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Lecture notes

Fundamentals of Finance Lecture Notes
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Notes for all 10 lectures of the Warwick Business School course Fundamentals of Finance. All material from the syllabus is covered with some added material for clarity. It contains all formulas and concepts needed for the exam. Enjoy!

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  • December 10, 2021
  • 33
  • 2021/2022
  • Lecture notes
  • Rory mullen
  • All classes

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2660 FUNDAMENTALS OF FINANCE LEGEND : =
HEADINGS

LECTURES WEEK 1 -
WEEK 9
=
SUB -
HEADINGS

PROF . RORY MULLEN
=
FORMULAS

WARWICK BUSINESS SCHOOL ,
2021

CARLO DALLE MULE




TOPICS :
DIFFICULTY :




1. FINANCIAL ARITHMETIC • • B.

2. RISK AND EXPECTED RETURN 88 88

3. INVESTMENT UNDER CERTAINTY Be Bo

4. RISK AVERSION AND EXPECTED UTILITY • 08 •

5. OPTIMAL PORTFOLIO SELECTION Ba • or • • !
6. CAPITAL ASSET PRICING MODEL • • • Boa

7. MARKET EFFICIENCY •

8. BOND Do • • ooo
.




PRICING

9. FORWARDS AND FUTURES Be • or

10 .
OPTIONS Bo • 08 Oo ooo !


1. FINANCIAL ARITHMETIC

READINGS : •
HILLIER ET AL .
: 4. I -4.4
•
HILLIER ET AL .
: 5. I -5.3



SENSE OF TOPIC : ARITHMETIC TOOLS FOR BASIC FINANCIAL CONCEPTS . THESE

ARE FOUND THROUGHOUT FINANCE AND ARE MOSTLY BASED

ON THE TIME -
VALUE OF MONEY



SUB -
TOPICS :
1.1 :
DISCOUNTING CASHFLOWS AND NPV

1. 2 : ANNUITIES AND PERPETUITIES

1. 3 :
COUPON BONDS AND ASSET RETURNS



1. 1 DISCOUNTING CASH FLOWS AND NPU


FUTURE CASH FLOWS NEED TO BE DISCOUNTED TO FIND PRESENT VALUE



NPV OF CASH FLOWS :




É
r T ⇐+
CFT
☐Ft =
(ntpjt
PV= [ Npv = -

I +
CAR)t
+ CAR)t +




Lor •
R IS THE RELEVANT COST OF CAPITAL
•
t ARE THE PERIODS
•
I IS THE INITIAL INVESTMENT


↳ IF Npv > 0 THE PROJECT BRINGS VALUE

,1. 2 ANNUITIES AND PERPETUITIES

PERPETVITIES :




↳ CASH FLOWS RECEIVED IN PERPETUITY
IF THE ARE



pv =
Ept → AS IT IS A GEOMETRIC SERIES
SO THAT
,
THE QUESTION IS HOW MUCH MONEY

C ? /r
DO I NEED TODAY MY INTEREST IS EXACTLY → c



CF
PV = → IF THE PERPETUITY GROWS
p -
g

↳ •
G MUST BE SMALLER THAN r

•
IT IS ASSUMED THAT CASH FLOWS OCCUR AT DISCRETE

POINTS IN TIME



ANNUITIES :




↳ IF THE CASHFLOWS ARE CONSTANT AND RECEIVED FOR T PERIODS


↳ CAN BE DERIVED DIFFERENCE BETWEEN PERPETUITY STARTING
BY THE A

TODAY AND ONE STARTING AT T


±

( F- ) eF( )
^

( Ent)
1
-




( Hrt
¥
⇐
-
→ →
t

r



AT IS THE ANNUITY FACTOR

]
→ SOMETIMES

( (F-ryt
,
1-
CF
pv =
FORMULA IS DEFINED AS EF .

AI
r




IF THE ANNUITIES GROW SAME FORMULA CAN BE USED , ACCOUNTING FOR G
,




Piece
[1-4^7++1] r -


g



1. 3 COUPON BONDS AND ASSET RETURNS


COUPON BONDS :




↳ PAY CASHFLOWS AS COUPON AND FACE VALUE AT LAST PERIOD


↳ TREATED AS AN ANNUITY 1- PV OF LAST PAYMENT




GIRI] +
/
FV
^ -




Pv= ee
r Gtr)T

,ASSET RETURNS :




↳ EXPRESSED IN PERCENTAGE


↳ ALWAYS REFERRING TO A PERIOD → IN THIS CASE t → tt s


↳ TWO COMPONENTS :
VALUE GAIN AND CASHFLOW S




→
RETURN RATE IS PRICE INCREASE PLUS CASH Flows
Ptts -

Ptt EÉ^CFt
Rt , tts DIVIDED INITIAL PRICE
=
BY
pt

, 2. RISK AND EXPECTED RETURN

READINGS : •
HILLIER ET AL .
:
9. I -9.6
•
BODIE ET AL .
:
5. 4- 5.5
•
BODIE ET AL .
: 18.2



SENSE OF TOPIC :
WHENEVER THERE IS RISK ,
IT IS COMPENSATED FOR . STOCK RETURNS ,



HOWEVER , CANNOT BE PREDICTED AND ARE THEREFORE RANDOM

VARIABLES . EXPECTED RETURN IS USED INSTEAD .




SUB -
TOPICS : 2.1 :
RANDOM VARIABLES

2. 2
:
DISCRETE PROBABILITY DISTRIBUTION

2. 3 :
CONTINUOUS PROBABILITY DISTRIBUTION



2. 1 RANDOM VARIABLES :




RETURN ON STOCK :




→ FORMED BY TWO COMPONENTS :
CAPITAL GAIN AND DIVIDEND
Pttn P+tDNt+,
-




Ry =
→ CAPITAL GAINS CAN GO UNREALISED
Pt


↳ STOCK RETURNS ARE RANDOM VARIABLES :




RANDOM VARIABLE :
A NUMERIC QUANTITY THAT DEPENDS ON THE REALISATION

OF A RANDOM PROCESS



RANDOM PROCESS :
A SITUATION IN WHICH POSSIBLE OUTCOMES ARE KNOWN BUT

NOT WHICH ONE WILL HAPPEN


↳ USE OF PROBABILITY IS REQUIRED



2. 2 DISCRETE PROBABILITY DISTRIBUTIONS :




DISCRETE RANDOM VARIABLE : A RANDOM VARIABLE THAT TAKES ONLY A COUNTABLE
NUMBER OF POSSIBLE VALUES



MEAN OF DISCRETE RANDOM VARIABLE :




MEASURES
[ Nn=np(✗=xn)xn
→ CENTRALITY
µ=E(×)=


VARIANCE OF DISCRETE RANDOM VARIABLE :




→
En? p(✗ =Xn)(xn MY
MEASURES DISPERSION
02-_E[ ( ✗ -
MY] =
,
-

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