second year

1. Basic Finance – Basic Concepts in Finance
1.1. What does finance mean ?
 Finance = f (money)
 Money = anything that is generally accepted as payment for goods and services
and repayment of debts
Meanings of “Finance”: - Financial Markets,
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- Investments,
- Corporate and Public Finance,
- Insurance and Banks,
- Monetary and Fiscal Policy,
- Valuation of Tangible and Financial Assets,
- Business Valuation
Finance = science of managing money matters, credit (loan), etc…
Finance = science of managing the issues related to Financial
Markets and Financial Systems

2. 2
Basic Finance – Basic Concepts in Finance
Corporate Finance vs. Public Finance
 Corporate finance is an area of finance dealing with the financial decisions
made by corporations and the tools and analysis used to make these decisions.
* Investment = real investment/financial investment
 Public finance is the field of economics that studies government activities and
the alternative means of financing government expenditures.

3. 1.2. Financial Systems and Financial Markets
Financial Markets = the mechanisms that allow people and companies to easily
trade financial securities, commodities and other fungible
items of value.
*Examples of financial securities: shares (stocks) and bonds
Financial System = the set of financial institutions and the relationships
between these, which serve to money transfer between
persons/ companies/institutions that have excess
funds to the persons/ companies/institutions that have deficits of
funds
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Basic Finance – Basic Concepts in Finance
EXCESS
FUNDS
(CREDITORS /
LENDERS)
DEFICIT OF
FUNDS
(DEBTORS /
BORRWERS)
FINANCIAL
SYSTEM
FUNDS FUNDS

4. 4
Basic Finance – Basic Concepts in Finance
Different financial systems
The Anglo-Saxon System, typical for UK and US, based on capital markets (Stock
Exchanges).
*stock exchange = a place where security trading is conducted on an organized system.
The Continental European System, typical for Germany and based on banks
(commercial banks).
*bank = a financial institution licensed as a receiver of deposits.
(Generally, there are two types of banks: commercial/retail banks - regulated by the Central
Bank and investment banks – regulated by the Security and Exchange Commission)
*The Japanese System, representative for Japan and South Korea, based on entities
known as keiretsu (in Japan) or chobol (in South Korea).
*keiretsu = a powerful alliance of Japanese businesses often linked by cross-shareholding
.

5. Financial Markets
 The money market, which refer to the short term financial market, related to
banks and monetary instruments (money orders, cashier’s checks, traveller’s
checks), including, exchange rate markets.
 The capital market, which refer to the long term financial market, respectively
the market of shares and bonds (primary securities).
By extension, in the capital market are included also futures and options contracts,
even if these are on short term (derivative securities).
*futures contract = a standardized contract to buy or sell a certain underlying instrument
(usually primary security) at a certain date in the future, at a specified price.
*options are financial instruments that convey the right, but not the obligation, to engage in a
future transaction on some underlying security, or in a futures contract.
 The insurance market – ins. companies intermediate funds based on risk transfer
 The real estate & other alternative investments markets (special markets):
on this market traders act as investors, but also as consumers. (include investments
in real estate, in platinum, gold, silver, etc.)
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Basic Finance – Basic Concepts in Finance

6. 6
Basic Finance – Basic Concepts in Finance
Example (for Time Value of Money basic concept):
Mary
Michael
Yearly Income (Y) € 100.000
€ 100.000
Consumption (C) € 50.000
€ 100.000 € 50.000
€ - 50.000
Savings (S) € 50.000
1. - Opportunity cost (sacrifice of
renouncing to consumption &
any other alternative)
2. - Risks (incertitude of
reimbursement, loss of
purchasing power)
Year I
Year II
Loan reimbursement
(10% interest included)
COMPENSATE
10 % interest rate (i)
€ - 55.000 € 55.000

7. 7
Basic Finance – Basic Concepts in Finance
I. Time value of money
 Future value
0=present 1 2……………………….……………………….. n time (t)
A0 A0(1+i) A0(1+i)2 A0(1+i)n
FV(A0, i, n) = A0(1+i)n;
i = interest rate
 Present value (discounting)
0=present 1 2……………………….……………………….. n time (t)
An
An
(1+i)n
PV(An, i, n) =
i = discount rate
An
(1+i)n
PV = FV-1

8. 8
Basic Finance – Basic Concepts in Finance
II. Risk and Return
Return (rate) = classical measure of earning
RT = (IF + Σ(Bi) - II) / II – hhoollddiinngg ppeerriioodd rreettuurrnn
Ry = (In + Bn – In-1) / In -1 – yearly return
Annualized return:
(1+RA) = (1+RT)1/n
*example (E(R) - also for frequency series)
Risk = the probability that an investment's actual return will be different than expected.
σ(R) = [E (R - E (R))2] (1/2)
Risk = standard deviation of the historical returns from the average return
*example (also for frequency series)

9. Basic Finance – Basic Concepts in Finance
III. Price, Value and Valuation. Efficiency of the markets
 Price = the amount of money paid for something.
(*Transaction => Price)
 Value = the utility of having something.
*utility = measure of the relative satisfaction from consumption of various goods and services
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I. Value 1. - utility
2. - value of exchange / rarity
II. Value = Cost of assets; Adam Smith (1776) - Objective Value Theory (theory of Work-based
value).
III.Value = marginal utility - Subjective Value Theory
Value is a subjective variable. (Each person sets a value for assets, related to his or her
own perceptions.)

10. Basic Finance – Basic Concepts in Finance
 Fair market value = an estimate of what a willing buyer would pay to a willing seller, in a
free market.
Fair market value = Price - conditions:
I. rational agents (which choose the project that will generate the higher level of satisfaction)
II. fair transaction:
- well informed buyer and seller (there is not an asymmetrical information)*;
- buyer and seller have equal ability in negotiation;
- buyer and seller are interested in that transaction.
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*Informational Efficiency – features (EMH):
- the price equals the fair market value;
- nobody can obtain systematic abnormal earnings (abnormal returns). *
*Earnings are proportional with the risk took over by investor.