FINANCE 21 Topics
MONEY AND BANKING
Types of Money
Commodity money is a good whose inherent value
serves as the value of money – gold or silver being one
good example.
Fiat money is currency that a government has declared
to be legal tender, but it is not backed by a
physical commodity. The value of fiat money is derived
from the relationship between supply and demand
rather than the value of the material from which the
money is made
Bank money consists of accounting credits that can be
drawn on by the depositor – checking accounts, for
instance.
Philippine Financial System
 Financial Intermediation a financial activity(process)
that distributes the surplus funds of a sector in an
economy to a sector of an economy that needs it
 Financial Institution is an organization through
which funds in the form of money or claims in money
are assembled and transferred from individuals and
firms having surplus of economic goods to those that
need it
 Financial Market is where borrowers and lenders or
investors are regulated and where the price of funds
(interest rate) is determined
Financial Institutions in Philippine Financial Markets
 Banking Institutions
 Universal and Commercial Banks - represent the
largest single group, resource-wise, of financial
institutions in the country. They offer the widest
variety of banking services among financial
institutions. In addition to the function of an
ordinary commercial bank, universal banks are
also authorized to engage in underwriting and
other functions of investment houses, and to invest
in equities of non-allied undertakings.
 Thrift banks are engaged in accumulating savings
of depositors and investing them. They also
provide short-term working capital and medium-
and long-term financing to businesses engaged in
agriculture, services, industry and housing, and
diversified financial and allied services, and to their
chosen markets and constituencies, especially
small- and medium- enterprises and individuals.
 Rural and Cooperative Banks’ role is to promote
and expand the rural economy in an orderly and
effective manner by providing the people in the
rural communities with basic financial services.
Rural and cooperative banks help farmers through
the stages of production, from buying seedlings to
marketing of their produce.
Rural banks and cooperative banks are
differentiated from each other by ownership.
While rural banks are privately owned and
managed, cooperative banks are
organized/owned by cooperatives or federation
of cooperatives.
 Non-Bank Thrift Institutions
Institutions that borrow funds from 20 or more
lenders for the purposes of relending or purchasing
receivables and other obligations.
 Mutual building and loan association
 Non-stock savings and loan association
 Financial Intermediaries
persons or entities whose principal functions
include lending, investing or placement of funds
among others
 Investment house
 Financing companies
 Security dealer / broker
TIME VALUE OF MONEY
Simple Interest – only the principal earns interest
Interest Payment = The amount of interest to
be paid by the debtor
= Principal x Interest x Time
Maturity Value = Total amount received by creditor
by the maturity date when borrowed amount is
paid only upon maturity.
= Principal + Interest Payment
Compound Interest – both the principal and interest
earn interest
Future Value – the amount to which a present cash
cash flow or series of cash flows will grow over a
given period of time when compounded at a given
interest rate.
Compounding – the process of determining the
final value of cash flow or series of cash flows
when compound interest is applied.
Future Value of One – the value of a one time
payment cash flow in the future using compound
interest.
FV of 1 = Present Value of Cash flow x FVof1 Factor
Where, FV of 1 factor = (1 + i)n
Therefore, FV of 1 = PV(1 + i)n
Future Value of Ordinary Annuity - the value of
ordinary annuity cash flow in the future using
compound interest
Ordinary Annuity – series of payment that
occur at the end of each period.
FV of OA = cash flow x FV of OA factor
Where, FV of OA = [(1 + i)n – 1]/i
Therefore, FV of OA = CF{[(1 + i)n – 1]/i}
Future Value of Annuity Due – the value of annuity
due payments in the future using compound
interest.
 Annuity Due – An annuity whose payments Cash Management
occur at the beginning of each period.  Cash Conversion Cycle – length of time funds(cash)
is tied up in working capital (from paying AP to
FV of AD = FV of OA (1+i) collection of AR)
Purchases of RM FG/Sold Collect
Present Value - the value of future cash flows today Inventory Conversion Period Average Collection Period(DSO)
Payment of Payable
Present Value of One – The value today of a Cash Conversion Period
lumpsum amount in the future. Cash Inventory Average Payables
PV of 1 = FV(1 + i) -n conversion = conversion + collection + deferral
period period period period
Present Value of Ordinary Annuity - the value Inventory AR AP
of ordinary annuity cash flow in the present = COGS/365 or 360 Sales/365 or 360 COGS/365 or 360
using compound interest 365 365 365
PV of OA = CF{[1-(1 + i)-n ]/i} = COGS/Ave.Inv. Sales/Ave.AR COGS/Ave.Inv
(Inv. turnover) (Rec. turnover) (Inv. turnover)
Present Value of Annuity Due
PV of AD = CF({[1-(1 + i)-n-1 ]/i}+1)  Optimum Cash Balance (Baumol’s Model) -
optimum cash transaction size which will result to
FS ANALYSIS – (AT THE BACK) lowest total relevant cash cost(TTC+TCC)
= √ 2 x Annual Demand x cost to order(transact)
FINANCE22 Topics Cost to carry(in %)

WORKING CAPITAL MANAGEMENT  Float – the delay in conversion of receivables into

Is concern about the management current assets and cash(collection float) net of delay in conversion of
current liabilities and the trade-off of liquidity and payables into disbursements(disbursement floats).
profitability.
 Lockbox System - A lockbox is a bank-operated
2 Types of Current Assets
mailing address to which a company directs its
 Temporary – current assets needed during peak
customers to send their payments.
seasons
Increase in Cash = Decrease in float x Ave. Daily Cash Receipts
 Permanent – current assets needed even during idle
seasons. Normal level of current assets Net Savings = (Increase in Cash x Interest Rate)-Cost of using Lockbox

2 Types of Liabilities Inventory Management

 Spontaneous – Automatically incurred when current  Economic Order Quantity – optimum order size
assets are increased. Accounts Payable and Accrued which will result to lowest total relevant inventory
Expenses(ex. wages and taxes) cost cost(TCC+TOC). At EOQ, TCC=TOC.
 Non-spontaneous – requires effort from company
just to be increased. Total Carrying Cost(TCC) = (Quantity/2) (CC per Unit)
Total Ordering = (Annual Demand/Quantity)(OC per unit)
Types of Investment Policies
Cost (TOC)
 Relaxed – Large current assets – liberal credit
What size to order?
policies (High Current Ratio)
TCC = TOC
 Moderate – Mid-level assets – moderate credit
(Q/2) (CC ) = (AD/Q)(OC)
policies
Q = √ 2 x AD x OC
 Restricted – Lean current assets – strict credit
CC (in Pesos)
policies (Low Current Ratio)
Types of Financing Policies When to order?
 Conservative – even a portion of temporary
asset is financed by LTD, spontaneous liab and Reorder Point = Lead Time(LT) Usage + Safety Stock(SS)
equity. Higher cost of debt but lower liquidity where,
 Ave. Usage = Annual Demand/Working Days
risk.
 Lead Time Usage = Normal LT x Ave. Usage
 Maturity Matching – Temporary assets are
 Safety Stock = SS in LT + SS in Usage
financed by short-term(nonspon) liab. >SS in LT = (Max. LT-Normal LT)(Ave. Usage)
 Aggressive – a portion of permanent asset is >SS in Usage =(Max. Usage-Ave. Usage)(Normal LT)
financed by short-term(nonspon) debt. Lesser
cost of debt but higher liquidity risk. Receivable and Payable Management
Effective Discount = Days in a year x Discount rate
Rate(EDR) remaining credit time 100% - Discount Rate
= Discount Time TO Periodic Discount %
Ex. Credit Term is 2/10, n30
EDR = 365 x 2% . = 36.73%
30-10 100% - 2%
Note, EDR is the COST OF DISCOUNT to SELLER while it is
the BENEFIT(OPPORTUNITY COST) to BUYER.
Cash Freed
Cash Freed(AR) = Decrease in ACP(DSO) x Daily Sales
Or Cash Freed(INV)= Decrease in ICP x Daily Cogs
Or Cash Freed (AP) = Increase in PDP x Daily COGS
Net Saving = Cash Freed x Investment Int. %
Financial Planning and Forecasting
Additional Financing Needed(AFN or EFN or RFN)
Amount of nonspontaneous funding of asset needed to
support the increase in sales.
FA Without Excess Capacity
1.) Increase in Sales in % = Increase in Asset in %
Sales Growth = Asset Growth
2.) AFN = Increase in Asset - Inc. in SL – RE Addition
= GS(TA) - GS(SL) – REA
= GS(TA -SL) – REA
FA With Excess Capacity
1.) Separate Current Asset and Fixed Asset
2.) AFNCA = GS(CA -SL) – REA
3) Full Capacity Sales = Current Sales(S0)/Current Capacity
4) Fixed Asset CIR = Current FA0/Full Capacity Sales
5) AFNFA = (Target Sales x FA CIR) – Current FA
Or
AFNFA = (Target Sales – FC Sales) x CIR
6) Total AFN = AFNCA + AFNFA
FINANCE33 Topics
INTEREST RATES
Nominal Rate/rCorporate Bond = r* + IP + MRP + DRP + LP
rTreasury Bond = r* + IP + MRP
rTreasury Bills = r* + IP
Corporate Bond Yield Spread = DRP + LP
Mark Industries, a corporation, has a real risk-free rate of
4% and since they are planning to issue 10 year bonds,
their maturity risk premium will be computed as .20(t-
1)%. Their economy is experiencing 3% inflation rate
currently but it is expected to increase by 2% after 4
years. Default risk premium and liquidity risk premium
assigned by the company financial analysts to Mark
Industries are 3% and 4% respectively.
a) What is Mark’s Maturity Risk Premium?
b) What is Mark’s Inflation Premium?
c) What is Mark’s nominal rate?
d) Using this information, what is the estimated treasury
rate?
Magsolve gurow? Dili kay magtan-aw ras solution (-.-)
a) MRP = .20(10-1) % = 1.8%
b) IP = ( 3%(4yrs) + 5%(6yrs))/10 = 4.2%
do not forget to average inflation
c) rCorporate Bond = 4% + 4.2% + 1.8% + 3% + 4% = 17%
d) rTreasury Bond = 4% + 4.2% + 1.8% = 10%
therefore, the CBYS= 3% + 4% = 7%
Pure Expectations Theory = treasury securities will have
the same return in a given period though their terms are
different. Based on assumption that there is no MRP.
8% ?%
9% 9%
Ex:
(1+.09)2 = (1+.08)(1+x)
1.1881 = 1.08 + 1.08x
.1081 = 1.08x
.1001= x or 10.01%
VALUATION TECHNIQUES
Note: Securities valuation/price investors should be
willing to pay is the present value of the cash flow they
are going to receive.
Bond Valuation
Bond Price = PV of Principal + PV of interest
Since we assume that Principal is paid on lumpsum and
interest(coupon) payment is paid on ordinary annuity,
Bond Price = PVof1(Principal) + PVofOA(Interest Payments)
PV Factors use the effective/going/current market rate
aka Yield to Maturity(YTM)
Face Value – Bond Price
YTM = Interest Payment + no. of payments ‘til maturity
Face Value + Bond Price
2
Ex:
Marlon Co. is planning to purchase 10-year term IML
Bonds with a face value of P5,000 and coupon rate of
12%. Current market rate for IML’s type of bond is 14%.
What price should Marlon pay for IML’s bonds?
PV of Principal = .2697(5,000) = P 1,348.72
PV of Interest = 5.2161(5,000 x .12) = 3,129.67
PV of future cash flows(BOND PRICE) = 4,478.39
Note that Marlon should be willing to pay less than the Face
Value(at a discount) since he should be earning 14%(P700)
interest payment if he will invest in currently issued bonds of
the same type(same bond grade).
Now use the computed Bond Price and using the
formula, compute for the YTM. It should be
approximately 14%(13.76%).
If the bonds are callable
Call Price – Bond Price
YTC = Interest Payment + no. of payments ‘til called
Face Value + Bond Price
2
Remember to adjust interest and n to payment terms.
Risk and Returns BL = Bu [ 1 + (1-Tax%)(Debt/Equity)]

Single/Stand-Alone Investments Ex. Queenie Co. currently has a capital structure that consists
Expected Return/r̂ = Σ ( ri x probability of each return) of 40% debt and 60% common equity. The company has a 40%
Risk = Standard Deviation = √(Σ ( r ̅-ri )2/n
tax rate. Current beta of the company is 1.44.

Multiple Asset/ Portfolio Investments a) What is the Unlevered Beta?

Risk = Portfolio Beta = Weighted Ave. of each stock’s beta b) What would the company’s levered beta(bL) if Barnes
Required Return(CAPM)/ = rRF + B(rm - rRF) changed its capital structure to 20% debt ad 80% common
 rRF = Risk Free rate = r* + IP equity.
 rm = Market rate
Stock Valuation a) bU = 1.4 /[1+(.6)(.4/.6)] = 1.0
Price Computation b) bL = 1[1+(.6)(.2/.8)] = 1.15
 Discounted Cash Flow Formula As debt portion decreases, so as levered beta.
 Preferred Stock
Capital Budgeting (Powerpoint presentation on LMS)
V = D/r (Dividend is fixed, perpetuity formula)
 Common Stock
 When dividend grow at a constant rate
P0 = D1 /(r -g) where D1 = Dividend after a year
P0 = Price Today g =growth%
 When Dividends are non constant for a time
P0 = D1 + D2 + … + Dn+1 /(r-g) Horizon value
(1+r)1 (1+r)2 (1+r)n n = horizon yrs
 Using the corporate value
CV0 = Free Cash Flow – CapEx Budget – WC
WACC – g

Rate Computation
 Using Discounted Cash Flow Formula
 Preferred Stock
rv = D/V (Dividend is fixed, perpetuity formula)
 Common Stock
r = (D1 / P0 ) + g

 Using CAPM Formula

= rRF + B(rm - rRF)

 Bond Yield Plus Risk Premium

r = Bond Yield(YTM) + Risk Premium RP= 2 to 4%

Remember, Stocks always have a higher rate than Bonds since

they are riskier than bonds which has a fixed interest return.

Cost of Capital
is calculated by multiplying the cost of each capital source
(debt and equity) by its relevant weight, and then adding the
products together to determine the value.

Long Term Liab weight x After-tax Cost of Debt(YTM x (1-Tax%) = xx%

Preferred Equityweight x Preferred Equity Cost (rv) = xx%
Common Equity weight x Common Equity Cost (r ) = xx%
Weighted Average Cost of Capital(WACC) XX%

Capital Structures and Leverage

Business Risk – inherent to business, incur loss
2 Types of Risk Finance Risk – due to use of debt capacity(LTD)

If there’s no LTD, Total Risk = Business Risk

Beta is UNLEVERED BETA (Bu)

If there’s LTD, Beta should be LEVERED BETA (BL). As company

uses LTD, total risk increases and therefore, beta should
increase so as to compensate stockholders for the additional
risk born.