocks, investors will shift from equities to bonds. this increase in the
demand for bonds, which increases the price lowers interest rate
2.3. Less willing because When brokerage commissions on stocks falls, they
become more liquid
2.4.Less willing because when interest rates rise, the price for bonds fall.
Therefore, the demand for bonds before rates go up will fall. This causes prices to fall
and rates to rise
3. when the fed sells bonds to the public, it increases the supply of bonds, shifting the
supply curve to the right. this decreases the price of bonds and increases the interest
rate. in the liquidity preference framework, the decrease in the money supply shifts
the money supply curve to the left and the equilibrium interest rate rises. the answer
from bond supply and demand analysis is consistent with the answer from the
liquidity preference framework.
4.In the loan-able funds framework, when the economy booms, the demand for bonds
increases: the public's income and wealth rises while the supply of bonds also increase,
because firms have more attractive investment opportunities. Both the supply and
demand curves (Bd and Bs) shift to the right, but as is indicated in the text, the dmand
curve probably shifts less than the supply curve so the equilibrium interest rate rises.
Similarly, when the economy enters a recession, both the supply and demand curves
shift to the left, but the demand curve shifts less than the supply curve so that the interest
rate falls. The conclusion is that interest rates rise during booms and fall during
recessions: that is, interest rates are procyclical. The same answer is found with the
liquidity preference framework. When the economy booms, the demand for money
increases: people need more money to carry out an increased amount of transactions
and also because their wealth has risen. The demand curve, Md, thus shifts to the right,
raising the equilibrium interest rate. When the economy enters a recession, the demand
for money falls and the demand curve shifts to the left, lowering the equilibrium interest
rate. Again, interest rates are seen to be procyclical.
5. Interest rates will rise because the expected increase in stock prices raises the
expected return on stocks relative to bonds and so the demand for bonds decreases.

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