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BA1
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Syllabus outline!
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Exam Format!
• 2 hour time limit!
• Multiple choice, drag and drop, number entry, hot spot, multiple
response (will say how many correct answers)!
• Ideally: leave 1 week after the end of the course, but not more than
3 weeks!
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Session structure!
1 Microeconomic and organisational context I: the goals and decisions of
organisations
2 Microeconomic and organisational context I: the market system!
3 Financial context of business I
4 Macroeconomic and institutional context I: the domestic economy
5 Macroeconomic and institutional context I: the international economy!
6 Financial context of business I: international aspects
7 Financial context of business III: discounting and investment appraisal
8 Informational context of business I: summarising and analysing data
9 Informational context of business II: index numbers!
10 Informational context of business III: inter-relationships between variables
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Session 1
Microeconomic and Organisational Context I:
The Goals and Decisions of Organisations
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The Business Organisation!
Views of
Profit!
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Not for Profit Organisations!
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Types of Organisation!
Control!
Public! Private!
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Shareholder Wealth!
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Shareholder Interest!
• Shares – Funds that are raised for the business activity by dividing up
ownership of the company into equal parts!
• Stock Exchange – The place where shares in quoted companies are bought
and sold!
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Shareholder Returns!
• The returns to a business owner can be considered
either as happening:
– In a single instance in time (short run) and could
be measured by:
• Return on capital employed
• Earnings per share
– Over a period of time (long run)
• This would involve consideration of the time
value of money (more on this later in the
syllabus)
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Short Term Measures!
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Short Term Measures!
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Long Term Measures!
The key to measuring long term success will be to
ensure that returns to shareholders are at least equal to
the cost of acquiring the capital required to produce a
long term flow of earnings.
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Long Term Measures!
Share Values
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Stakeholders!
Interest and
Influence!
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Risk & Return!
Before deciding whether to buy, hold or sell shares in a firm the investor will
consider whether the returns from the firm are adequate to compensate them
for the risks of investing in the firm. The minimum rate of return that is
acceptable to shareholders is called the required rate.!
Unsystematic risk (or specific risk) is the risk associated with investing in a
particular firm. For example a firm’s shares may have high unsystematic risk
due to the firm’s high dependence on the sales of a single line of product!
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Risk Return Curve!
Time value of
money!
Risk Free Rate!
Rate of inflation!
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Corporate Governance!
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Key Principles!
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Transaction Costs!
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Session 2
Microeconomic and Organisational
Context II: The Market System
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Session 2
Microeconomic and Organisational Context I:
Measuring Returns to the Shareholder
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Influences on Prices!
Demand: Supply:
The plans of consumers The plans of producers
Price
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Influences on Prices!
Demand: Supply:
The plans of consumers The plans of producers
Price
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Consumer Behaviour and Demand!
• Construction of a demand curve.!
Price
P2
P1
D
Q2 Q1 Quantity
Contraction
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Conditions of Demand!
• Income!
• Tastes and preferences!
• Substitutes!
• Complements !
• Population!
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Shift in a demand curve!
Price
Shift due to a change in one
of the conditions of demand
P1
D2
D1
Q1 Q2 Quantity
increase
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Elasticity of Demand!
• Elasticity measures responsiveness of one variable to changes in another
variable in percentage terms.!
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Price Elasticity of Demand!
• This is measured as:!
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Price Elasticity of Demand!
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Position on the demand curve!
• Elasticity varies along the length of straight line demand curves as
shown:!
PED = 0 =
Inelastic section perfectly
inelastic
Quantity
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Determinants of PED!
• Income!
• Availability and closeness of substitutes!
• Necessities!
• Habit!
• Time!
• Definition of market!
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Supply and Market!
• Construction of a supply curve.!
Price
S1
P2
P1
Q1 Q2 Quantity
extension
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Conditions of Supply!
• Costs of production change!
• Technological change!
• Indirect taxes!
• Number of firms!
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Shift in a supply curve!
Price
S1 S2
Q1 Q2 Quantity
increase
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Elasticity of Supply!
• This is measured as:!
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Supply Elasticity!
• Elasticity of straight line supply curves:!
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Determinants of Price Elasticity
of Supply!
• Time!
• Factors of production!
• Stocks!
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The Price Mechanism!
• Equilibrium price determination:!
S1
Price
Excess supply
P1
Equilibrium point
P2 where demand = supply
D1
Qd Q2 Qs Quantity
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An example:!
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Changes to the equilibrium!
From the initial demand and supply curves and
equilibrium position:!
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Effect of a change in demand
conditions!
S1
Price
P2
New equilibrium point where
P1 new demand = supply
D2
D1
Q1 Q2 Quantity
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Effect of a change in supply
conditions!
S1
Price S2
P1
P2 New equilibrium point where
demand = new supply
D1
Q1 Q2 Quantity
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Market failure!
The inability of a market to allocate resources in a way that maximises
utility!
• Public goods!
• Externalities!
• Merit goods!
• Demerit goods!
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Interferences in market prices!
• Governments will sometimes interfere with the equilibrium position when
they feel this is necessary. An example of this are the minimum wage
rule.!
• This
can lead to excess supply (i.e. unemployment) which the
government then have to deal with (through paying unemployment
benefits).!
• Minimum prices!
• Maximum prices!
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Economies and diseconomies of scale!
• Internal economies of scale:!
– technical!
– financial!
– trading!
• Diseconomies of scale!
– technical!
– trading!
– managerial!
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Session 3
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Financial Markets!
• money markets!
• capital markets!
• foreign exchange markets!
• commodity markets!
• derivatives markets!
• insurance markets !
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Financial intermediaries!
Channelling funds between lenders and borrowers can be achieved
by:!
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Financial Intermediaries!
• Risk reduction!
• Aggregation!
• Maturity transformation!
• Financial intermediation!
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Liquidity surpluses and deficits!
Businesses!
• Receipts!
• Payments!
• Lack of synchronisation!
Government!
• Receipts!
• Payments!
• Lack of synchronisation!
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Financial products!
Considerations:!
• Yield / cost!
• Risk!
• Time period!
• Liquidity!
• Transaction costs!
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Capital and money markets!
Capital markets – maturities > 1 year!
Products:!
• Bonds!
• Credit agreements!
• Mortgages!
• Bills of exchange!
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Yields on financial products!
• Returns/Yields:!
• This
means that yields rise when the market
price of the security falls.!
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Relationship with interest rates!
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The Central Bank & Interest
Rates!
• Interest
rates in a free market economy will be determined by the
demand and supply of money (just like any other economy).!
• However because interest rates effect other parts of the economy (such
as inflation, the housing market, the value of bonds and shares), the
central bank often control the supply and demand for money in order to
control interest rates.!
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Banks!
Main activities:!
• safeguarding money!
• transferring money!
• lending money!
• facilitating trade!
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Credit creation!
BANK
£100 Loans £90
£ Loans £81
Dep £90
Spends Spends
Dep £81 Vault £81 £90
£10
£9
£8.10
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Merchant banks!
Main activities:!
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Non-bank financial
intermediaries!
• Building societies!
• Pension funds!
• Insurance companies!
• Finance companies!
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The Central Bank!
Roles:!
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Session 4
Macroeconomic and Institutional
Context I: The Domestic Economy
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Macroeconomics and
Government Policy Goals!
Government policies!
• Economic growth!
• Manage inflation!
• Manage unemployment!
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The Circular Flow Model!
These are analysed using the framework of the circular flow model of
income.!
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Simple circular flow model!
This assumes:!
• No government!
• No savings or investment!
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Simple circular flow model!
Expenditure Income
Households
Land Rent
Consumption Output of goods Labour Wages
Expenditure and services or Capital Interest
real income Enterprise Profit
Firms
Income Expenditure
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A more complex model!
• household may save, and financial institutions can use these savings
for investment!
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Abbreviations!
Ø Y national income!
Ø C consumption!
Ø S savings!
Ø Iinvestment!
Ø T taxation!
Ø G government expenditure!
Ø X exports!
Ø M imports!
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Incorporating withdrawals and injections!
Financial Savings & hoarding Government
Institutions
Income tax
Outflow Households
& NIC
on B of P
Inflow on Wages &
Overseas the B of P salaries
Sector
Overseas
Consumption Sector Government
Financial
Expenditure Institutions
Overseas
Overseas Sector
Sector investment
Government Imports
Specific
taxes &
Exports Contracts
VAT Taxes Government
Firms
Financial
Government
Institutions
Savings
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Withdrawals and injections!
Withdrawals [W] are not passed on as expenditure and reduce the level of
income!
• Savings [S]!
• Taxation [T]!
• Investment [I]!
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Equilibrium!
Inflow = Outflow
Expenditure [E] = Income [Y] 1
Fact E ≡ C+J
Fact Y ≡ C+W
C+J = C+W
J = W 2
Fact J≡I+G+X
Fact W≡S+T+M
I+G+X = S+T+M 3
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Consumption!
• Average propensity to consume (APC):!
• Consumption/income!
• APC = C/Y!
• MPC = ∆C/ ∆ Y!
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Savings!
• income!
• interest rates!
• inflation!
• credit!
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Investment!
This is affected by:!
• the accelerator!
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The multiplier!
• Disturbancesto equilibrium can arise because of increases or
decreases in injections!
• Any
change in an expenditure results in income changing by smaller
and smaller steps towards a new final equilibrium level!
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The Trade Cycle!
Aggregate demand!
Aggregate supply!
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The Trade Cycle!
Boom! Recession!
Recovery! Stagflation!
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Government Economic Policy!
• Fiscal policy!
• Monetary policy!
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Fiscal Policy!
This involves changing:!
• taxation!
• raises revenue!
• changes markets!
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Supply Side Policy!
This is aimed at increasing aggregate supply by:!
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Monetary policy!
In effect, this means managing the interest rate. For example a rise in
interest rates should result in:!
• a fall in spending!
• a fall in investment!
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Managing interest rate risk!
Avoid the effects of a drop in interest rates for monetary deposits and a rise
in interest rates for borrowings!
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Unemployment!
• Demand deficiency!
• consumer expenditure!
• business investment!
• exports!
• government expenditure!
• Structural change!
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Effects of unemployment!
• Under-utilisation of resources!
• Social problems!
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Inflation!
Causes of inflation:!
• demand-pull inflation!
• cost-push inflation!
• expectations effect!
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Session 5
Macroeconomic and Institutional
Context II: The International Economy
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International Trade!
Reasons countries trade:!
• To obtain goods they cannot produce!
• To obtain goods more cheaply from other
countries!
Advantages to trade!
• More output for same amount of inputs!
• Increased productivity from repetition!
• Economies of scale!
• Greater consumer choice!
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Protectionism!
Reasons for restrictions on trade:!
• to protect employment!
• to raise revenue!
• to maintain security!
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Protectionism!
• inefficiency is encouraged!
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Protectionism!
Methods of protection:!
• tariffs!
• quotas!
• hidden restrictions!
• subsidies!
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Trade agreements!
• Bi-lateral vs multi-lateral!
• Customs unions!
• Single markets!
• Economic unions!
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World Trade Organisation!
The major functions are:!
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Balance of Payments!
This is a record in account form of all the transactions arising between
the residents of one country and the inhabitants of the rest of the world
for a specified time period.!
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The Current Account!
Typical Current Account!
Services £3,000
Rent interest profits &
£1,000
dividends
Invisible trade balance £4,000
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Capital Financial Account!
Capital & Financial Account!
Capital Account
This includes transfers of capital and +£300,000
£1,000
acquisition/disposal of non-produced assets £0
Balance £1,000
£300,000
Financial Account
UK Overseas investment ( (£40,000)
£40,000)
Overseas investment in the UK £35,000
£35,000
Reserve assets £9,000
£100,000
Balance £4,000
£400,000
Net movement in external assets/liabilities £5,000
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Reconciliation!
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Deficit Solutions!
• Expenditure switching strategies:!
• Devaluation !
• Expenditure reducing strategies (deflation):!
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Globalisation!
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Globalisation!
Other aspects would involve:!
• the reduction of trade barriers!
• homogenisation of tastes!
• firms selling the same product all markets!
• greater harmonisation of laws!
• dilution of traditional cultures!
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Globalisation!
Consequences of globalisation:!
• Industrial relocation!
• Increased competition!
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Globalisation!
• Political realignments!
• Cost differentials!
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External analysis of the macro environment!
PESTEL analysis:!
• Political!
• Economic!
• Social!
• Technological!
• Ecological / environmental!
• Legal!
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Session 6
Financial Context of Business II:
International Aspects
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Foreign Exchange!
• An exchange rate is the price of one currency in terms of another
currency!
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Exchange rates: determinants of demand!
• Exports of goods!
• Interest rates!
• Speculation!
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Exchange rates: determinants of supply!
• Imports of goods!
• Interest rates!
• Speculation!
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Floating Exchange Rate!
P
P1
D1
D2
Q1 Q2
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Foreign exchange risks!
• Transaction risk!
• Economic risk!
• Translation risk!
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Session 7
Financial Context of Business III:
Discounting and Investment Appraisal
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The time value of money!
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The time value of money!
Three reasons:
Impact of inflation
Effect of risk
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Simple interest!
!
Interest = P × r × n!
!
!
Future Value = P + (P × r × n)!
!
P = amount invested!
n = number of years!
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Illustration of simple interest!
£1,000 is invested for 5 years. The sum earns 10% simple interest each
year. How much will accumulate by the end of the fifth year?!
Answer!
= P + (P × r × n)!
= £1,500!
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Compound interest!
Interest is paid or received on the principal plus any accumulated interest!
Formula is given !
• n = number of years!
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Illustration of compound interest!
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Illustration of compound interest!
Answer!
= £1,000 (1 + 0.1)5!
= £1,611!
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Illustration of compound interest!
The formula should be used in the exam but it may help to look at the
calculation in this way:!
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Equivalent annual interest rates!
• This is called the equivalent annual interest rate or the annual percentage
rate (APR)!
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Illustration of equivalent annual interest rates!
Answer!
!
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Terminal values!
• Compound each cash flow over the life of the investment using the interest
rate!
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Illustration of terminal values!
An investment of $3,000 is made initially and then $1,800 at the end of the
first, second and third years and finally $600 at the end of the fourth year.!
If interest is paid annually at 6.5%, calculate the terminal value at the end of
the fifth year.!
Answer!
Total = $11,280.81!
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Sinking funds!
• These have equal sums paid into them each period, e.g. a regular savings
account!
• Use the formula to calculate the amount at the end of the investment period!
!
S = A (Rn – 1)!
(R – 1)!
!
A = Equal sum!
n = number of periods!
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Illustration of sinking funds!
Answer!
(R – 1)!
(1.1 – 1)!
= £3,310!
!
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Illustration of sinking funds!
How would the answer differ if the funds were paid in at the start of each
year?!
Answer!
In the previous illustration we said that if the payments were made at the
end of each year we would have £3,310 by the end of year 3!
However, if the payments are made at the start of each year they will
attract an extra year’s interest and the final sum will be £3,310 × 1.1 =
£3,641!
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Discounting!
• When we looked at compound interest we said that the future value after n periods,!
S = X (1 + r)n!
• However, we may know the future value, S, but need to calculate the present value, X
Rearranging the equation we get:!
S = future sum!
n = number of periods!
r = cost of capital/ discount rate as a decimal (we called this the interest rate
previously)!
Present value, X = S !
(1 + r)n!
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Illustration of discounting!
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Illustration of discounting!
Find the present value of £25,000 receivable in 6 years’ time, if the
interest rate is 10% pa.!
Answer!
Present value, X = S!
(1 + r)n!
= £25,000!
1.16!
= £14,112!
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Discounting the quick way!
• We already know that present value, X = S !
n!
(1 + r)
(1 + r)n!
• This is called the discount factor and can be found in our mathematical
tables!
• This gives an alternative and quick method of calculating the present value !
!
Present value, X = S × Discount Factor (from tables)!
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Illustration of discounting using tables!
Use the present value table to find the present value of £25,000
receivable in 6 years’ time, if the interest rate is 10% pa.!
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Illustration of discounting using tables!
Use the present value table to find the present value of £25,000
receivable in 6 years’ time, if the interest rate is 10% pa.!
Answer!
= £25,000 × 0.564!
= £14,100!
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Net present value (NPV)!
NPV = present value of all the cash inflows minus the present value of
all the cash outflows.!
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Illustration of NPV!
Year 1 2 3 4 5!
Calculate the net present value of this project if the firm has a cost of
capital of 10%!
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Illustration of NPV!
Answer!
• Project has a positive NPV of £18,176: accept!
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Annuities!
!
• Questions may require us to calculate the present value of a constant
amount!
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!
Illustration of annuities!
Suppose I expect to receive £1,000 per annum for 3 years, starting in one
year’s time, and want to calculate the present value using a discount rate of
5%.!
Answer!
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Illustration of annuities!
Method 1!
• One approach would be to discount each cash flow separately and sum the
results:!
2.723 £2,723!
• The present value of £2,723 is correct but this is a time consuming method,
particularly if the annuity continues for a long period!
!
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!
Illustration of annuities!
Method 2!
• This is the sum of all of the individual discount factors and can be found
from the tables.!
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Illustration of annuities!
Method 3!
• The cumulative present value factor may not be available from the tables. !
• The calculation is the same as in method 2 but we will need to calculate the
cumulative present value factor.!
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Perpetuities!
!
A perpetuity is an annuity that continues forever.!
!
Present value of a perpetuity =
perpetuity × 1/r!
!
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Illustration of a perpetuity!
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Illustration of a perpetuity!
Answer!
= £333,333!
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Internal rate of return (IRR)!
!
• IRR is another method of appraising investments and involves discounting!
• Accept the project if the IRR is more than the company’s cost of capital!
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Internal rate of return (IRR)!
NPV £
Positive
! NPV
! IRR
Cost of
Capital %
Company cost
of capital
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Internal rate of return (IRR)!
Estimate of IRR!
• Step 1: Take a small discount rate r1 and calculate the NPV (NPV1 )!
• Step 2: Take another discount rate r2 and calculate the NPV (NPV2 )!
⎡ NPV1 ⎤
IRR = r1 + ⎢ (r2 − r1 )⎥
⎣ NPV1 − NPV2 ⎦
(learn)!
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Illustration of IRR!
Year 1 2 3 4!
Discount the project at 10% and at 15%, then calculate the internal rate
of return of the project!
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Illustration of IRR!
Answer!
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Illustration of IRR!
Answer!
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Illustration of IRR!
Step 3: Calculate the IRR!
!
⎡ NPV1 ⎤
!
IRR = r1 + ⎢ (r2 − r1 )⎥
! ⎣ NPV1 − NPV2 ⎦
!
(10,125 + 3,230)!
= 13.79%!
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Session 8
Informational Context of Business I:
Summarising and Analysing Data
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Information!
Data vs information!
• A!
• C!
• C!
• U!
• R!
• A!
• T!
• E!
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Bar charts!
• Height of the bar is proportional to the frequency!
(a) Simple !
(b) Multiple!
(c) Compound!
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Illustration of simple bar chart!
!
!
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Illustration of multiple bar chart!
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Illustration of compound bar chart!
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Scatter diagrams!
• Visual way of determining if there might be a relationship between two
variables!
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Illustration of scatter diagram!
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Types of correlation!
!
!
!
! x
x ! x
! x x
!
x
! !
x
x
! x
! x
! !
! !
r = +1!
r = - 1!
!
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Types of correlation!
!
!
!
x x x
!
!
x
! x
! x
x
!
!
x x
! x
!
! !
! !
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!
!
Types of correlation!
!
!
!
x
x x
!
! x x
x
x !
! x x x
x
x
x x !
! x
! !
No correlation! !
r = 0! !
! !
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Histograms!
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Illustration of a histogram!
12
10
Weight (kg)
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Ogives!
• More useful for continuous data since the intermediate values of x mean something!
• Step 1: Plot the cumulative frequency on the y axis against the UPPER end of each class interval on the x axis!
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Illustration of an ogive!
• The following cumulative frequency distribution relates to the weight of some sand bags:!
(kg)!
> 10 ≤ 20 1 1!
> 20 ≤ 30 6 1 + 6 = 7!
> 30 ≤ 40 8 7 + 8 = 15!
> 40 ≤ 50 10 15 + 10 = 25!
> 50 ≤ 70 10 25 + 10 = 35!
> 70 ≤ 90 6 35 + 6 = 41!
50!
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Illustration of an ogive!
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Session 9
Informational Context of Business II:
Index Numbers
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Simple index numbers!
• The most common type of indices are price indices. They compare the price in one
year to the price in another year, called the base year !
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Example of a simple price index!
Turn the following prices into an index series with 2003 as the base year!
Answer!
Sample interpretation In 2004 the price was 10.7% higher than in 2003.!
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Changing the base year!
• Exam tip: To change to a new base year divide all index numbers by the
index number of the new base year and multiply by 100!
Re-base the index calculated in the previous worked example to the Year
2006 !
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Changing the base year!
Answer!
Sample interpretation The price in 2003 was 77.8% of the price in the year 2006.!
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Combining series of index numbers!
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Illustration of combining indices!
• The price index below changed its base to 1983 after many years with base 1970.
Recalculate it as a single series with base 1983. By how much have prices risen from 1981
to 1985?!
(1970 = 100)!
1981 271!
1982 277!
1983 280!
(1983 =100)!
1984 104!
1985 107!
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Illustration of combining indices!
Answer!
(1970 = 100)!
(1983 =100)!
! www.ultimateaccess.net
Illustration of combining indices!
• Now that we have a single series spanning both 1981 and 1985, we
can compare the two:!
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Relative price indices!
• When several items are being considered it is important to recognise the
importance of the different items within the group. Hence a weighting is
usually attached to each item. In the examination the weightings will
always be given.!
∑w!
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Illustration on relative price
indices!
Item Price (2007) Price (2008) Weighting!
• Calculate a weighted relative price index for the data above and interpret your answer.!
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Illustration on relative price
indices!
Answer!
P1/P0 W P1/P0 x W!
18 18.84!
= 104.7!
• The average price rise of the three items has been 4.7%!
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Choice of weighting!
Advantages of base year weights!
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Quantity indices!
• Calculated in a similar way to the price indices but changing quantities are
measured instead of price!
∑w!
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Illustration on quantity indices!
A company manufactures two products, A and B. The sales figures over the
past three years have been as follows:!
Year A B!
Weighting 22 19!
Using 2006 as a base, compute a weighted relative quantity index for 2007 and
2008, and interpret their values.!
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Illustration of quantity indices!
Answer!
2006 to 2007!
Q1/Q0 W Q1/Q0 x W!
41 41.939!
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Illustration of quantity indices!
2006 to 2008!
Q1/Q0 W Q1/Q0 x W!
41 42.642!
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Session 10
Informational Context of Business III:
Inter-relationships Between Variables
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Big data!
Helps companies make more informed business decisions by!
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Correlation!
• Correlation establishes the strength of the relationship between
variables that are related to each other!
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Pearson’s correlation coefficient, r!
!
!
2 2 2 2
√(n∑x – (∑x) )(n∑y - (∑y) )!
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Illustration of Pearson’s correlation
coefficient!
A new machine has been purchased and management are keen to
explore the link between output and cost. Output and cost figures for the
last four months are as follows:!
Output 3! 4! 5! 6!
(000s)!
Cost 6! 7! 7! 10!
(£000s)!
!
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Illustration of Pearson’s correlation
coefficient!
Answer!
r= n∑xy - ∑x∑y!
x! y! xy! x2! y2!
2 2 2 2
√(n∑x – (∑x) )(n∑y - (∑y) )! 3! 6! 18! 9! 36!
√(20)(36) = + 0.89!
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Coefficient of determination, r2!
!
• Coefficient of determination is calculated by squaring the correlation
coefficient i.e. r2!
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Illustration of coefficient of
determination!
Using the information in the previous illustration calculate, and comment on, the
coefficient of determination !
Answer!
r2 = 0.892 = 0.7921!
This means that 79.21% of the change in cost relating to the machine can be
explained by a change in machine output!
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Spurious correlation!
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Rank correlation: Spearman’s coefficient!
• Used when a distribution is given in terms of rank, rather than actual values!
2 !
R = 1 - 6 ∑ d
2
n(n - 1 ) (given)!
• The rank correlation coefficient can be interpreted in the same way as the ordinary correlation!
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Illustration of Spearman’s rank coefficient!
Calculate the rank correlation coefficient for this data and comment on its
value!
Interviewee! Interview grade! Test score!
!
One! A! 60!
Two ! B! 61!
Three! A! 50!
Four! C! 72!
Five! D! 70!
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Illustration of Spearman’s rank coefficient!
Answer!
Note: Interviewees one and three share the best interview grade. They
therefore share the ranks 1 and 2 giving them 1.5 each!
Interviewee! Rank of Rank of test d! d2!
interview score!
grade!
One ! 1.5! 4! 2.5! 6.25!
Two! 3! 3! 0! 0!
Three! 1.5! 5! 3.5! 12.25!
Four! 4! 1! 3! 9!
Five! 5! 2! 3! 9!
∑= 36.50!
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Illustration of Spearman’s rank
coefficient!
2 !
R=1 - 6 ∑ d
2
n(n - 1 )!
= 1 – (6 x 36.50)!
5(25-1)!
= −0.825!
!
• There is a strong negative correlation between the interview grade and the test score!
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Regression!
• Expresses the relationship between two sets of data using the equation
of a straight line, !
y = a + bx!
Method 1: Draw a scatter diagram and estimate the line of best fit (not
directly examinable but it is useful to understand this method)!
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Regression using scatter
diagram!
• A scatter graph is drawn showing the sales achieved (£000’s) for different
levels of advertising spend (£000)!
• This straight line can then be used to forecast the sales for any given level
of advertising spend.!
!
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Regression using least squares
method!
• Finds the line of best fit computationally by minimising the sum of the
squares of the distances between the data and the line.!
• i.e. rather than drawing a graph this method uses formulae to calculate the
values of ‘a’ and ‘b’ in the equation of a straight line, y = a + bx!
• We can then forecast the value of ‘y’ (e.g. sales)for any given value of
‘x’ (e.g. advertising spend)!
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Regression using least squares method!
b = n∑xy - ∑x ∑y !
2 2
n∑x - (∑x) !
a = y - bx!
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Regression using least squares
method!
Interpolation and extrapolation!
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Regression using least squares
method!
Limitations of linear regression analysis!
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Illustration of least squares
method!
Using the data given below, establish the least squares regression line!
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Illustration of least squares method!
Answer!
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Illustration of least squares method!
b = n∑xy - ∑x ∑y !
2 2
n∑x - (∑x) !
= 6(3,344) – (54)(336)!
6(566) – (54)2!
= 1,920!
480!
= 4.0!
Calculation of a!
a = y - bx = 336 - 4 54 = 56 - 36 = 20!
6 6!
!
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Illustration of least squares method!
Least squares regression line: y = a + bx!
y = 20 + 4x!
Using the regression line ‘y = 20 + 4x’ obtained above, predict the average
daily sales of a supermarket if the monthly advertising expenditure is:!
(ii) £100,000!
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Illustration of least squares
method!
Answer!
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Session 11
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Time series analysis!
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Time series analysis
components!
• Trend (T): this is a general movement of the time series over a long period
of time!
• Cyclical variation (C): recurring patterns over a long time period, not
generally fixed in nature!
!
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Time series analysis models!
• Calculation questions tend to focus on the trend and seasonal variation only. These
can be combined together in two ways to give the actual results, i.e. the time series:!
• Some questions also ask for the calculation of the residual (R). In this case, the two
equations above should be extended to include R!
!
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Illustration of residual
calculation!
• The multiplicative model for a time series shows that at a certain time the actual,
trend and seasonal variations are 555, 463 and 1.16. Find the residual at this point.
(Round your answer to four decimal places).!
Answer!
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Seasonal variations!
• For the additive model the seasonal variations will be given as a
positive or negative number. The total of the seasonal variations will
be zero!
• If this is not the case, any difference should be spread evenly across
the seasonal variations!
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Illustration of seasonal variations!
Using the multiplicative model the seasonal variations are found to be !
They are subsequently adjusted so that their total = 4. What is the new
value of the average currently valued at 1.04?!
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Illustration of seasonal variations!
Using the multiplicative model the seasonal variations are found to be !
They are subsequently adjusted so that their total = 4. What is the new value
of the average currently valued at 1.04?!
Answer!
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!
!
Forecasting with time series!
!
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Illustration using least squares analysis!
• Least squares regression was used to calculate the straight line of best
fit, y= a + bx, for sales against time.!
! www.ultimateaccess.net
Illustration using least squares analysis!
Step 1!
• Using the least squares regression line the trend, T, can be calculated
for quarter 14!
y = 13.7 + 1.5x!
Step 2!
!
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Illustration using least squares analysis!
(a) If the seasonal variation is given as a number (positive or negative) we must use
the additive model:!
= 34.7 + 2.4!
= 37.1!
(b) If the seasonal variation is given as a percentage or decimal we must use the
multiplicative model:!
= 34.7 × 1.1!
= 38.17!
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Forecasting with time series!
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Illustration using moving
averages!
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Illustration using moving averages!
Year! Qtr! Sales (Y)! 4 point 8 point 4 point moving
moving total! moving total! average (T)!
2006! 1! 24.8! -! -!
2! 36.3! -! -!
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Seasonal adjustment!
• If the seasonal variations (SV) are already known, then it is possible to de-
seasonalise the actual results (TS) to identify the trend (T)!
Multiplicative model!
Additive model!
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Illustration of seasonal adjustment!
Unemployment numbers actually recorded in a town for the second quarter of
20X8 were 2,400. The seasonal variation for this quarter is 0.95. Using the
multiplicative model for seasonal adjustment, calculate the seasonally-
adjusted figure (in whole numbers) for the quarter!
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Illustration of seasonal adjustment!
Unemployment numbers actually recorded in a town for the second quarter of
20X8 were 2,400. The seasonal variation for this quarter is 0.95. Using the
multiplicative model for seasonal adjustment, calculate the seasonally-
adjusted figure (in whole numbers) for the quarter!
Answer!
= 2,400 ÷ 0.95!
= 2,526!
!
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Revision!
• Make short notes, and attempt all the Test your Understanding exercises!
• Visit the cimaglobal website to check on any recent articles that may be
relevant!
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On the assessment day!
• Make sure that you are thoroughly familiar with the software before the
exam starts !
• Write down all the question numbers on a piece of paper and use a key
to identify questions!
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On the assessment day!
• You will be given a five minute warning before the end of the
exam!
• Make sure before you finish the exam that you have submitted answers to
all questions: guessing if necessary. !
• GOOD LUCK!!
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