Basic Finance

Basic Finance
• Investing vs. Savings
• Capital Budgeting
• Financial market and the economy
• Real and financial assets
• Financial intermediaries
Investment Vs. Savings
Investment:
• Involves allocating money to assets like stocks, bonds, real estate, or
mutual funds, with the goal of generating a return over time.
Investments carry a higher level of risk, but they also offer the
potential for higher returns.
• Unlike savings, investments are typically less liquid and require a
longer time horizon
Savings:
• Refers to the act of setting aside a portion of your income for future
use, typically in low-risk, liquid accounts such as a savings account,
checking account, or a money market account.
• The primary goal of savings is to ensure safety and liquidity,
preserving capital while earning minimal interest
Investment Vs. Savings
Purpose
• Savings: The primary purpose of savings is to create an emergency
fund or to meet short-term financial goals, such as buying a car, going
on vacation, or covering unexpected expenses. It’s about maintaining
financial security and preparing for unforeseen events.
• Investment: The purpose of investing is to grow wealth over time by
earning returns on the capital you invest. This can help achieve long-
term financial goals such as retirement, buying a house, or building
wealth for future generations.
Key Differences
Examples

Savings Investments
• Savings accounts • Stocks
• Money market accounts • Bonds
• Certificates of deposit (CDs) • Mutual funds
• Cash • Real estate
• Retirement accounts
Capital Budgeting
• Capital budgeting is the process by which companies evaluate and
decide on potential investments in long-term assets or projects.
• It involves analyzing the costs, risks, and returns associated with these
investments to determine whether they will add value to the business
in the long run.
• The goal of capital budgeting is to ensure that the company makes the
most efficient use of its capital resources by choosing projects that
are expected to generate the highest return relative to their risk.
Key Concepts in Capital Budgeting
Capital Expenditure (CapEx):
• This refers to the money a company spends on acquiring or upgrading
physical assets such as property, equipment, or machinery that will be used
for long-term purposes (typically over one year).
Investment Decision:
• Capital budgeting involves decisions about large-scale investments in projects
or assets that require substantial financial resources. These decisions are
crucial because they have a significant impact on a company’s future
profitability and growth.
Steps in Capital Budgeting Process
1. Identifying Investment Opportunities:
• The first step involves identifying potential projects or investments that align with the
company’s strategic objectives, such as acquiring new technology, expanding into new
markets, or increasing production capacity.
2. Estimating Cash Flows:
• For each investment, estimated future cash inflows (revenues or savings from the
investment) and outflows (costs of the investment and maintenance) need to be
forecasted. This step involves considering both the initial investment cost and the
expected returns over the project's life.
3. Evaluating Investment Projects:
• Different methods are used to evaluate the potential profitability of a project. These
methods often focus on the time value of money, risk, and profitability of the
investment.
Additional Factors To Consider
1. Risk:
• Assessing the risk of a project is crucial, as higher risk may require higher returns to justify the
investment. Sensitivity analysis and scenario analysis are often used to assess how changes in
assumptions (like cash flows, discount rate, or project life) can affect the project's viability.
2.Project Life:
• The time horizon of the project can influence capital budgeting decisions. A longer project life
might involve higher uncertainty, but it may also provide greater potential for returns.
3.Inflation:
• The impact of inflation on future cash flows must be considered, as inflation can erode the
real value of future revenues and increase costs.
4.Strategic Fit:
• The project should align with the company’s strategic goals and objectives. Even if a project is
financially sound, it may be rejected if it doesn’t fit with the long-term vision of the company.
Financial Market in the Economy
• A financial market is a marketplace where buyers and sellers trade
financial assets such as stocks, bonds, commodities, currencies, and
other financial instruments.
• These markets play a vital role in the global economy by facilitating
the efficient allocation of capital, enabling businesses to raise funds
and investors to buy and sell assets.
• Investors in the stock market ultimately decide which firms are to
grow and which firms are to die (risky)
Types of Financial Market
• Capital market (stocks and bonds)
• Money market (treasury bills, commercial paper, certificate of
deposits)
• Foreign exchange market
• Derivatives markets (future contracts, options, swaps)
• Commodity market (Oil, wheat, coffee, and gold trading)
• Insurance Markets (health risks, accidents, or property damage)
• Cryptocurrency Market (digital platforms)
Functions of Financial Market
1.Price Discovery:
• Financial markets play a critical role in determining the price of financial assets. The forces of
supply and demand dictate the price of stocks, bonds, commodities, and currencies in the
market.
2.Liquidity:
• Markets provide liquidity, meaning that investors can buy or sell assets quickly without
causing a significant price change. This encourages more participants in the market and
allows for the easy exchange of financial assets.
3.Capital Formation:
• By allowing companies and governments to raise funds, financial markets facilitate capital
formation, which is crucial for economic development. Companies issue shares or bonds to
raise funds for expansion, research, or infrastructure projects.
4.Risk Management:
• Financial markets allow participants to manage risk through various financial instruments. For
example, derivatives allow investors to hedge against price fluctuations in underlying assets,
such as commodities or foreign currencies.
5.Information Efficiency:
• Financial markets help disseminate information about an asset’s value. Investors use this
information to make decisions about buying and selling. Efficient markets help allocate
resources to their most productive uses.
Participants in Financial Market
1. Individual Investors:Retail investors who buy and sell financial assets for personal
investment purposes, such as retirement savings, college funds, or wealth accumulation.
2. Institutional Investors:Large entities like mutual funds, pension funds, hedge funds, and
insurance companies that manage significant amounts of money and engage in large-
scale transactions in financial markets.
3. Brokers and Dealers:Brokers act as intermediaries who facilitate the buying and selling
of assets for clients, while dealers buy and sell securities for their own accounts.
4. Governments and Central Banks:Governments issue bonds to finance their spending,
and central banks regulate money supply, set interest rates, and manage currency
exchange rates to stabilize the economy.
5. Investment Banks:Investment banks help businesses raise capital by issuing new
securities, assist in mergers and acquisitions (M&A), and engage in trading and market-
making activities.
Importance of Financial Markets
1. Efficient Allocation of Capital:Financial markets help direct funds from savers to
borrowers (businesses and governments). Efficient capital allocation ensures
that the best investment opportunities are funded, driving economic growth.
2. Economic Growth:By providing businesses with access to capital, financial
markets support economic growth and innovation. This leads to more jobs,
higher productivity, and overall economic development.
3. Investment Opportunities:Financial markets provide individuals and institutions
with opportunities to invest and diversify their portfolios, spreading risk and
increasing the potential for returns.
4. Facilitate Trade:Markets like the Forex market and commodity exchanges
enable the exchange of currencies and goods, facilitating international trade.
This is particularly important in a globalized economy.
Real Assets
Real assets are tangible or physical assets that have intrinsic value due
to their substance and properties.
• These assets typically have utility, can be used or consumed, and
often serve as a store of value or provide income.
• These are resources deployed to produce goods and services
• Examples are land, building, supplies, inventories, and machines
Characteristics of Real Assets

1.Tangible: Real assets are physical, meaning they can be touched, seen, and utilized in
the real world. This is in contrast to financial assets, which are intangible claims on
future earnings or cash flows.
2.Intrinsic Value:Real assets have inherent value derived from their utility or the
resources they provide. For example, land has intrinsic value because it can be used for
farming, construction, or development.
3.Hedge Against Inflation:Many real assets (like real estate, commodities, and precious
metals) serve as a hedge against inflation. As inflation rises, the price of these assets
tends to increase, preserving purchasing power.
4.Income-Generating:Real assets, such as real estate, infrastructure, and natural
resources, often generate income through rents, dividends, or royalties. For example,
owning rental properties can provide regular rental income.
Real Assets

Advantages Disadvantages
• Diversification • Illiquidity
• Protection Against Inflation • High Initial Capital Requirement
• Tangible Asset Ownership • Management and Maintenance
• Long-Term Capital Appreciation Costs
• Income Generation • Market Risk
Financial Assets

• Examples are stocks, bonds, or bank deposits

• It represents ownership of a claim on future cash flows or profits
• These are also known as paper assets, evidenced by supporting claims
on real assets by its holders
Characteristics of Financial Assets
1. Intangible: Financial assets do not have a physical form. Their value is derived from a contractual
agreement or a claim on future cash flows. For example, a bond represents a claim on future interest
payments and principal repayment, while stocks represent ownership in a company.
2. Liquidity: Financial assets vary in liquidity. Some, like stocks and bonds, can be traded quickly in the
market, while others, such as certain derivatives or private equity, may be harder to sell and convert into
cash.
3. Risk and Return: The risk and return of financial assets can vary greatly. Generally, higher returns are
associated with higher risks. For example, stocks tend to offer higher potential returns but come with
higher volatility compared to bonds, which offer more stable but lower returns.
4. Marketability: Many financial assets are traded in public markets (e.g., the stock market), making them
marketable. This allows investors to buy and sell assets, adjusting their portfolios as needed.
5. Income Generation: Financial assets can generate income in various forms, such as dividends from stocks,
interest from bonds, or capital gains from the sale of securities at a higher price.
6. Ownership or Claim: Depending on the asset, financial assets can represent ownership (e.g., stocks
represent partial ownership in a company) or a claim to future income (e.g., bonds represent a claim to
future interest payments).
Financial Assets

Advantages Disadvantages
• Diversification • Complexity (hard to understand)
• Liquidity • Market risk (market fluctuation)
• Income and growth • Inflation risk
• Transparency and regulation • Credit risk
• Financial intermediaries are institutions or entities that act as
middlemen between two parties in financial transactions.
• Their primary role is to channel funds from savers (investors) to
borrowers (individuals, companies, or governments), helping to
facilitate the flow of capital in the economy.
• Financial intermediaries make it easier for individuals and
organizations to access financial services, manage risks, and invest
efficiently.
Types of Financial Intermediaries
• Banks
• Investment banks
• Insurance companies
• Pension funds
• Mutual funds
• Hedge funds
• Private equity firms
• Credit unions
Benefits of Financial Intermediaries
• Access to Capital: Intermediaries provide businesses and individuals with
easier access to capital, allowing them to fund growth, innovation, and
consumption.
• Risk Mitigation: By pooling resources and diversifying investments,
intermediaries help manage and reduce financial risk for individuals and
businesses.
• Increased Market Efficiency: Financial intermediaries contribute to market
efficiency by facilitating price discovery, lowering transaction costs, and
enhancing liquidity.
• Financial Inclusion: Intermediaries help promote financial inclusion by
providing services to underserved populations, such as those without access to
traditional banking.
THANK YOU