CALCULATIONS

Chapter 6: equity market - investor Chapter 8: Time value of money

1) The franking credit:

2) Financial indicators
a) Capital structure
● Proportion of company assets (funding)
obtained through debt and equity
○ Usually measured by debt to equity
ratio (D/E)
1) Simple interest
■ Higher debt levels increase
a) Simple interest accumulation
financial risk (i.e. firm may not
● The amount of interest paid on debt, or earned
be able to meet interest
on a deposit is:
payments)

b) The final amount payable (S)

○ Also measured by proprietorship ratio ● The final amount payable (S) on the
(tỷ lệ sở hữu), which is the ratio of borrowing is the sum of the principal plus the
shareholders’ funds to total assets interest amount
■ Indicates firm’s longer term
financial viability/stability; a
higher ratio indicates less
reliance on external funding

c) Present value with simple interest

b) Liquidity
● The ability of a company to meet its
short-term financial obligations
● Measured by current ratio
 ○ Fails to consider the not very liquid ● the price (i.e. present value) of another
nature of certain current assets, such discount security, the Treasury note (T-note):
as inventory

● Measured by liquid ratio d) Calculation of yields

● The higher the current and liquid ratios, the
better the liquidity position of a firm

e) Holding period yield (HPY)

● HPY is the yield on securities sold in the
c) Debt servicing
secondary market prior to maturity (lợi tức
● Ability to meet debt-related obligations, i.e.
của chứng khoán được bán trên thị trường
interest and repayment of debt
chứng khoán trước ngày đáo hạn)
● Measured by debt to gross cash flow ratio
○ Indicates number of years of cash flow
required to repay total firm debt
● Measured by interest coverage ratio

d) Profitability
● Wide variation in the measurement of
profitability
○ Earnings before interest and tax
(EBIT) to total funds ratio 2) Compound interest
○ Earnings per share (EPS) a) Compound interest accumulation
○ EBIT to long-term funds ratio (future value)
○ Return on equity (net income/equity)
○ Higher ratios indicate greater
b) Present value with compound interest
profitability
 c) Present value of an ordinary annuity
(niên kim thông thường)
● An annuity is a series of periodic (định kỳ)
cash flows of the same amount
e) Share price
● Price to earnings ratio (P/E)
○ Share price divided by earnings per
share
■ A higher P/E indicates more d) Present value of an annuity due (đầu

growth in future net cash flows kỳ)

○ Share price to net tangible assets ratio ● Annuity due—cash flows occur at the

(P/NTA) beginning of each period

■ Measures the theoretical

premium or discount at which
a firm’s share price is trading
relative to its NTA e) Present value of a Treasury bond
3) Pricing of shares
● Calculate the price (or present value) of a
● Estimating the price of a share
corporate bond:
a) General dividend valuation model

b) Valuing a share with a constant f) Present value of a perpetuity (vô hạn)

dividend (D0) ● A perpetuity is a special type of annuity

where the payments continue forever
● The calculation of present value:

c) Valuing a share with constant dividend

growth (g)
g) Future value: the accumulated value of
an annuity
● The accumulated (or future) value of an
annuity:
● The value of right:
 h) The formula for converting a nominal
rate into an effective rate is:

Chapter 9: Short-term debt Chapter 10: Medium to long-term debt

1) Trade credit 1) Term loan or fully drawn advances

a) The opportunity cost of the purchaser a) Calculating the loan installment
forgoing the discount on an invoice ordinary annuity
(1/7, n/30) is: ● Calculating the loan installment (số tiền trả nợ
theo kỳ) — an ordinary annuity

2) calculation : discount securities

a) Calculating price - yield known

b) Calculating face value - issue price

b) Calculating the loan installment -
and yield known
annuity due

c) Calculating yield
 d) Calculating price - discount rate 2) Mortgage finance
a) Calculating the instalment on a
known
mortgage loan:

e) Calculating discount rate

3) Calculations: fixed-interest securities

a) Price of a fixed-interest bond at
coupon date
● The price of a fixed-interest security is the
sum of the present value of the face and the
present value of the coupon stream

b) Price of a fixed-interest bond between

coupon dates

Chapter 15: The foreign exchange market

1) Spot market quotations 2) Forward market quotations

a) Two-way quotations
● Example: Given AUD/USD (spot)0.7630–40
● The difference between the buy and sell price
and six-month forward points: 0.0032–0.0027
is the ‘spread’, represented in percentage
○ Since the forward points are falling,
terms in equation
subtract them from the spot rate to
obtain the six-month forward rate of:
0.7598–0.7613
b) Transposing spot quotations ● Equation to calculate forward points
● Example: Given a quotation of
EUR/AUD1.3755–1.3765, the AUD/EUR
quotation can be determined by transposing
the quotation (i.e. ‘reverse and invert’)

c) Crossing two direct FX quotations

● Step 1: place the currency that is to become
the unit of the quotation first
● Step 2: divide opposite bid and offer rates;
that is:
● Step 3: divide the base currency offer into the
terms currency bid (this gives the bid rate)
● Step 4: divide the base currency bid into the
terms currency offer (this gives the offer rate)
 d) Crossing a direct and an indirect FX
quotation
● Step 1: multiply the two bid rate (this gives
the bid rate)
● Step 2: multiply the two offer rates (this gives
the offer rate)

e) Crossing two indirect FX quotations

● Step 1: place the currency that is to become
the unit of the quotation first
● Step 2: divide opposite bid and offer rates;
that is:
● Step 3: divide the terms currency offer rate
into the base currency bid rate (this gives the
bid rate)
● Step 4: divide the terms currency bid rate into
the base currency rate (this gives the offer
rate)

CHAPTER 2: COMMERCIAL BANK

1. The main activities of commercial banking
- Commercial banks take deposits from customers and then invest those deposits by making loans to their
customers
- Commercial bank products and services include balance-sheet transactions and off-balance-sheet
transactions
- Balance sheet transactions are assets (e.g. loans), liabilities (e.g. deposits), and shareholders’
funds (equity).
- Off-balance-sheet items are contingent liabilities; that is, they are transactions that do not appear
on the balance sheet
- Asset management (before the 1980s): The loan portfolio is tailored to match the available deposit base
- Liability management (1980s onwards): deposit base and other funding sources are managed to meet
loan demand
- Borrow directly from domestic and international capital markets
- Provision of other financial services
- Off-balance-sheet (OBS) business

2. Sources of funds
- The main sources of commercial bank funds considered in this section are:
- Current account deposits
- Call or demand deposits
- Term deposits
- Negotiable certificates of deposit
- Bill acceptance liabilities
- Debt liabilities
- Foreign currency liabilities
- Loan capital and shareholders’ equity
- Current account deposits
- Funds held in a cheque account
- Highly liquid
- It may be interest or non-interest-bearing
- Call or demand deposits (tiền gửi vào ngân hàng bình thường)
- Funds held in savings accounts that can be withdrawn on demand
- Includes passbook account, electronic statement account with ATM, and EFTPOS (electronic
funds transfer at point of sale)
- Term deposits (tiền gửi ngân hàng theo định kì)
- Funds lodged (tiền gửi) in an account for a predetermined period at a specified interest rate
- Term: one month to five years
- Loss of liquidity owning to fixed maturity
- Higher interest rate than current or call accounts
- Generally fixed interest rate
- Negotiable certificates of deposit (CDs): dạng chứng khoán ngắn hạn mua từ ngân hàng sau đó có thể
chuyển nhượng, tức là bán lại cho thị trường thứ cấp
- Paper issued by a bank in its own name
- Issued at a discount to face value
- Specifies repayment of the face value of the CD at maturity
- Highly negotiable (có khả năng chuyển nhượng) security
- Short term (30 to 180 days)
- Bill acceptance liabilities
- Bill of exchange: a security issued into the money market at a discount to the face value. The
face value is repaid to the holder at maturity
- Acceptance:
- The bank accepts primary liability to repay the face value of the bill to the holder
- The issuer of the bill agrees to pay the bank the face value of the bill, plus a fee, at the
maturity date
- Acceptance by the bank guarantees the flow of funds to its customers without using its
own funds
- Debt liabilities
- medium -to longer-term debt instruments issued by a bank
- Debenture: a bond supported by a form of security, being a charge (thế cấp) over the
assets of the issuer (e.g. collateralized floating charge)
- Unsecured note: a bond issued with no supporting security
- Foreign currency liabilities
- Debt instruments issued into the international capital markets that are denominated (được mệnh
giá) in a foreign currency
- Allows diversification of funding sources into international markets
- Facilitates matching of foreign exchange-denominated assets
- Meets the demand of corporate customers for foreign exchange products
- Loan capital and shareholders’ equity
 - Sources of funds that have characteristics of both debt and equity (e.g. subordinated debentures
and subordinated notes)
- Subordinated means the holder of the security has a claim on interest payments or the
assets of the issuer after all other creditors have been paid (excluding ordinary
shareholders)

3. Uses of funds
- Uses of funds of commercial banks are categorized into:
- Personal and housing finance
- Commercial lending
- Lending to government
- Other bank assets
- Personal and housing finance:
- Housing finance: mortgage, amortized loan
- Investment property
- fixed-term loan
- Credit card
- Commercial lending
- Involves bank assets invested in the business sector and lending to other financial institutions
- Fixed-term loan: a loan with negotiated terms and conditions
- Period of the loan
- Interest rates: fixed or variable rates set to a specified reference rate (e.g. BBSW: the
average mid-point of banks’ bid and offer rates in the bank bill secondary market)
- Timing of interest payments
- Repayment of principal
- Overdraft: a facility allowing a business to take its operating account into debit up to an agreed
limit
- Bills of exchange:
- Bank bills held: bills of exchange accepted and discounted by a bank and held as assets
- Commercial bills: bills of exchange issued directly by businesses to raise finance
- Rollover facility: The bank agrees to discount new bills over a specified period as
existing bills mature
- Leasing
- Lending to government
 - Treasury notes: short-term discount securities issued by the Commonwealth Government
- Treasury bonds: medium to longer-term securities issued by the Commonwealth Government
that pay a specified interest coupon stream
- State government debt securities
- Low risk and low return
- Other bank assets: include electronic network infrastructure and shares in controlled entities

4. Off-balance-sheet business
- OBS transactions are a significant part of a bank’s business
- OBS transactions include:
- Direct credit substitutes
- Trade-and performance-related items
- Commitments
- Foreign exchange, interest rate, and other market-rate-related contracts
- Direct credit substitutes:
- An undertaking by a bank to support the financial obligations of a client
- The bank acts as a guarantor on behalf of a client for a fee

CHAPTER 3: NON - BANK FINANCIAL INSTITUTIONS

1. Investment banks
● Investment banks are innovators at the cutting edge of developments in the financial system, often using
the latest theoretical work produced by finance scholars
● The organization of an investment bank is interesting:
○ front office
■ The name given to those activities within an investment bank that involve client relations
(quan hệ khách), especially trading, investment banking, research and investment
management
○ middle office
■ The name given to those activities within an investment bank that do not involve client
relations but may complement (bổ sung) or monitor front office activities; risk
measurement and reporting are examples.
○ back office
 ■ The name given those functions within an investment bank that are most removed from
client relations; accounting and compliance (tuân thủ) are examples
● In Australia, investment banks or money market corporations do not control a large share of the total
assets of financial institutions
● However, they remain important as innovators and deal-makers
● Sources of funds
○ Mainly securities issued into international money markets and capital markets
● Uses of funds
○ Limited lending to clients, usually on a short-term basis
○ These loans tend to be sold into the secondary market
○ Primarily focused on off-balance-sheet advisory services
● Off-balance-sheet business
○ Innovative products and services in the provision (việc cung cấp) of advice, management, and
funding services, generating their main income from fees, for example:
■ FOREX dealers, advice on raising funds, underwriting (bảo lãnh) equity/debt issues,
shares placements (phát hành), balance-sheet restructuring, venture capital
■ Mergers and acquisitions—takeover company seeks to gain control over a target
company
● Spin-offs, horizontal, vertical, conglomerate, and hostile takeovers
● Synergies (sự hiệp lực), economic/legal/accounting/tax considerations
● Analysis, valuation, negotiation, due diligence (sự cần mẫn)

2. Managed funds
● There has been tremendous growth in the amount of funds under management
● Australia’s superannuation funds (quỹ hưu) are by far the largest component of the managed funds
sector
● Funds under management in superannuation funds: $2.5 trillion
● Unlike other sectors, which have experienced modest growth (tăng trưởng khiêm tốn) (or even declines)
since 2010, funds under management in the superannuation sector more than doubled between 2010 and
2019
● Investment vehicle for investing the pooled savings (tiết kiệm gộp) of individuals in various asset
classes in domestic and international money and capital markets by fund managers
○ Mutual fund (United States): quỹ tương hỗ
■ Managed funds established under a corporate structure
 ■ Investors purchase shares in the fund
○ Trust fund (Australia and the United Kingdom): quỹ ủy thác
■ Managed funds established under a trust deed (this is a document), managed by a trustee
or responsible entity
■ Investors in the fund obtain a right to the assets of the fund and a share of the income and
capital gains (losses) derived
● Main categories of managed funds
○ Cash management trusts (section 3.3) → qũy quản lí tiền mặt
○ Public unit trusts (section 3.4) → quỹ đầu tư chung
■ Property trusts
■ Equity trusts
■ Mortgage trusts
■ Fixed-interest trusts: invests in a range of debt securities such as government and
corporate bonds
○ Superannuation funds (section 3.5) → quỹ hưu trí
○ Statutory funds of life offices (section 3.6) → quỹ khi gặp tai nạn
○ Hedge funds (section 3.8) → quỹ đầu tư mạo hiểm
○ Common funds
■ Operated by trustee companies, they pool funds of beneficiaries and invest in specified
asset classes
■ Differ from unit trusts in that units are not issued → khác với unit trust là không niêm yết
■ Include solicitors (luật sư) offering mortgage trusts
○ Friendly societies
■ Mutual organizations that provide members with investment and other services
(insurance, sickness, unemployment benefits)
■ Investment products include the issue of bonds that invest in asset classes like cash,
fixed-interest, equities, and property
● Growth in the sector driven by deregulation, affluent (giàu có) and aging (già hóa) population, and more
educated investors
● Sources of funds
○ Funding derived from specific contractual commitments of investors
■ Periodic payments to the fund (e.g. superannuation)
■ Single payment or premium (e.g. insurance policy)
○ Total assets $3100 billion as of December 2017
 ■ More than $2000 billion is managed by superannuation funds
○ Funds under management make up about 35% of all financial institution assets
● Uses of funds
○ Large funds typically allocate a portion of the total asset portfolio to several professional fund
managers for risk- and performance-management purposes
○ Professional managers invest in asset types authorized under the trust deed of a particular fund
● Categorisation of managed funds by investment risk profile
○ Balanced growth funds
■ Investments in longer-term income streams supported by limited capital growth
■ Investments include domestic and foreign equities
○ Managed growth (or capital growth) funds
■ Invest for greater return through capital growth and less through income streams
■ Investments include a greater proportion of domestic and foreign equities

3. Cash management trusts

● A mutual investment fund, often managed by a financial intermediary, is established under a trust deed,
specifying the trust’s investments
● Generally, invest in short-term money-market instruments
● Provide high liquidity for the investor
● The share of total financial institutions assets grew from 0.6% in 1990 to 1.1% in 2010. Despite
substantial declines during and after the GFC, cash management trusts controlled 4.57% of the total
assets of financial institutions at the end of 2017
● Provide retail investors with access to the wholesale market
○ Cash and deposits 75%, other assets 25%

4. Public unit trusts

● Investment fund established under trust deed
● Investors purchase a share in the trust called a ‘unit’
● The trustee invests the pooled funds received from investors
● Unit holders receive a return in the form of income and/ or capital gain
● Types of unit trusts and share of public unit trust assets
○ Property trusts
○ Equity trusts
○ Mortgage trusts
 ○ Fixed-interest trusts
● Listed trusts
○ Units quoted and sold on the ASX (more liquid)—mainly property trusts
● Unlisted trusts
○ Units sold back to trustee after giving the required notice (less liquid)—mainly equity trusts

5. Superannuation funds
● The largest part of the managed funds industry is the superannuation sector
● Indeed, superannuation funds account for almost one-fifth of the assets held by financial institutions in
Australia
● Most surprisingly, self-managed superannuation funds (SMSFs) hold the largest amount of assets within
the superannuation sector
● There are more than 500 000 SMSFs holding a total of more than $700 billion in assets
● Savings accumulated to fund an individual’s retirement
● Superannuation assets exceeded $2600 billion by 2018. More than $700 billion of this is held in SMSFs
● APRA classifies superannuation funds as:
○ entities with more than four members
○ pooled superannuation trusts (PSTs)
○ small APRA funds
○ balance of life office statutory funds → quỹ cty bảo hiểm quản lý
○ self-managed funds → quỹ tự quản lý
● Sources of funds
○ Corporate, industry, and public-sector superannuation funds
■ Corporate funds provide benefits to employees of a specific company
■ Industry funds provide benefits to employees working within a particular industry
■ Public sector funds provide benefits to government employees and can be underfunded
(không đủ kinh phí)
■ They can be contributory (employer and employee contribute) or non-contributory (only
employer contributes)
○ Compulsory superannuation funds
■ Legislation requires employers to contribute a defined amount to employees’
superannuation accounts
■ Australian employers not paying the mandatory 9.50% into employees’ superannuation
funds must pay the superannuation guarantee charge (SGC)
 ○ Retail superannuation funds → quỹ hưu trí cho người dân, quản lý bởi tổ chức tài chính thương
mại như ngân hàng
○ Self-managed superannuation funds
■ 30% of Australia’s super savings, regulated by ATO, not risk-free, trustees are
middle-aged and above
○ Rollover superannuation funds
■ Hold eligible termination payments (ETP) within the regulated superannuation
environment
● Mô tả: Là một loại quỹ tiết kiệm hưu trí chuyên dành để giữ và quản lý các khoản
thanh toán kết thúc hợp lệ (ETP).
● Ví dụ: Nhận và quản lý các khoản thanh toán như tiền hưu trí, tiền trợ cấp liên
quan khi người lao động chấm dứt hợp đồng lao động.
■ ETPs are superannuation funds due on termination of employment plus related
redundancy payments
● Defined benefit funds and accumulation funds
○ Defined benefit funds → quỹ hưu trí cơ bản
■ The amount paid to employees on retirement is based on a defined formula
■ The risk lies with the employer, who must make good any shortfall
○ Accumulation funds
■ The amount of funds available at retirement consists of contributions plus earnings less
taxes and expenses
● Regulation
○ Legislation directly impacting on the operation of superannuation funds is:
■ Superannuation Industry (Supervision) Act 1993 (Cwlth) (SIS)
■ Income Tax Assessment Act 1936 (Cwlth)
○ Concessional 15% tax treatment of fund contributions (with a cap) and earnings
■ Limitations on maximum annual contributions
○ Members can withdraw funds as pension or in lump sum tax-free at age 60

6. Life insurance offices

● Sell life insurance and superannuation policies
● Sources of funds
○ Premiums (tiền bảo hiểm) are paid and policy holders or beneficiaries (người thụ hưởng) receive
payment upon death/disablement or at a nominated maturity date, subject to policy terms
 ○ Superannuation/retirement contributions
■ The inflow of funds is regular, predictable, and long-term
○ Life insurance office policies
■ Whole-of-life, term-life, total and permanent disablement, trauma, income protection,
business overheads
● Uses of funds
○ Outflow of funds quite predictable and stable and therefore invest mainly in long-term securities
○ Statutory funds invested in:
■ equities and unit trusts
■ long-term securities
■ cash and short-term securities
■ Overseas
● Regulation
○ Supervised by APRA, which applies the same capital and liquidity management requirements as
for banks
○ Life Insurance Act 1995 (Cwlth)—licensing and control

7. General insurance offices

● The insurer pays the insured a predetermined amount if some prespecified event occurs (Công ty bảo
hiểm trả cho người được bảo hiểm một số tiền được xác định trước nếu xảy ra một số sự kiện được xác
định trước)
● Sources of funds
○ Contractual premiums paid in advance for:
■ house and contents
● co-insurance, public liability insurance
■ motor vehicle insurance
● comprehensive; third party, fire and theft; third party; compulsory third party
■ other risk insurance policies for individuals in the retail market and businesses in the
commercial market.
○ The flow of funds is not as stable as in life offices
● Uses of funds
○ Generally shorter term, highly marketable securities, owing to the less predictable nature of the
risks underwritten
○ Examples
 ■ Money market securities, such as bills of exchange, commercial paper and certificates of
deposit
● Share of total assets declined from 4.4% in 1990 to 3% in 2018

8. Hedge funds (quỹ đầu cơ)

● Hedge funds operate in a relatively unregulated environment
● Often, hedge funds are open to ‘high net worth’ individuals who will be required to invest a relatively
large sum
● Because the strategies and operations of hedge funds are neither transparent nor straightforward, hedge
funds are often the target of criticism when markets experience significant levels of volatility (biến động
lớn)
● This was certainly the case during the GFC where the short selling activities of the hedge funds attracted
much scrutiny
● Use sophisticated investment strategies and products mainly for high-net-worth individuals and
institutions to achieve higher returns
○ Tend to specialise in different financial instruments such as equity, FOREX, bonds, commodities
and derivatives
○ Hedge fund sector generally divided into single-manager hedge funds and fund of funds
○ Sources of funds mainly from superannuation and life offices, and high-net-worth individuals
○ May leverage investments through debt financing and/or use of derivative products

9. Finance companies and general financiers

● Borrow in domestic and international financial markets and make loans to small business and
individuals
○ They emerged largely owing to previously highly regulated banking sector to circumvent
restrictions on interest rates and lending.
○ The sector can be classified into:
■ diversified finance companies
■ manufacturer-affiliated companies (e.g. Ford Credit)
■ niche specialists (e.g. motor vehicle and lease financing).
○ The sector share of total assets has declined from 7.5% in 1990 to less than 2% in 2018 as
commercial banks are more competitive in deregulated environment
● Sources of funds
○ Issue of debentures and unsecured notes
 ○ Borrowings from related corporations and banks
○ Borrowing direct from domestic and international money and capital markets
● Uses of funds
○ Loans to individuals, possibly higher risk
○ Lease financing
○ Loans to small- and medium-sized businesses (e.g. bills finance, term loans, floor plan financing,
factoring and accounts receivable financing)

10. Building societies

● Authorized deposit-taking institutions mainly lending for residential property
● During period of regulation, building societies gained market share at the expense of savings banks
● Since deregulation, the sector share of total assets declined from 3.1% in 1990 to less than 1% in 2018.
In response some building societies have:
○ merged to rationalise costs
○ become banks (e.g. Challenge Bank, Advance Bank and Heritage Bank)
○ improved technology for service and cost reasons
○ diversified activities and products offered to savers and borrowers
● Sources of funds
○ Mainly deposits from customers
● Uses of funds
○ Personal finance to individual borrowers
■ Mainly housing finance
■ Term loans and credit card finance
● Regulation
○ As they are ADIs (i.e. authorised by APRA to accept retail deposits), regulation is by APRA
with the same prudential and reporting standards as banks

11. Credit unions

● Common bond of association often exists between members owing to employment, industry or
community (e.g. Shell Employees’ Credit Union)
● Share of total financial institutions assets remained relatively stable, only declining from 1.2% in 1990
to less than 1% in 2018
● Sources of funds
○ Mainly deposits from members (payroll deductions)
 ○ Other credit unions and the issue of promissory notes and other securities
● Uses of funds
○ Primarily personal finance to members
■ Residential housing loans
■ Personal loans and credit card facilities
■ Limited commercial lending
● Regulation
○ As ADIs, they are regulated by APRA, which applies the same prudential and reporting
standards as for banks and PBSs

12. Export finance corporations

● Export finance companies support the export activities of domestic firms
● In Australia, the official export credit agency is the government authority, Export Finance and Insurance
Corporation
● The purpose of the EFIC is to ‘[o]vercome financial barriers for exporters by providing financial
solutions, risk management options and professional advice, when the private market lacks capacity or
willingness, we create opportunities for Australian exporters and offshore investors to grow their
international business’ (efic.gov.au)
● EFIC facilitates export trade by providing trade insurance and financial services and products that may
not be available from other financial institutions
○ Insures Australian exporters against non-payment
○ Guarantees trade finance for the purchase of Australian goods and services
○ Insures Australian firms against political risk of overseas investments
○ Indemnifies financial transactions of insurers that provide bonds/guarantees to overseas buyers
and provide performance bonds in support of Australian export contracts

CHAPTER 6: EQUITY MARKET - INVESTOR

1. Share-market investment
● Investors buy shares to receive returns from dividends and capital gains (losses)
● Other factors encouraging investment in securities quoted on a stock exchange (SX)
○ Depth of the market
■ Overall capitalization of corporations listed on an SX
○ Liquidity of the market
 ■ The volume of trading relative to the size of the market
○ Efficient price discovery
■ Speed and efficiency with which new information is reflected in the current share price
● The SX offers a wide range of security types to the investor
● Securities listed on the SX are categorized into industry groups, allowing investors a choice from a
range of economic sectors
● Two types of risk impact on security returns
○ Systematic risk
■ Factors that generally impact on share prices in the market (e.g. economic growth, and
changes in interest rates and exchange rates)
○ Unsystematic risk
■ Factors that impact specifically on the share price of a corporation (e.g. resignation of the
CEO, technology failure, board problems)
● Diversified investment portfolio
○ A portfolio containing a wide range of securities
○ Diversifies most of the unsystematic risk of the individual securities
■ Investors will not receive higher returns for unnecessarily bearing unsystematic risk
○ The remaining risk is systematic risk, which is measured by beta
■ Beta is a measure of the sensitivity of the price of an asset relative to the market
○ Expected portfolio return is the weighted average of expected returns of each share
○ Portfolio variance (risk) is the correlation of pairs of securities within the portfolio
● Investors may take one of two approaches
○ Active investment approach
■ Portfolio structure is based on share analysis, new information and risk-return preferences
○ Passive investment approach
■ Portfolio structure is based on the replication (sự sao chép) of a specific share-market
index (e.g. industrial or telecommunications sector index)
● Some managed funds are index funds
○ Portfolios are structured to fully or partially replicate a specific share-market index
● Investors need to consider asset allocation within a share portfolio
○ Risk versus return
○ Investment time horizon
○ Income versus capital growth
○ Domestic and international shares
● Asset allocation may be:
○ Strategic
■ A portfolio structured to meet an investor’s personal preferences
○ Tactical
■ A portfolio structured to take account of a dynamic investment environment

2. Buying and selling shares

● Direct investment in shares
○ Investor buys and sells shares through a stockbroker
■ Discount broker (i.e. phone and internet) → mô giới thông qua điện thoại
■ Full-service advisory broker → vừa mô giới vừa giúp phân tích
○ Consideration of liquidity, risk, return, charges, taxation, social security, etc.
● Indirect investment in shares
○ Investor purchases units in a unit trust or managed fund (e.g. equity trusts)

3. Taxation
● Pre-dividend imputation (việc cắt giảm) (prior to 1987)
○ Dividends were taxed twice—first at company level (as profits) and then at the investor’s
marginal rate
● Dividend imputation (since 1987)
○ Removed the double taxation of dividends
○ Investors receive franking credit for the tax a company pays on a franked dividend
■ Franked dividend: Khi một công ty trả cổ tức, nó có thể được "franked" hoặc "imputed",
điều này có nghĩa là công ty đã trả một khoản thuế thu nhập cá nhân trước đó trên phần
lợi nhuận đã tạo ra cổ tức.
■ Franking credit: Nhà đầu tư sau đó được cấp một "franking credit" (tức là một số tiền
tương đương với thuế đã được trả bởi công ty). Khi nhà đầu tư khai thuế thu nhập cá
nhân của mình, "franking credit" này được trừ đi từ số thuế phải trả, giảm bớt số tiền thuế
mà họ phải trả hoặc tăng số tiền hoàn trả thuế mà họ nhận được.
● The Franking credit is calculated as follows:

● Capital gains tax on shares purchased → thuế áp dụng cho lợi nhuận từ việc mua bán cổ phiếu
○ Prior to 19/9/1985 tax free
○ 19/9/1985–21/9/1999
■ Taxpayer’s marginal tax rate applied if held less than 12 months
■ Taxpayer’s marginal tax rate applied to indexed capital gain if held over 12 months
○ Since 21/9/1999
■ 50% discounted gain if held at least 12 months, or
■ indexed capital gain or 50% discounted gain if purchased 19/9/1985–21/9/1999

4. Financial performance indicators (các chỉ số)

● Potential investors are concerned with the future level of a company’s performance
● Company’s performance affects both the profitability of the company and the variability of the cash
flows
● Indicators of company performance
○ Capital structure
○ Liquidity
○ Debt servicing
○ Profitability
○ Share price
○ Risk
a. Capital structure
● Proportion of company assets (funding) obtained through debt and equity
○ Usually measured by debt to equity ratio (D/E)
■ Higher debt levels increase financial risk (i.e. firm may not be able to meet interest
payments)

○ Also measured by proprietorship ratio (tỷ lệ sở hữu), which is the ratio of shareholders’ funds to
total assets
■ Indicates firm’s longer term financial viability/stability; a higher ratio indicates less
reliance on external funding

b. Liquidity
● The ability of a company to meet its short-term financial obligations
● Measured by current ratio
○ Fails to consider the not very liquid nature of certain current assets, such as inventory

● Measured by liquid ratio

● The higher the current and liquid ratios, the better the liquidity position of a firm

c. Debt servicing
● Ability to meet debt-related obligations, i.e. interest and repayment of debt
● Measured by debt to gross cash flow ratio
○ Indicates number of years of cash flow required to repay total firm debt
● Measured by interest coverage ratio
d. Profitability
● Wide variation in the measurement of profitability
○ Earnings before interest and tax (EBIT) to total funds ratio
○ Earnings per share (EPS)
○ EBIT to long-term funds ratio
○ Return on equity (net income/equity)
○ Higher ratios indicate greater profitability

e. Share price
● Represents investors’ view of the present value of future net cash flows of a firm
● Share price performance indicators
● Price to earnings ratio (P/E)
○ Share price divided by earnings per share
■ A higher P/E indicates more growth in future net cash flows
○ Share price to net tangible assets ratio (P/NTA)
■ Measures the theoretical premium or discount at which a firm’s share price is trading
relative to its NTA
f. Risk
● Variability (uncertainty) of the share price
● Two components
○ Systematic risk (often referred to as beta)
■ Arises from factors affecting the whole market (e.g. state of the domestic economy and
world economy)
○ Non-systematic risk
■ Arises from firm-specific factors (e.g. management competence, labour productivity,
financial and operational risks)
■ Can be eliminated in a well-diversified portfolio
5. Pricing of shares
● Share price is mainly a function of supply and demand for a share
○ Supply and demand are influenced mainly by information
○ Share price is considered to be the present value of future dividend payments to shareholders
○ New information that changes investors’ expectations about future dividends will result in a
change in the share price
● Estimating the price of a share
○ General dividend valuation model

○ Valuing a share with a constant dividend (D0)

○ Valuing a share with constant dividend growth (g)

● Cum-dividend and ex-dividend

○ Dividends are payments made to shareholders, expressed as cents per share
○ Dividends are declared at one date (ngày cổ tức được công bố) and paid at a later, specified date
○ During the period between the two dates, the shares have the future dividend entitlement
attached (i.e. cum-dividend)
○ Once the dividend is paid the shares are traded ex-dividend
○ Theoretically, the share price will fall on the ex-dividend date by the size of the dividend

● Bonus share issues

○ Where a company has accumulated reserves (dự trữ tích lũy), it may distribute these to existing
shareholders by making a bonus issue of additional shares
 ○ As with dividends (giống như việc trả cổ tức), there will be a downward adjustment in share
price when shares go ex-bonus
○ As no new capital is raised, there is no change in the assets or expected earnings of the company

● Share splits
○ Involves division of the number of shares on issue
○ Involves no fundamental change in the structure or asset value of the company
○ Theoretically, the share price will fall in the proportion of the split

● Pro-rata rights issue (quyền mua cổ phiếu theo tỷ lệ)

○ Involves an increase in the company’s issued capital → liên quan đến việc tăng vốn điều lệ
○ Typically issued at a discount to market price
○ Theoretically, the market price will fall by an amount dependent on the:
■ number of shares issued
■ size of the discount.
○ Example—market price cum-rights (giá thị trường trước quyền mua) $1.00, with 1:5 rights issue
priced at $0.88:

○ A renounceable right is a right that can be sold before it is exercised

■ The value of the right is determined by equation:
 ○ For example, a company with a cum-rights share price of $2.00 has made a one-for-four rights
issue price date $1.80; that is, the new share will cost$1.80.The Theoretical Ex-rights price
would be calculated as:

6. Stock-market indices and published share information

● Stock-market indices
○ Measure of the price performance of a share market or industry sector, for example:
■ Performance benchmark index
● Measures overall share-market performance based on capitalisation (vốn hóa thị
trường) and liquidity
■ Tradeable benchmark index
● A narrow index used as the basis for pricing certain derivative products
■ Market indicator index
● Measure of overall share-market performance
● Market indicator indices
○ Price-weighted (e.g. Dow Jones)
■ Weighting of a company proportional to its share price
○ Capitalisation-weighted (e.g. S&P/ASX All Ords)
■ Weighting of a company proportional to market capitalisation
 ○ Share-price index measures capital gains/losses from investing in an index-related portfolio
○ Accumulation index includes share price changes and reinvestment of dividends
○ Global industry classification standard (GICS) comprises 10 standard international industry
sector indices (e.g. energy, materials, industrials)

CHAPTER 8: TIME VALUE OF MONEY

1. Simple interest

● Simple interest is interest paid on the original principal amount borrowed or invested
○ The principal is the initial, or outstanding, amount borrowed or invested
○ With simple interest, interest is not paid on previous interest
a. Simple interest accumulation
● The amount of interest paid on debt, or earned on a deposit is:

● Example 1: If $10 000 is borrowed for one year, and simple interest of 8% per annum is charged, the
total amount of interest paid on the loan would be:

● Example 2: Had the same loan been for two years the total amount of interest paid would be:
● The market convention (common practice occurring in a particular financial market) is for the number of
days in the year to be 365 in Australia and 360 in the United States and the Euromarkets

b. The final amount payable (S)

● The final amount payable (S) on the borrowing is the sum of the principal plus the interest amount

c. Present value with simple interest

● The present value is the current value of a future cash flow, or series of cash flows, discounted by the
required rate of return
● Alternatively, the present value of an amount of money is the necessary amount invested today to yield a
particular value in the future
○ The yield is the effective rate of return received

● Example 5: A company discounts (sells) a commercial bill with a face value of $500 000, a term to
maturity of 180 days and a yield of 8.75% per annum. How much will the company raise on the issue?
○ Commercial bills → Briefly, a bill is a security issued by a company to raise funds. A bill is a
discount security (i.e. it is issued with a face value payable at a date in the future, but in order to
raise the funds today the company sells the bill today for less than the face value)
○ The investor who buys the bill will receive face value at the maturity date. The price of the bill
will be:
● Equation 8.3 may be rewritten to facilitate its application to calculating the price (i.e. present value) of
another discount security, the Treasury note (T-note):

d. Calculation of yields

● Example 7: What is the yield (rate of return) earned on a deposit of $50 000 with a maturity value of $50
975 in 93 days? That is, this potential investment has a principal (A) of $50 000, interest (I) of $975 and
an interest period (d) of 93 days:

e. Holding period yield (HPY)

● HPY is the yield on securities sold in the secondary market prior to maturity (lợi tức của chứng khoán
được bán trên thị trường chứng khoán trước ngày đáo hạn)
○ Short-term money market securities (e.g. T-notes) may be sold prior to maturity because:
■ The investment was intended as short-term management of surplus cash held by investor
■ the investor’s cash flow position has unexpectedly changed and cash is needed
■ a better rate of return can be earned in an alternative investment
○ The yield to maturity is the yield obtained by holding the security to maturity
○ The HPY is likely to be different from the yield to maturity
● The HPY will be:
○ greater than the yield to maturity when the market yield declines from the yield at purchase (i.e.
interest rates have decreased and the price of the security increases)
 ○ less than the yield to maturity when the market yield increases from the yield at purchase (i.e.
interest rates have increased and the price of the security decreases)

2. Compound interest
● Compound interest (unlike simple interest) is paid on both:
○ the initial principal
○ The accumulated previous interest entitlements
a. Compound interest accumulation (future value)

● This method can be simplified using the general form of the compounding interest formula:

● Applying Equation 8.6 to Example 10:

● On many investments and loans, interest will accumulate more frequently than once a year (e.g. daily,
monthly, quarterly)
○ Thus, it is necessary to recognise the effect of the compounding frequency on the inputs i and n
in Equation 8.6
○ If interest had accumulated monthly on the previous loan, then:

● Example 11a: The effect of compounding can be further understood by considering a similar deposit of
$8000 paying 12% per annum, but where interest accumulates quarterly for four years:
b. Present value with compound interest

c. Present value of an ordinary annuity (niên kim thông thường)

● An annuity is a series of periodic (định kỳ) cash flows of the same amount
○ Ordinary annuity—series of periodic cash flows occur at end of each period (Equation 8.8):

● Example 14: The present value of an annuity of $200, received at the end of each quarter for 10 years,
where the required rate of return is 6.00% per annum, compounded quarterly, would be:

d. Present value of an annuity due (đầu kỳ)

● Annuity due—cash flows occur at the beginning of each period
● Example 15: The present value of an annuity of $200, received at the beginning of every three months
for 10 years, where the required rate of return is 6.00% per annum, compounded quarterly, would be:

e. Present value of a Treasury bond

● Treasury bond: là một loại trái phiếu mà chính phủ phát hành để vay tiền từ công dân và các tổ chức
trong nước. Chính phủ sử dụng nguồn tiền từ việc bán trái phiếu này để đáp ứng nhu cầu về nguồn vốn
cho các dự án, chính sách và chi tiêu của họ. Treasury bonds thường có thời hạn lâu dài, thường từ 10
đến 30 năm
● Calculate the price (or present value) of a corporate bond:

f. Present value of a perpetuity (vô hạn)

● A perpetuity is a special type of annuity where the payments continue forever
● The calculation of present value:

● If we want the present value of a perpetuity that pays $1000 every year and the interest rate is 5%, we
divide $1000 by 0.05 to get our answer: $20 000
g. Future value: the accumulated value of an annuity
● The accumulated (or future) value of an annuity:

● Example 17: A university student is planning to invest the sum of $200 per month for the next three
years to accumulate sufficient funds to pay for a trip overseas once she has graduated. Current rates of
return are 6% per annum, compounding monthly. How much will the student have available when she
graduates?

● The nominal rate of interest is the annual rate of interest, which does not take into account the frequency
of compounding
● The effective rate of interest is the rate of interest after taking into account the frequency of
compounding
● The formula for converting a nominal rate into an effective rate is:

● Example 18: What is the effective rate of interest if you are quoted:
○ a)10% per annum, compounded annually?
○ b)10% per annum, compounded semi-annually?
○ c)10% per annum, compounded monthly?
 CHAPTER 9: SHORT-TERM DEBT
1. Trade credit
● Short-term debt is a financing arrangement for a period of less than one year with various characteristics
to suit borrowers’ particular needs
○ Timing of repayment, risk, interest rate structures (variable or fixed) and the source of funds
● Matching principle
○ Short-term assets should be funded with short-term liabilities.
○ The importance of this principle was highlighted by the GFC
● A supplier provides goods or services to a purchaser with an arrangement for payment at a later date
● Often includes a discount for early payment (e.g. 2/10, n/30, i.e. 2% discount if paid within 10 days,
otherwise the full amount is due within 30 days)
● From the provider’s perspective:
○ advantages include increased sales
○ disadvantages include costs of discount and increased discount period, increased total credit
period and accounts receivable, increased collection and bad debt costs
● The opportunity cost of the purchaser forgoing the discount on an invoice (1/7, n/30) is:

2. Bank overdrafts (vay thế chấp quá đà ngân hàng)

● Major source of short-term finance
● Allows a firm to place its cheque (operating) account into deficit (chi tiêu nhiều hơn so với số dư tài
khoản ngân hàng), to an agreed limit
● Generally operated on a fully fluctuating basis
● Lender also imposes an establishment fee, monthly account service fee and a fee on the unused overdraft
limit
● Interest rates negotiated with bank at a margin above an indicator rate, reflecting the borrower’s credit
risk
○ Financial performance and future cash flows
○ Length of mismatch between cash inflows and outflows
○ Adequacy of collateral (tài sản bảo đảm)
● Indicator rate typically a floating rate (tỷ lệ thay đổi) based on a published market rate (e.g. BBSW)
● In some countries the overdraft borrower may be required to hold a credit average balance or
compensating credit balance

3. Commercial bills
● A bill of exchange is a discount security issued with a face value payable at a future date
● A commercial bill is a bill of exchange issued to raise funds for general business purposes
● A bank-accepted bill is a bill that is issued by a corporation and incorporates the name of a bank as
acceptor

● Features of commercial bills—parties involved (bank-accepted bill)

○ Drawer (người ký) → bên thứ I
 ■ Issuer of the bill
■ Secondary liability for repayment of the bill (after the acceptor)
○ Acceptor (bên chấp nhận)
■ Undertakes to repay the face value to the holder of the bill at maturity
■ Acceptor is usually a bank or merchant bank
→ Ví dụ: Cty A muốn huy động vốn ngắn hạn, thì nó phát hành commercial bills - đây là hóa đơn có sự
tham gia của ngân hàng B. Tức là khi tới ngày đáo hạn thì ngân hàng sẽ đứng ra trả lại tiền cho các đối
tượng mà cty A đã huy động vốn, rồi cty A sẽ trả lại số tiền đó cho ngân hàng sau → tăng độ uy tín, tin
tưởng cho cty A đối với người cho vay vốn. Còn nếu ngân hàng không có khả năng trả thì cty A phải có
nghĩa vụ trả.
○ Payee (người nhận tiền)
■ The specified party to whom the bill is to be paid (i.e. the party who receives the funds)
■ Usually the drawer, but the drawer can specify some other party as payee
→ Tức là draw là người phát hành bill để nhận tiền, nhưng có thể chỉ định người khác là người
nhận tiền (payee)
○ Discounter (nôm na là người mua lại bill) → bên thứ III
■ The party that discounts the face value and purchases the bill
■ The provider or lender of the funds
■ May also be the acceptor of the bill
→ người này thường mua lại bill với giá thấp hơn số tiền trong tương lai nhận được → để có
được tiền lời
○ Endorser (người mua bill đầu tiên) → bên thứ II
■ The party that was previously a holder of the bill
■ Signs the reverse side of the bill when selling, or discounting, the bill → họ ký tên mình
ở phía sau của hóa đơn để chuyển quyền sở hữu và quyền nhận thanh toán cho bên thứ III
■ Order of liability for payment (quyền trách nhiệm thanh toán) of the bill runs from
acceptor to drawer and then to endorser.
→ Nếu bên chấp nhận (acceptor) và người ký (drawer) đều không thực hiện nghĩa vụ
thanh toán trên hóa đơn, thì trách nhiệm sẽ chuyển đến người ký kết (endorser). Người ký
kết sẽ chịu trách nhiệm tiếp theo trong chuỗi thanh toán. Điều này có nghĩa là người ký
kết sẽ phải thanh toán giá trị nominal của hóa đơn cho người giữ hóa đơn (holder) hoặc
người được chỉ định nhận thanh toán.
● The flow of funds (non-bank bills) → TH này thì cty A và ngân hàng B hoán đổi vị trí cho nhau, cty A -
acceptor còn ngân hàng B là drawer
 ○ Alternatively, a bill can be drawn by the bank and accepted by the borrower
→ Ngân hàng A tạo ra một hóa đơn thương mại và ký kết nó (draw) như là bên ký kết. Điều này
có thể được thực hiện để huy động vốn từ thị trường tài chính.
○ The bank is both drawer and endorser of the bill
■ If the bank rediscounts a bill (sells to a third party), the bank becomes the endorser,
creating a bank-endorsed bill
○ Funds are lent to borrower as payee
○ At maturity date the borrower, as acceptor of the bill, is liable to pay face value to the holder of
the bill
● Establishing a bill financing facility → thiết lập cơ sở vay vốn qua hóa đơn
○ Borrower approaches bank or merchant bank
○ Assessment made of borrower’s credit risk → đánh giá rủi ro tín dụng của người vay
○ Credit rating of borrower affects size of discount → Người vay có đánh giá tín dụng cao thường
nhận được chiết khấu lớn hơn.
○ Maturity usually 30, 60, 90, 120 or 180 days
○ Minimum face value usually $100 000
● Advantages of commercial bill financing
○ Lower cost than other short-term borrowing forms (i.e. overdraft, fully-drawn advances)
○ Borrowing cost (yield) determined at issue date (not affected by subsequent changes in interest
rates)
○ A bill line
■ Arrangement with a bank where it agrees to discount bills progressively up to an agreed
amount
○ Term of loan may be extended by ‘rollover’ at maturity

4. Calculations: discount securities

● Calculations considered
○ Calculating price—yield known
○ Calculating face value—issue price and yield known
○ Calculating yield
○ Calculating price—discount rate known
○ Calculating discount rate
a. Calculating price - yield known

● An alternative formula for calculating price:

b. Calculating face value - issue price and yield known

c. Calculating yield

d. Calculating price - discount rate known

e. Calculating discount rate

5. Promissory notes
● Also called P-notes or commercial paper, they are discount securities, issued in the money market with a
face value payable at maturity but sold today by the issuer for less than face value
● Typically available to companies with an excellent credit reputation because:
○ there is no acceptor or endorser
○ they are unsecured instruments
● Calculations—use discount securities formulae
● Issue programs
○ Usually arranged by major commercial banks and money market corporations
○ Standardised documentation
○ Revolving facility
○ Most P-notes are issued for 90 days
■ By tender, tap issuance or dealer bids
● Underwritten P-note issues → giai đoạn P-note được bảo hiểm
 ○ Underwriting guarantees the full issue of notes is purchased and typical fee is 0.1% per annum
○ Underwriter (bên cam kết mua toàn bộ số chứng khaons chiết khấu) is usually a commercial
bank or investment bank
○ The underwritten issue can incorporate a rollover facility (khoản vay gia hạn), effectively
extending the borrower’s line of credit beyond the short-term life of the P-note issue
○ Credit rating
● Issues may also be non-underwritten
○ Issuer may approach money market directly
○ Commercial bank or investment bank may be retained as lead manager and receive fees

6. Negotiable certificates of deposit

● Short-term discount security issued by banks to manage their liabilities and liquidity
● Maturities range up to 180 days
● Issued to institutional investors in the wholesale money market
● The short-term money market has an active secondary market in CDs
● Calculations—use discount securities formula

7. Inventory finance, accounts receivable financing and factoring

● Inventory finance
○ Most common form is ‘floor plan finance’
○ Particularly designed for the needs of motor vehicle dealers to finance their inventory of vehicles
■ Bailment common—finance company holds title to dealership’s stock
○ Dealer is expected to promote financier’s financial products
● Accounts receivable financing
○ A loan to a business secured against its accounts receivable (debtors)
○ Mainly supplied by finance companies
○ Lending company takes charge of a company’s accounts receivable; however, the borrowing
company is still responsible for the debtor book and bad debts
● Factoring
○ Company sells its accounts receivable to a factoring company
■ Converting a future cash flow (receivables) into a current cash flow
○ Factoring provides immediate cash to the vendor; plus it removes administration costs of
accounts receivable
○ The main providers of factor finance are the finance companies
 ○ Factor is responsible for collection of receivables
○ Notification basis: vendor is required to notify its (accounts receivables) customers that payment
is to be made to the factor
○ Recourse arrangement
■ Factor has a claim against the vendor if a receivable is not paid
○ Non-recourse arrangement
■ Factor has no claim against vendor company

CHAPTER 10: MEDIUM TO LONG-TERM DEBT

1. Term loan or fully drawn advances

● Term loan
○ A loan advanced for a specific period (three to 15 years), usually for a known purpose (e.g.
purchasing land, premises, plant and equipment)
○ Secured by mortgage over asset purchased or other assets of the firm
● Fully drawn advance
○ A term loan where the full amount is provided at the start of the loan
● Provided by:
○ mainly commercial banks and finance companies
○ to a lesser degree, investment banks, insurance offices and credit unions

a. Term loan structures

● Interest only during term of loan and principal repayment on maturity
● Amortised or credit foncier loan
○ Periodic loan installments consisting of interest due and reduction of principal
● Deferred repayment loan
○ Loan installments commence after a specified period related to project cash flows and the debt is
amortized over the remaining term of the loan
→ các đợt trả nợ không bắt đầu ngay sau khi vay mà được chờ đến một khoảng thời gian nhất định,
thường liên quan đến dòng tiền dự án
● Interest may be fixed (for a specified period of time e.g. two years) or variable
● The interest rate charged on a term loan is based on:
○ an indicator rate (e.g. BBSW or a bank’s own prime lending rate) and is also influenced by:
 ■ credit risk of borrower—risk that borrower may default on loan commitment, giving rise
to a risk premium
■ term of the loan—usually longer-term attracts a higher interest rate
■ repayment schedule—frequency of loan repayments (e.g. monthly or quarterly) and form
of the repayment (e.g. amortised or interest-only loan)
● Other fees include:
○ establishment fee
○ service fee
○ commitment fee
○ line fee
○ Bill option clause fee

b. Loan covenants (điều khoản vay)

● Restrict the business and financial activities of the borrowing firm
○ Positive covenant
■ Requires borrower to take prescribed actions (thực hiện các hành động cụ thể) (e.g.
maintain a minimum level of working capital)
○ Negative covenant
■ Restricts the activities and financial structure of borrower (e.g. maximum D/E ratio,
minimum working-capital ratio, unaudited periodic financial statements)
● Breach of the covenant (vi phạm hợp đồng) results in default of the loan contract, entitling lender to act

c. Calculating the loan installment ordinary annuity

● Calculating the loan installment (số tiền trả nợ theo kỳ) — an ordinary annuity
● Calculating the loan installment - annuity due

2. Mortgage Finance
● A mortgage (thế chấp) is a form of security for a loan
○ The borrower (mortgagor) conveys an interest in the land and property to the lender (mortgagee)
● The mortgage is discharged when the loan is repaid
● If the mortgagor defaults on the loan the mortgagee is entitled (có quyền) to foreclose (tịch thu) on the
property (i.e. take possession of assets and realize any amount owing on the loan)
● Use of mortgage finance
○ Mainly retail home loans
 ■ Up to 30-year terms
○ To a lesser degree commercial property loans
■ Up to 10 years as businesses generate cash flows enabling earlier repayment
● Providers (lenders) of mortgage finance
○ Commercial banks, building societies, life insurance offices, superannuation funds, trustee
institutions, finance companies and mortgage originators
● Interest rates
○ Both variable and fixed interest-rate loans are available to borrowers
■ With fixed-interest loans, interest rates reset every five years or less
○ With interest-only mortgage loans, interest-only period is normally a maximum of five years
● Mortgagee (lender) may reduce their risk exposure to borrower default by:
○ requiring the mortgagor to take out mortgage insurance up to 100% of the mortgage value
● Calculating the instalment on a mortgage loan:

3. The bond market: debentures, unsecured notes and subordinated debt

● These securities are issued in the corporate bond market
○ Markets for the direct issue of longer-term debt securities
○ Lenders attract higher:
■ risk compared with lending indirectly through intermediaries
 ■ yield owing to sharing in the profit margin usually taken by intermediaries
● Debentures and unsecured notes
○ Are corporate bonds
○ Specify that the lender will receive regular interest payments (coupon) during the term of the
bond and receive repayment of the face value at maturity
○ Unsecured notes are bonds with no underlying security attached
○ Debentures:
■ are secured by either a fixed or floating charge over the issuer’s unpledged assets (tài sản
không thế chấp)
■ are listed and traded on the stock exchange
■ have a higher claim (bồi thường cao) over a company’s assets (e.g. on liquidation) than
unsecured note holders
● Issuing debentures and notes
○ There are three principal issue methods
■ Public issue—issued to the public at large, by prospectus
■ Family issue—issued to existing shareholders and investors, by prospectus
■ Private placement—issued to institutional investors, by information memorandum
○ Usually issued at face value, but may be issued at a discount or with deferred or zero interest
○ A prospectus contains detailed information about the business
● Subordinated debt → nợ ưu đãi
○ More like equity than debt (i.e. quasi-equity)
○ Claims (quyền lời) of debt holders are ‘subordinated’ to all other company liabilities
○ Agreement may specify that the debt not be presented for redemption until after a certain period
has elapsed
→ Hợp đồng có thể quy định rằng nợ không được đòi lại cho đến sau một khoảng thời gian nhất
định
○ May be regarded as equity in the balance sheet, improving the credit rating of the issuer

4. Calculations : fixed-interest securities

● Price of a fixed-interest bond at coupon date
○ The price of a fixed-interest security is the sum of the present value of the face and the present
value of the coupon stream
● Price of a fixed-interest bond between coupon dates

○ Where k is the number of days elapsed (những ngày trôi qua) since the last coupon payment,
expressed the fraction of the coupon period
5. Leasing
● Leasing defined
○ A lease is a contract where the owner of an asset (lessor) grants another party (lessee) the right to
use the asset for an agreed period of time in return for periodic rental payments
○ Leasing is the borrowing (renting) of an asset, instead of borrowing the funds to purchase the
asset
● Advantages of leasing for lessee over ‘borrow and purchase’ alternative
○ Conserves capital (bảo toàn vốn)
○ Provides 100% financing
○ Matches cash flows (i.e. rental payments with income generated by the asset)
○ Less likely to breach any existing loan covenants (ít vi phạm các điều khoản vay)
○ Rental payments are tax deductible
● Advantages of leasing for lessor over a straight loan provided to a lessee
○ Leasing has relatively low level of overall risk as asset can be repossessed (thu hồi) if lessee
defaults
○ Leasing can be administratively cheaper than providing a loan
○ Leasing is an attractive alternative source of finance to both business and government
● Operating lease
○ Short-term lease
■ Lessor may lease the asset to successive lessees (e.g. short-term use of equipment)
■ Lessee can lease asset for a short-term project
○ Full-service lease—maintenance and insurance of the asset is provided by the lessor
○ Minor penalties for lease cancellation
○ Obsolescence risk remains with lessor
● Finance lease
 ○ Longer term financing
→ thuê dài hạn
○ Lessor finances the asset
→ lessor cung cấp tài chính để mua tài sản
○ Lessor earns a return from a single lease contract
○ Net lease—lessee pays for maintenance and repairs, insurance, taxes and stamp duties associated
with lease
→ lessee trả tiền bảo dưỡng, sửa chữa, bảo hiểm, thuế liên quan đến hợp đồng thuê
○ Residual amount due at end of lease period
→ tại cuối kỳ, người thuê phải thanh toán khoản “số dư cuối kỳ” để sở hữu tài sản
○ Ownership of the asset passes to lessee on payment of the residual amount
→ sau khi thanh toán số dư cuối kỳ, quyền sở hữu của tài sản chuyển từ bên cho thuê sang người
thuê
● Sale and lease back
○ Existing assets owned by a company or government are sold to raise cash (e.g. government car
fleet)
○ The assets are then leased back from the new owner
○ This removes expensive assets from the lessee’s balance sheet
● Cross-border lease
○ A lessor in one country leases an asset to a lessee in another country
● Direct finance lease
○ Involves two parties (lessor and lessee)
○ Lessor purchases equipment with own funds and leases asset to lessee
○ Lessor retains legal ownership of asset and takes control or possession of asset if lessee defaults
○ Security of the lessor provided by:
■ lease agreement
■ leasing guarantee—an agreement by a third party to meet commitments of the lessee in
the event of default
● Leveraged finance lease
○ Lessor contributes limited equity and borrows the majority of funds required to purchase the
asset
○ Lease manager:
■ structures and negotiates the lease and manages it for its life
■ brings together the lessor (or equity participants), debt parties and lessee
 ○ Asset then leased to lessee
○ Lessor gains tax advantages from the depreciation of equipment and the interest paid to the debt
parties
● Equity leasing
○ Similar to a leveraged lease, except funds needed to buy asset are provided by the lessor
○ Therefore, it is usually smaller than a leveraged lease
○ Has many characteristics of a leveraged lease, including the formation of a partnership to
purchase the asset, but not the advantage of leverage

CHAPTER 15: THE FOREIGN EXCHANGE MARKET

1. Exchange rate regimes (tỷ giá hối đoái)

● Each country or monetary union is responsible for determining own exchange rate regime
● Exchange rate is value of one currency relative to that of another currency
● Major currencies like USD, GBP, JPY, EUR and AUD adopt floating exchange rate (free float) regime
○ Where exchange rate is determined by supply and demand factors in the FX markets
● Other types of exchange rate regimes
○ Managed float
■ Exchange rate held within defined band relative to other currency
○ Crawling peg
■ Exchange rate allowed to appreciate in controlled steps over time
○ Linked exchange rate
■ Value of currency tied to value of another currency or basket of currencies

2. Foreign exchange market participants

● FX markets
○ Comprise all financial transactions denominated in foreign currency, currently estimated to be
over USD5 trillion per day
○ Facilitate exchange of value from one currency to another
○ Internationally adopted FX market conventions to improve market functionality
● FX market participants can be classified as:
○ FX dealers and brokers
○ central banks
 ○ firms conducting international trade transactions
○ investors and borrowers in the international money markets and capital markets
○ foreign currency speculators
○ Arbitrageurs
a. FX dealers:
● are financial institutions, typically commercial banks and investment banks, that quote two-way (i.e. buy
and sell) prices and act as principals in the FX market
● are usually licensed or authorised by the central banks of the countries in which they operate

b. FX brokers:
● transact almost exclusively with FX dealers; they obtain the best prices in global FX markets matching
FX dealers’ buy and sell orders for a fee

c. Central banks enter FX market to:

● purchase foreign currency to pay for government imports or pay interest on, or redeem, government debt
● change the composition of holdings of foreign currencies in managing official reserve assets
● influence the exchange rate

d. Firms conducting international trade transactions

● Exporters receive foreign currency for the sale of their goods and services
● Exporters use the FX market to sell foreign currency and buy AUD
● Importers use the FX market to buy foreign currency (sell AUD) for purchasing imports

e. Investor and borrowers in the international money markets and capital markets
● Commercial bank foreign borrowings are usually converted into the home currency
○ Payments of interest and principal need to be made in the denominated currency of the loan
● Corporations and financial institutions investing overseas
○ need to purchase FX in order to make investments
○ dividends or interest payments received from overseas investments will be denominated in a
foreign currency

f. Speculative transactions
● Businesses and financial institutions may attempt to anticipate future exchange rate movements to make
a profit
● There is a risk involved that the exchange rate will move:
○ in the opposite direction to that anticipated
○ In the anticipated direction but by less than expected
● Example:

g. Arbitrage transactions
● Profit is made through FX transactions that involve no FX risk exposure
● Types of arbitrage
○ Geographic
■ Where two dealers in different locations quote different rates on the same currency
○ Triangular
■ When exchange rates between three or more currencies are out of perfect alignment
● Example:

3. The operation of the FX market

● The FX market:
○ is a global market, operating 24 hours a day according to business hours across the time zones
○ consists of a vast and highly sophisticated global network of telecommunications systems that
provide the current buy and sell rates for various currencies in dealing rooms located around the
globe
○ involves larger FX dealers like commercial and investment banks providing the FX function as
part of their overall Treasury operations within which they establish an FX dealing room
● FX market instruments are typically:
○ Spot transactions (giao dịch ngay)
■ have maturity date two business days after the FX contract is entered into
● are used, for example, if an Australian importer has an account in USD to pay
within the next few days
○ forward transactions (giao dịch chuyển tiếp)
■ have maturity date more than two days after FX contract is entered into
● are used, for example, if Australian importer has to pay a USD liability in two
months, and covers or hedges against an appreciation (sự gia tăng giá) of the USD

4. Spot and forward transactions

● Dealers may also provide short-dated transactions if necessary
○ ‘Tod’ value transactions—same-day settlement (thanh toán trong ngày)
○ ‘Tom’ value transactions—settlement tomorrow (thanh toán và ngày mai)

5. Spot market quotations

● Asking for a quotation
○ The price of a currency is expressed in terms of another currency.
○ The first currency mentioned is the price being sought (also called base currency or the unit of
quotation)
○ The second is the terms currency
■ Example: USD/AUD is the price of USD1 in terms of AUD
● Two-way quotations
○ Example: Australian dollar/euro may be expressed as EUR/AUD1.3755–1.3765
○ Usually abbreviated to EUR/AUD1.3755–65
■ The two numbers indicate the dealer’s buy (bid) (giá mua) and sell (offer) price (giá bán).
■ A dealer quoting both bid and offer prices is a price-maker (người tạo giá)
■ The dealer will buy EUR1 for AUD1.3755
■ The dealer will sell EUR1 for AUD1.3765
 ■ Dealer ‘buys low’ and ‘sells high’
■ The difference between the buy and sell price is the ‘spread’, represented in percentage
terms in equation

● Transposing spot quotations

○ Example: Given a quotation of EUR/AUD1.3755–1.3765, the AUD/EUR quotation can be
determined by transposing the quotation (i.e. ‘reverse and invert’)

● Calculating cross-rates
○ All currencies are quoted against the USD
○ There are two ways currencies can be quoted against the USD:
■ direct quote—the USD is the base currency
■ indirect quote—the USD is the terms currency and the other currency is the base currency
○ When FX transactions occur between two currencies, usually where neither currency is the USD,
the cross-rate needs to be calculated
■ The method of cross-rate calculation depends on whether the quote is direct or indirect
a. Crossing two direct FX quotations
● Step 1: place the currency that is to become the unit of the quotation first
● Step 2: divide opposite bid and offer rates; that is:
● Step 3: divide the base currency offer into the terms currency bid (this gives the bid rate)
● Step 4: divide the base currency bid into the terms currency offer (this gives the offer rate)
b. Crossing a direct and an indirect FX quotation
● Step 1: multiply the two bid rate (this gives the bid rate)
● Step 2: multiply the two offer rates (this gives the offer rate)

c. Crossing two indirect FX quotations

● Step 1: place the currency that is to become the unit of the quotation first
● Step 2: divide opposite bid and offer rates; that is:
● Step 3: divide the terms currency offer rate into the base currency bid rate (this gives the bid rate)
● Step 4: divide the terms currency bid rate into the base currency rate (this gives the offer rate)
6. Forward market quotations
● Forward points and forward exchange rates
○ The forward exchange rate is the FX bid/offer rates applicable at a specified date beyond the spot
value date
○ The forward exchange rate varies from the spot rate owing to interest rate parity
■ Interest rate parity is the principle that exchange rates will adjust to reflect interest rate
differentials between countries
● Forward points and forward exchange rates
○ Forward exchange rates are quoted as forward points, either above or below the spot rate
■ Forward points represent the forward exchange rate variation to a spot rate base
■ If the forward points are rising, add them to the spot rate (i.e. base currency is at a
forward premium; interest rate of the base currency is lower)
■ If the forward points are falling, subtract them from the spot rate (i.e. base currency is at a
forward discount; interest rate of the base currency is higher)
○ Example: Given AUD/USD (spot)0.7630–40 and six-month forward points: 0.0032–0.0027
■ Since the forward points are falling, subtract them from the spot rate to obtain the
six-month forward rate of: 0.7598–0.7613
○ Equation to calculate forward points
 ■ Another rule of thumb is that points are subtracted from the spot rate when the interest
rate on the base currency is higher than the interest rate on the terms currency. When the
interest rate of the base currency is lower, the points are added to the spot rate

CHAPTER 18: DERIVATIVES - INTRODUCTION

1. Understanding risk
● Risk—the possibility or probability of something occurring that is unexpected or unanticipated
● Categories of risk
○ Operational risk
○ Financial risk
● Operational risk
○ Exposure that may impact on the normal commercial functions of a business, affecting its
operational and financial performance; for example:
■ technology
■ property and equipment
■ personnel
■ competitors
■ natural disasters
■ government policy
■ suppliers and outsourcing
● Financial risk
○ Exposures that result in unanticipated changes in projected cash flows or the structure and value
of balance-sheet assets and liabilities, for example:
■ interest rate risk
■ foreign exchange risk
■ liquidity risk
 ■ credit risk
■ capital risk
○ Relationships between risks can result in one risk impacting on another risk.
■ Direct risk is the initial risk event that impacts on the operational or financial position of
an organisation.
■ Consequential risks are exposures that eventuate as a result of an initial direct risk event

2. The risk management process

● Effective management of risk exposures requires a structured risk management process
● Although the range of risks varies by organisation, one such model is:
○ identify operational and financial risk exposures
○ analyse the impact of the risk exposures
○ assess the attitude of the organisation to each identified risk exposure
○ select appropriate risk management strategies and products
○ establish related risk and product controls
○ implement the risk management strategy
○ monitor, report, review and audit
● Identify operational and financial risk exposures
○ Requires full understanding of the business, including operations, personnel, competitors,
regulators, legislative requirements, stakeholders, cash flows and balance sheet structure
○ Also need to understand interrelationships and causal links between the above categories
● Analyse the impact of the risk exposures
○ A business impact analysis is used to document each risk exposure and measure the operational
and financial impacts should the risk event occur
○ Need to consider both quantitative and qualitative risks
● Assess the attitude of the organisation to each identified risk exposure
○ Not all risks will be mitigated or removed.
○ The risks to be avoided, controlled, transferred or retained should be documented
● Select appropriate risk management strategies and products
○ An integrated process to analyse the risk management options available
○ Generally, several risk management strategies available, the choice between them to be subject to
cost–benefit analysis
○ All risk management processes and strategies should be periodically audited
● Establish related risk and product controls
 ○ Ensure adequate controls established, documented and circulated among personnel
○ These include procedural controls and system controls
■ Procedural controls document risk management products that can be used by the
organisation.
■ System controls cover all electronic product delivery and information systems relating to
the identification, measurement, management and monitoring of risk management
● Implement the risk management strategy
○ Obtain written authority to proceed with implementation
○ Check that time lags between the commencement of this process and the implementation of the
strategy have not impaired the effectiveness of the strategy
○ Risk strategies are developed for different planning periods
● Monitor, report, review and audit
○ As risk management is ongoing, the strategies must be continuously monitored to ensure they
achieve the expected risk management objectives and outcomes

3. Futures contracts
● An agreement between two parties to buy, or sell, a specified commodity or financial instrument at a
specified date in the future at a price determined today
● An exchange traded contract where standardised contracts are traded in a formal market
● Examples include:
○ a fund manager holding shares who is concerned the price may fall before they are sold
○ an investor concerned that share prices may rise before they are purchased
● Strategy involves carrying out an initial transaction in the futures market that corresponds with the
transaction to be conducted in the physical market at a later date (see Figure 18.1, next slide)
● Relevant terms
○ Clearing house—records transactions conducted on an exchange and facilitates value settlement
and transfer → đây là một tổ chức
○ Initial margin—deposit lodged (khoản tiền đặt cọc) with clearing house to cover adverse price
movements (những chuyển biến tiêu cực về giá) in a futures contract
○ Marked-to-market—the periodic repricing (định giá lại định kỳ) of an existing contract to reflect
current market valuations
○ Maintenance margin call—the top-up of an initial margin (việc bổ sung thêm tiền đặt cọc) to
cover adverse futures contract price movements

4. Forward contracts
● A financial instrument designed mainly to manage specified risks
● Offered over the counter by financial institutions
○ Therefore, more flexible than highly standardised exchange-traded products like futures, as the
terms and conditions of a forward contract, such as amount and timing of the contract, can be
negotiated
● Two main types
○ Forward rate agreements (FRAs)
○ Forward foreign exchange contracts
● Forward rate agreements (FRAs)
○ An over-the-counter product used to manage interest rate risk exposures
 ○ Allows a borrower to manage future interest rate risk exposure by locking in an interest rate
today that will apply at a specified future date
■ Is given effect by one party to the contract compensating the other party if the reference
rate is different from the agreed rate
○ Relevant terms
■ FRA agreed rate (tỷ lệ thỏa thuận)—the fixed interest rate stipulated in the FRA at the
start of the contract
■ FRA settlement date (ngày thanh toán)—the date when the FRA agreed rate is compared
with the reference rate (tỷ lệ tham chiếu) to calculate the compensation amount
■ FRA contract period (thời kỳ hợp đồng)—the term of the interest rate protection built into
the FRA

● Forward foreign exchange contracts

○ Also known as a forward exchange contract; locks in an exchange rate today for delivery of
foreign currency at a specified future date
○ For example, an Australian company may be importing goods from overseas and the company
will need to pay USD1 million in three months’ time

5. Option contracts
● An option gives the buyer the right, but not the obligation, to buy or sell a specified commodity or
financial instrument at a predetermined price (exercise or strike price), on or before a specified date
(expiration date)
● Types of options
○ Call options
 ■ Give the option buyer the right to buy the commodity or instrument at the exercise price
○ Put options
■ Give the buyer the right to sell the commodity or instrument at the exercise price
● An option will only be exercised if it is in the buyer’s best interests
○ A buyer will not exercise the right to sell if the physical market price is above the exercise price
of the option
→ Người mua (Investor A): Mua một tùy chọn mua trên 100 cổ phiếu của công ty XYZ với giá thực
hiện là 50 đô la và ngày đáo hạn là sau 30 ngày.
Tình huống: Nếu giá cổ phiếu của XYZ tăng lên, ví dụ, lên 60 đô la trong vòng 30 ngày, người
mua có quyền mua 100 cổ phiếu với giá 50 đô la và sau đó bán chúng trên thị trường với giá 60
đô la, kiếm lời từ sự tăng giá.

○ A buyer will not exercise the right to buy if the physical market price is below the exercise price
of the option contract at expiration date
→ Người mua (Investor B): Mua một tùy chọn bán trên 100 cổ phiếu của công ty ABC với giá thực
hiện là 30 đô la và ngày đáo hạn là sau 60 ngày.
Tình huống: Nếu giá cổ phiếu của ABC giảm xuống, ví dụ, xuống 25 đô la trong vòng 60 ngày,
người mua có quyền bán 100 cổ phiếu với giá 30 đô la mỗi cổ phiếu và sau đó mua chúng trên
thị trường với giá 25 đô la, kiếm lời từ sự giảm giá.
● Options can be exercised either:
○ only on expiration date (European option)
○ any time up to expiration date (American option)
● Premium (phí)
○ The price paid by an option buyer to the writer (seller) of the option
● Exercise price or strike price
○ The price specified in an options contract at which the option buyer can buy or sell
● Call option profit and los payoff profiles
● Put option profit and loss payoff profiles

6. Swap contracts
● An over-the-counter financial product allowing parties to enter into a contractual agreement to exchange
cash flows
● Intermediated swap
○ A party enters into a swap with a financial intermediary
● Direct swap
○ Two parties enter into a swap with each other without using a financial intermediary
● Two main types of swap contracts
○ Interest rate swaps
○ Cross-currency swaps
a. Interest rate swaps
● The exchange of interest payments associated with a notional principal amount
● Notional principal amount (số tiền chủ thể)—the underlying amount specified in a contract that is used
to calculate the value of the contract
● Vanilla swap—a swap of a series of fixed interest rate payments for floating interest rate payments
● Basis swap—a swap of a series of two different reference rate (tỷ lệ tham chiếu) interest payments
● Swap rate—the fixed interest rate specified in a swap contract

b. Cross-currency swaps
● Two parties, such as a bank and a company, exchange debt denominated in different currencies
● Interest payments are exchanged
● Principals are exchanged at beginning of agreement and then re-exchanged at conclusion of agreement,
usually at the same exchange rate
○ Example:
■ If the swap is an AUD-USD contract based on USD1 million and an exchange rate set at
AUD/USD0.7245, at the start of the contract one party would exchange USD1 million for
AUD1 380 262.25
 ■ At each future interest payment date, interest payments would be calculated using the
same exchange rate (i.e. AUD/USD0.7245)
■ Finally, at the swap completion date, the original AUD and USD principal amounts
would be re-exchanged

CHAPTER 19: DERIVATIVES - FUTURE AND FORWARD

1. Hedging using futures contracts

● Futures contracts and FRAs are called derivatives because they derive their price from an underlying
physical market product
● Two main types of derivative contracts
○ Commodity (e.g. gold, wheat and cattle)
 ○ Financial (e.g. shares, government securities and money market instruments)
● Derivative contracts enable investors and borrowers to protect assets and liabilities against the risk of
changes in interest rates, exchange rates and share prices
● Hedging involves transferring the risk of unanticipated changes in prices, interest rates or exchange rates
to another party
● A futures contract is the right to buy or sell a specific item at a specified future date at a price
determined today
● The change in the market price of a commodity or security is offset by a profit or loss on the futures
contract
● Example: A farmer wants to sell wheat in a couple of months, but is concerned that the price is going to
fall in the mean time. How can the farmer hedge this price risk?
○ Solution
■ Enter into a wheat futures contract to sell
● If wheat prices fall, the futures contract will rise in value, offsetting the loss in the
physical market from the fall in the wheat price
● If wheat prices rise, the futures contract will fall in value, offsetting the gain in the
physical market from a rise in the wheat price

2. Main features of a futures transaction

● Although futures contracts are highly standardised, variations exist between countries owing to:
○ the types of contract being based on the underlying security traded in that country
■ ASX Trade24 (formerly Sydney Futures Exchange) Commonwealth Treasury bonds,
CBOT (Chicago Board of Trade) US Treasury bonds
○ differences in the quotation convention
■ clean price bond quotation in US and European markets—present value of a bond less
accrued interest
■ yield to maturity bond quotation in Australian markets
● Orders and agreement to trade
○ Futures contracts are highly standardised and an order normally specifies:
■ whether it is a buy or sell order
■ the type of contract (varies between exchanges)
■ delivery month (expiration)
■ price restrictions (if any) (e.g. limit order)
■ time limits on the order (if any)
● Margin requirements
○ Both the buyer (long position) and the seller (short position) pay an initial margin, held by the
clearing house, rather than the full price of the contract
○ Margins are imposed to ensure traders are able to pay for any losses they incur owing to
unfavourable price movements in the contract
○ A contract is marked-to-market on a daily basis by the clearing house
■ This means re-pricing of the contract daily to reflect current market valuations
○ Subsequent margin calls may be made, requiring a contract holder to pay a maintenance margin
to top up the initial margin to cover adverse price movements
● Closing out of a contract
○ Involves entering into an opposite position
○ Example:
■ Company S initially entered into a ‘sell one 10-year Treasury bond contract’ with
company B
■ Company S would close out the position by entering into a ‘buy one 10-year Treasury
bond contract’ for delivery on the same date, with a third party, say company R
● The second contract reverses or closes out the first contract and company S would
no longer have an open position in the futures market
● Contract delivery
○ Settlement details, including the calculations of cash settlement amounts, for each contract traded
on the ASX Trade24 are available on the exchange’s website at www.asx.com.au

3. Futures market instruments

● Futures markets can be established for any commodity or instrument that:
○ is freely traded
○ experiences large price fluctuations at times
○ can be graded on a universally accepted scale in terms of its quality
○ is in plentiful supply, or cash settlement is possible
● Examples
○ Commodities
■ Mineral—silver, gold, copper, petroleum, zinc
■ Agricultural—wool, coffee, butter, wheat and cattle
○ Financial
■ Currencies—pound sterling, euro, Swiss franc
 ■ Interest rates
● Short-term instruments—US 90-day treasury bills, three-month eurodollar
deposits, Australian 90-day bank-accepted bills
● Longer-term—US 10-year T-notes, Australian three-year and 10-year
Commonwealth Treasury bonds
● Share price indices—S&P/ASX 200 Index

4. Futures markets participants

5. Four main categories of participants:
a. Hedgers
b. Speculators
c. Traders
d. Arbitragers
6. These participants provide depth and liquidity to the futures market, improving its efficiency
a. Hedgers
7. Attempt to reduce the price risk from exposure to changes in interest rates, exchange rates and share
prices
8. Take the opposite position to the underlying, exposed transaction
9. Example:
a. An exporter has USD receivable in 90 days. To protect against falls in USD over the next three
months, the exporter enters into a futures contract to sell USD
b. Speculators
● Expose themselves to risk in an attempt to make profit
● Enter the market with the expectation that the market price will move in a direction favourable for them
● Example:
○ Speculators who expect the price of the underlying asset to rise will go long and those who
expect the price to fall will go short
c. Trader
● Special class of speculator
● Trade on very short-term changes in the price of futures contracts (i.e. intra-day changes)
● Provide liquidity to the market

d. Arbitrage
10. Simultaneously buy and sell to take advantage of price differentials between markets
11. Attempt to make profit without taking any risk
12. Example:
a. Differentials between the futures contract price and the physical spot price of the underlying
commodity

13. Hedging: risk management using futures

● Futures contracts may be used to manage identified financial risk exposures such as:
○ hedging the cost of funds (borrowing hedge)
○ hedging the yield on funds (investment hedge)
○ hedging a foreign currency transaction
○ hedging the value of a share portfolio
14. Risks in using futures markets for hedging
● The risks of using the futures markets for hedging include the problems of:
○ standard contract size
○ margin risk
○ basis risk
○ cross-commodity hedging
● Standard contract size
○ Owing to contract size the physical market exposure may not exactly match the futures market
exposure, making a perfect hedge impossible
● Margin payments
○ Initial margin required when entering into a futures contract
○ Further cash required if prices move adversely (i.e. margin calls)
○ Opportunity costs associated with margin requirements
● Basis risk
○ Two types of basis risk
■ Initial basis
● The difference between the price in the physical market and the futures market at
commencement of a hedging strategy
■ Final basis
● The difference between the price in the physical market and the futures market at
completion of a hedging strategy
○ A perfect hedge requires zero initial and final basis risk
● Cross-commodity hedging
○ Use of a commodity or financial instrument to hedge a risk associated with another commodity
or financial instrument
■ Often necessary as futures contracts are available for few commodities or instruments
○ Selection of a futures contract that has price movements that are highly correlated with the price
of the commodity or instrument to be hedged

15. Forward rate agreements (FRAs)

● The nature of the FRA
○ An FRA is an over-the-counter product enabling the management of an interest rate risk
exposure
■ It is an agreement between two parties on an interest rate level that will apply at a
specified future date
■ Allows the lender and borrower to lock in interest rates
■ Unlike a loan, no exchange of principal occurs
■ Payment between the parties involves the difference between the agreed interest rate and
the actual interest rate at settlement
● The nature of the FRA
○ Disadvantages of FRAs include:
■ risk of non-settlement (i.e. credit risk)
■ no formal market exists
○ The FRA specifies:
■ FRA agreed date, fixed at start of FRA
■ notional principal amount of the interest cover
■ FRA settlement date when compensation is paid
■ contract period on which the FRA interest rate cover is based (end date)
■ reference rate to be applied at settlement date
● Settlement compensate amount = FRA settlement rate − FRA agreed rate

● Example: On 19 September this year a company wishes to lock in the interest rate on a
prospective borrowing of $5 000 000 for a six-month period from 19 April next year to 19
October of the same year. An FRA dealer quotes ‘7Mv13M (19) 13.25 to 20’. On 19 April the
BBSW on 190-day money is 13.95% per annum
● Main advantages of FRAs
○ Tailor-made, over-the-counter contract, providing great flexibility with respect to contract period
and the amount of each contract
○ Unlike a futures contract, an FRA does not have margin payments
● Main disadvantages of FRAs
○ Risk of non-settlement (credit risk)
○ No formal market exists and concern about difficulty closing out FRA position is overcome by
entering into another FRA opposite to the original agreement

CHAPTER 20: DERIVATIVES - OPTIONS

1. The nature of options
● Options differ from futures because they provide asymmetric cover against price movements
● Options limit the effects of adverse price movements without reducing profits from favourable price
movements
● Options involve the payment of a premium by the buyer to the seller (writer)
● An option gives the buyer the right, but not the obligation, to buy or sell a specified commodity or
financial instrument at a predetermined price (exercise or strike price), on or before a specified date
(expiration date)
● An option will be exercised only if it is in the buyer’s best interests
● Types of options
○ Call options
■ Give the option buyer the right to buy the commodity or instrument at the exercise price
○ Put options
■ Give the buyer the right to sell the commodity or instrument at the exercise price
● Options can be exercised either:
○ only on expiration date (European)
○ any time up to expiration date (American)
● Premium
○ The price paid by an option buyer to the writer (seller) of the option
● Exercise price or strike price
○ The price specified in an options contract at which the option buyer can buy or sell

2. Option profit and loss payoff profiles

● Call option profit and loss payoff profiles
○ Example: a call option for shares in a listed company at a strike or exercise price (X) of $12, and
a premium (P) of $1.50
■ Figure 20.1 indicates the profit and loss profiles of a call option for (a) the buyer or
holder (long call) and (b) the writer or seller (short call)
■ The critical break points of the market price of the share (S) at expiration date are <$12,
$12 to $13.50 and >$13.50
■ If S (market price of asset) > X (i.e. > $12) , option is ‘in the money’
● Call option profit and loss payoff profiles
○ The value of the option to the buyer or holder (long call party) is:
○ V = max(S – X, 0) – P
○ The value of the option to the writer (short call party) is:
○ V = P – max(S – X, 0)
● Put option profit and loss payoff profiles
○ Example: a put option for shares in a listed company at a strike or exercise price (X) of $12, and
premium (P) of $1.50
■ Figure 20.2 indicates the profit and loss profiles of a put option for (a) the buyer or holder
(long put) and (b) the writer or seller (short put)
■ The critical break points of the market price of the share (S) at expiration date are
<$10.50, $10.50 to $12 and >$12
■ Buyer exercises option if S < X (i.e. < $12)
● Put option profit and loss payoff profiles
○ The value of the option to the buyer or holder (long put party) is:
○ V = max(X – S, 0) – P
○ The value of the option to the writer (or short put party) is:
○ V = P – max(X – S, 0)
● Covered and naked options
○ Unlike futures, the risk of loss for a buyer of an option contract is limited to the premium
○ However, sellers (writers) of options have potentially unlimited risk and may be subject to
margin requirements unless they write a covered option
■ The writer of an option holds the underlying asset or provides a financial guarantee
○ The writer of a call option has written a covered option if the writer either:
■ owns sufficient of the underlying asset to satisfy the option contract if exercised
■ is also the holder of a call option on the same asset, but with a lower exercise price
○ The writer of a put option has written a covered option if the writer is also the holder of a put
option on the same asset, but with a higher exercise price
3. Organisation of the market
● Option markets are categorised as:
○ over the counter
○ exchange-traded
■ They are recorded through a clearing house
■ The clearing house acts as counterparty to buyer and seller, thus creating two options
contracts through the process of ‘novation’
■ The clearing house allows buyers and sellers to close out (i.e. reverse) their contracts
● International options markets
○ An exchange in a particular country will usually specialise in option contracts that are directly
related to physical or futures market products also traded in that particular country
○ Trading on international exchanges varies
■ The largest exchanges, the Chicago Board of Trade (CBOT) and Chicago Mercantile
Exchange (CME) retain open-outcry trading on the floor. However, this is now a rarity
and is disappearing as almost all trading moves electronic
○ International links between exchanges allow 24-hour trading
● The Australian options markets
○ Types of options traded
■ Options on futures contracts
■ Share options
■ Low-exercise-price options
■ Warrants
■ Over-the-counter options

4. Factors affecting an option contract premium

● Option price (or premium) is influenced by four key factors
○ Intrinsic value
○ Time value
○ Price volatility
○ Interest rates
a. intrinsic value
● The market price of the underlying asset relative to the exercise price
● The greater the intrinsic value, the greater the premium (i.e. positive relationship)
● Options with an intrinsic value
 ○ Positive are ‘in the money’ and the buyer is able to exercise contract at a profit
○ Negative are ‘out of the money’ and the buyer will not exercise
○ Zero are ‘at the money’
b. Time value
● The longer the time to expiry, the greater the possibility that the option will be able to be exercised for a
profit (‘in the money’) (i.e. positive relationship)
● If the spot price moves adversely, the loss is limited to the premium

c. Price volatility
● The greater the volatility of the spot price, the greater the chance of exercising the option for a profit, or
a loss
● The option will be exercised only if the price moves favourably
● The greater the spot price volatility, the greater the option premium (i.e. positive relationship)

d. Interest rates
● Interest rates have opposite impacts on put and call options
○ Positive relationship between interest rates and the price of a call
■ Benefit of present value of deferred payment if exercised > lower present value of profit
if exercised
○ Negative relationship between interest rates and the price of a put
■ Opportunity cost of holding asset
■ Lower present value of the profit if exercised

5. Option risk management strategies

● Single-option strategies
○ Example: long asset (i.e. bought) and bearish (negative) about future asset price
■ Strategy
● Limit downside risk by writing (selling) a call option (i.e. short call)
● Figure 20.5 and Table 20.4 in the textbook illustrate the profit profile of this
strategy
○ Example: short asset (i.e. sold) and bullish (positive) about future asset price
■ Strategy
● Buy a call in the underlying asset (i.e. take a long-call position)
 ● Figure 20.6 and Table 20.5 in the textbook illustrate the profit profile of this
strategy

● Combined-options strategies
○ Example: very bullish about future price of the asset
■ Strategy: ‘vertical bull spread’—contracts with same expiration dates, different exercise
prices
 ● Write (sell) a put option and earn a premium to benefit from fall in spot price
● Hold (buy) a call option with exercise price greater than written put
● Effect: Offsets high premium associated with call
● Figure 20.7 in the textbook illustrates the profit profile
○ Example: quite bullish, but with some risk of a price fall
■ Strategy
● Hold (buy) a call option to benefit from fall in spot price
● Write (sell) a call option with a higher exercise price than the long call
● This ‘call bull spread’ limits the potential loss
● Figure 20.8 in the textbook illustrates the profit profile
○ Example: very bearish about the future price of the asset
■ Strategy
● Hold (buy) a put option to benefit from fall in spot price
● Write (sell) a call option with a higher exercise price than the long put
● This ‘vertical bear spread’ limits the potential gain but exposes the writer to
unlimited losses
● Figure 20.9 in the textbook illustrates the profit profile
○ Example: quite bearish, but with some risk of a price rise
■ Strategy
● Hold (buy) a put option to benefit from fall in spot price
● Write (sell) a put option with a lower exercise price than the long put
● This ‘put bear spread’ limits the potential loss if the price rises
● Figure 20.10 in the textbook illustrates the profit profile
○ Example: expectation of increased price volatility, with no trend
■ Strategy
● Hold (buy) a put option
● Hold (buy) a call option with common exercise price
● ‘Long straddle’ provides positive pay-off for both large upward and downward
price movements
● If prices remain unchanged, individual makes loss equal to sum of premiums
● Figure 20.11 in the textbook illustrates the profit profile
○ Example: expectation of increased volatility, without trend, with stagnation
■ Strategy
● Hold (buy) call option with out-of-the-money exercise price
 ● Hold (buy) put option with out-of-the-money exercise price
● With ‘long strangle’ loss is decreased if price remains unchanged, compared with
‘long straddle’
● Figure 20.12 in the textbook illustrates the profit profile
○ Example: expectation of asset price stability
■ Strategy
● Take opposite position to long straddle and long strangle
● Strategy I: Short straddle
○ Sell call and put options with same exercise price
● Strategy II: Short strangle
○ Sell call and put options, both out of the money
● Figure 20.13 in the textbook illustrates the profit profiles
● Combined-options strategies
○ Barrier options: knock-out and knock-in options
■ Another form of option strategy suited to the management of FX risk exposures
■ Knock-out option:
● is extinguished if a specified spot exchange rate barrier is breached
■ Knock-in option:
● is created if a specified spot exchange rate is achieved
■ The barrier rate can be set above or below the current spot FX rate.
■ As the barrier limits the exposure of the writer, the premium is not as high as it is with a
straight option