Fundamentals of Finance

• Fundamentals of Finance

Gross Domestic Product (GDP)

• An economic indicator measuring the value of goods/services produced in a country
• Used to understand the economic state of a nation
• Data is consulted from DANE (National Administrative Department of Statistics)
• Calculated quarterly, based on production

Economic Agents

• Families
• Government
• Foreign entities

Absolute Change

• Refers to the difference between two financial values like asset prices, income, or benefits
• Determines how much an investment, asset, or company's value has changed without considering negative or positive changes
• Useful tool for comparing movements of different assets/values
• Provides a clear measure of absolute modifications

Absolute Change formula

• Absolute change = |Final Value - Initial Value|

Relative Change

• A measure expressing the change between two values in terms of their proportion or percentage relative to the initial value.
• Considers the change's magnitude relative to the initial value
• Generally expressed as a percentage

Relative Change Formula

• Relative change = (Final Value - Initial Value) / Initial Value * 100
• Used to calculate inflation

Absolute vs. Relative Change Differences

• Absolute change is measured in monetary or value units
• Relative change is measured in percentage, reflecting the proportional variation with respect to the initial value

Inflation

• Consistent rise in prices
• Continuous growth of the CPI(Consumer Price Index)
• Starts affecting consumption in a country
• Without consumption, there is no economic growth
• Central banks primarily aim to control inflation by controlling prices

Interest Rates

• Used as a tool for economic control
• Rise in interest rates diminishes consumption and inflation, reducing demand
• Used as a monetary policy
• Lower interest rates increases both consumption and inflation by boosting demand
• Used as a expansionary monetary policy

Interest Rate Impact

• Aspect, High Interest Rate Impact, Low Interest Rate Impact
• Cost of Loans, Discourages debt, Encourages debt
• Consumption & Spending, Decreases spending, Increases spending
• Business Investment, Decreases Investment, Increases Investment
• Inflation, Tends to decrease, Tends to increase
• Savings, Promotes saving
• Discourages savings, as interests are lower
• Currency Value, May appreciate as investors seek higher returns, May depreciate as investors seek better returns elsewhere
• Economic Growth, May decelerate economic growth, May stimulate economic growth

Price Formation

• Controlled by supply and demand

Supply

• When supply rises, prices fall
• When supply falls, prices rise
• Refers to the quantity of products offered in the market

Demand

• When demand falls, prices fall
• When demand rises, prices rise
• Refers to the quantity of a good/service that consumers are willing to buy at different prices

Taxes

• Increasing taxes helps raise funds

Tax Reform

• Helps collect funds

Economic Growth

• Potential economic growth depends on a country's installed capacity

Deflation

• Decrease in prices
• Can have negative effects like decelerating economic growth and raising unemployment
• Can occur after financial downturns/severe recessions
• Causes an oversupply and a drop in demand
• Diminished demand causes producers and vendors to drop prices to encourage purchases
• When supply rises faster than demand, prices can drop due to competition among vendors

Consumer Price Index (CPI)

• An economic indicator
• Measures the average change over time in the prices paid by urban consumers for a representative basket of goods and services
• Crucial for understanding how prices behave in an economy
• Helps in making decisions at personal/governmental levels
• Allows evaluation of inflation levels, indicating whether prices are rising or falling
• Managed on a monthly basis

Components of the Family Basket:

• Includes non-alcoholic and alcoholic beverages
• Tobacco
• Clothing
• Footwear
• Housing
• Water
• Electricity
• Gas
• Other fuels

Products and Services Basket

• Furniture
• Health
• Household items
• Information
• Communications
• Recreation
• Culture
• Education
• Restaurants
• Hotels

Sticky Products

• Products whose prices do not change easily, includes electricity, water, gas, health, furniture, telecommunications and lodging

Highly Variable Products

• Products that are more likely to fluctuate in price, includes fuels, TVs, mobile phones, computers, information/communications, housing, restaurants and hotels

Constant Products

• Inputs that can be changed to increase or reduce production
• Includes soap, shampoo, non-alcoholic beverages, medications, bread, hygienic paper, recreation, and culture

Analysis

• Analyzed without considering the effects of inflation, eliminating price changes over time

Tariffs

• Apply to both internal and external consumption
• Has an effect on prices
• Tax for bringing products into the country
• Controlled by the government
• Acts a sale price
• Increase in tariffs causes an increase in prices

Price Elasticity

• Measures a product's ability to maintain demand despite price increases

Inelastic Goods

• Refers to products that experience a drop in demand when prices change or increase

Inflation Target in Colombia

• Intended to be in the 2%-4% range
• Inflation above 4%
• Interest rates are lowered when below 2%

Central Bank

• Tasked with controlling inflation
• Focused on fostering economic growth
• Inflation is managed through the intervention rate

Intervention Rate

• The minimum interest rate that the central bank charges financial institutions for liquidity

Commercial Banks

• Generates capital through savings rates and lends funds to people
• Can receive funds from the central bank

Central Bank

• Sets the interest rate at which it lends resources
• Can intervene in the market
• Takes interest rate deposits
• Controls market interest rates

NIM (Net Interest Margin)

• Income generated by a person

Interest Rates

• Set for deposits and loans

Unemployment Rate

• Percentage of the active population that is unemployed but actively seeking work

Unemployment Rate Formula

• TD = Unemployment Rate
• DS = People seeking work
• DEA = People integrated into the labor force
• (%)TD = DS / DEA * 100

Importance

• Most important when the economy is slowing down or starting to shrink

High Inflation & Recession

• Referred to as Deflation

DANE (National Administrative Department of Statistics)

• Responsible for monitoring unemployment
• Monitors inflation of sticky products

Branches of Economic Activity

• Agriculture, livestock, hunting, fishing, and forestry (forest management)
• Mining and quarrying
• Manufacturing industries
• Electricity supply: gas, steam and air conditioning
• Construction
• Wholesale and retail trade
• Information and communications
• Financial and insurance activities
• Real estate activities
• Professional, scientific and technical activities
• Public administration: defense, education, and health
• Artistic, entertainment and recreational activities

Opportunity Cost

• Decisions that turn out well but could have been better

Potential Growth

• Growth that can occur in a sensible way

Gross Domestic Product Formula

• GDP = C + I + G + (X-M)
• C = Consumption , spending on goods and services by households
• I = Investment, spending by companies on equipment and by families on housing
• G = Spending, state spending on purchasing goods or payments to personnel
• (X-M) = Net Exports (spending by foreigners on goods in our country (Exports) less spending by residents abroad (Imports))

Nominal GDP

• GDP Growth

Real GDP

• Nominal value of the variable less inflation

Real GDP formula

• Nominal GDP – Inflation = Real GDP

Monetary Policy

• Intended to control inflation
• Extensive: Lowers interest rates
• Contractive: Raises interest rates

Fiscal Policy

• Controlled by the Government
• Uses taxes

Fiscal and Monetary policy

• Are related

Economic Growth

• Economic growth aligns with potential growth

Economic Agents

• Households (Consumption)
• Companies (Investment)
• Foreign Entities (Import-Export)
• Government (Infrastructure & Spending)

Interest

• Cost paid for the use of money over time, a relationship between money and time

Interest Rate

• Represents the income when lending money
• Lends resources and receives resources
• Can be capitalized and insured
• Can be invested
• The higher the term, the higher the interest rate

Investments

• Investments are represented in annual terms

Returns

• Returns are expressed annually

Effective Annual (EA)

• Represented as EA

Controlled Inflation

• Central bank lowers rates to control the growth of consumption

Curve Inversion

• Inverted curve means interest rate drops and the inflation rises sharply

DTF (Fixed Term Deposit)

• Weighted average of the deposit rates of 90-day CDs
• Calculated weekly by the central bank based on deposit rates
• Benchmark rate for the Colombian market

CDs (Certificates of Deposit)

• Instrument to invest money based on loans

Weighted Average

• Sum of the total captured

IBR (Banking Reference Indicator)

• Short-term interest rate reflecting the price at which market participants are willing to offer fundsor capture resources
• Involves 8 banks to capture or lend resources
• Calculated by the central bank

Banks

• Each bank applies its interest rate

Capture

• Borrow through a savings account or CDs
• Involves the Bank
• Cost is low rate

Place

• Provide resources or money through a credit card
• Involves the bank
• Income is high rate

Interest Rate

• Interest Rate Capto Average To Initial Rate
• Interest Rate Placement Average To Initial Rate
• 10.5 ABOVE = PLACE
• 10, 5 BELOW = CAPTO

Real Value Unit (UVR)

• A unit whose value in pesos is determined exclusively based on inflation
• Commonly used to calculate the cost of housing loans
• Frequency is daily
• Is certified by the central bank

Inflation Formula

• Final variation / Initial variation - 1% = CPI Variation = Monthly Inflation

Usury Rate

• The limit at which a financial institution can charge interest on its loan

Superfinancial Entity

• Delivers the maximum rate that can be charged
• Calculated and varies every 15th of the month

Market Representative Rate (TRM)

• Amount of Colombian pesos per 1 US dollar
• Calculated daily and certified by the Financial Superintendency
• Consulted in the central bank
• FIX is its weighted average
• Used to settle financial instruments
• Operates only on weekdays
• Weekends and holidays are excluded
• TRM calculation: Current TRM together with the following day

Devaluation

• Decrease in a local currency's value compared to a foreign currency in nominal value

Nominal Value Devaluation

• Local currency loses value

Loss

• Loss of the value of the local currency
• Increase in the exchange rate

Revaluation

• The currency value's gain
• Decrease in the exchange rate

Legal Minimum Monthly Wage (SMMLV)

• The minimum remuneration to which every worker is entitled to cover their basic needs
• National government is responsible for defining the minimum wage
• Calculated based on inflation expectations for the coming year
• Increasing the wage causes inflation

Financial Transactions Tax (GMF)

• Tax applied to Colombian financial transactions
• 4 per 1000 pesos of a transaction, withdrawal, or payment from a savings account
• 4 per 1000 = GMF

Value Added Tax (VAT)

• Tax levied on most goods and services
• Applied on Consumption
• Supports the environment
• VAT = 19%
• 5% - 35% products violence

Debt Rating

• Level of confidence one can have in a country's securities
• Associated with the government's ability and willingness to punctually fulfill external debt obligations

Risk Rating Agencies

• Standard and Poor's
• Fitch Ratings
• Moody’s

Investment Grade

• High quality, superior quality, upper-medium grade, medium grade

Speculative Grade

• Default, risk of non-payment, lack of investment characteristics

Different Impact of an Investor Degree

• Investors are impacted differnetly

Reference Rates

• Number of shares x price = Standard and Poor's 500
• s & p 500, 500 companies with the highest stock market capitalization in the U.S.

Investment Funds

• Collective investment with a goal in the documents

Prospectus

• Indicates where investment funds are allowed to invest

Liabilities

• Aims to replicate an index's behavior

Assets

• Aims to beat a benchmark, i.e. portfolios, although they tend to be riskier

COLCAP

• Cannot be purchased
• Colombian stock index

Exchange Traded Fund (ETF)

• Investment fund
• Traded on the stock exchange
• Riskier
• Greater profitability

Finances

• Managing money
• Allocating resources over a long time

Capital Flow

• Consists of Companies, State, Financial Institutions and Capital Market

Superative Agents

• Agents with money
• Deposit collection in the banks
• Invest money

Deficit Agents

• Agents without money
• Loans in banks
• Get money

Finance areas

• Financial Administration
• Financial Markets
• Financial Investments

Financial Administration

• Efficient use of financial resources in an economic entity

Financial Markets

• Conversion of savings into investment

Financial Investments

• Designing and delivering financial products to individuals, companies, and governments to provide advice

Financial Principles

• Basic financial goal: to make or generate money
• Value of money over time: Amounts of money cannot be compared at different times
• Risk vs. Return Dilemma: Tension between the possibility of losing money and earning it; greater risk, greater return
• Risk: The possibility that an investment will not yield the expected results
• Return: What can be earned on an investment
• Liquidity vs. Return Dilemma: Tension between the ability to generate profits and the ease of converting assets into cash; less liquidity, higher return
• Liquidity: Ability of a company to pay its short-term debts
• Long-Term Assets: More profitable, less liquid
• Short-Term Assets: Less profitable, more liquid

Business Cycles

• Refers to the cycle of commercial and economic activity

Commercial Cycle

• Set of processes carried out to generate a sale

Company Lifecycle

• Stages a company experiences throughout its life

Economic Cycles

• Recurring patterns of economic growth and decline experienced by organizations in relation to the overall economic activity of a country

Efficient Diversification

• Investment strategy that involves distributing resources across different assets to reduce portfolio risk, improving the chances of achieving a balanced and stable return

Opportunity Cost

• Profitability that is being forfeited
• Loss of benefit when choosing one option over others

Tail Event

• Worst associated event at 1% probability, occurs in the risks