Principle of Investment - R. Sheet PDF

PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER Principle of Investment - R. Sheet Q.1 : ( Complete … ) 1- The financial system consists of…. Ans. the group of ins9tu9ons in the economy that help to match one person’s saving with another person’s investment. 2- The financial system...

PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER Principle of Investment - R. Sheet Q.1 : ( Complete … ) 1- The financial system consists of…. Ans. the group of ins9tu9ons in the economy that help to match one person’s saving with another person’s investment. 2- The financial system is made up of financial ins9tu9ons that …. Ans. coordinate the ac9ons of savers and borrowers. 3- Financial ins9tu9ons can be grouped into …. Ans. Two different categories …. 1- Financial markets 2- Financial intermediaries 4- Financial Markets CONTENTS OF …. Ans. 1- Stock Market 2- Bond Market 5- Financial Intermediaries CONTENTS OF …. Ans 1- Banks 2- Mutual Funds 6- Financial intermediaries are financial ins9tu9ons through which. Ans (…. savers ) can Ans (…. indirectly ) provide funds to -1-  PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER Ans (…. borrowers ). 7- sacrifice IS …. Ans. ( The giving up of something important to us now (money or 9me) to get something beSer in the future ) 8- stock tables provide the following informa0on …. Ans. …. 1-Price (of a share) …. 2- Volume (number of shares sold) …. 3- Dividend (profits paid to stockholders) …. 4- Price-earnings ra0o 9- The most banks opera9ons …. Ans. …. 1- Take deposits from people who want to save and use the deposits to make loans to people who want to borrow… CR. …. 2- Pay depositors interest on their deposits and charge borrowers slightly higher interest on their loans… DEP. …. 3- Help create a medium of exchange by allowing people to write checks against their deposits. A medium of exchange is an item that people can easily use to engage in transac9ons. …. 4- Facilitate the purchases of goods and services. 10- A mutual fund is Ans. An ins9tu9on that sells shares to the public and uses the proceeds to buy a por[olio, of various types of stocks, bonds, or both. 11- Intermediaries financial ins9tu9on contents of ….. -2-  PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER Ans. …. 1- Credit unions …. 2- Pension funds …. 3- Insurance companies …. 4- Loan sharks 12- Financial Intermediaries Important in Financial Markets because of … Ans. 1- Transac9on cost: Refers to the 9me and money spent in carrying out financial transac9ons. 2- Risk sharing: Financial intermediaries sell assets with risk characteris9cs that people are comfortable with and then use the funds to purchase other assets that may have far more risk. 3- Asymmetric informa9on (i.e., where one party has more or beSer informa9on): Financial intermediaries are usually beSer at credit risk screening than individuals, therefore reducing losses due to wrong investment decision making. 13- Transac9on cost Refers to… Ans. the 9me and money spent in carrying out financial transac9ons. 14- Risk sharing in financial intermediaries sell assets with … Ans. risk characteris9cs that people are comfortable with and then use the funds to purchase other assets that may have far more risk. 15- To value bonds and stocks we need to… Ans. -3-  PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER A- Es0mate future cash flows, size (how much) and 9ming (when) B- Discount future cash flows at an appropriate rate 16- A bond IS … Ans. Debt issued by a corpora0on or a governmental body 17- A bond represents … Ans. a loan made by investors to the issuer. 18- Money Markets…. Ans. The financial markets for short-term debt instruments (generally those with original maturity of one year or less). 19- Capital Markets …. Ans. The financial market for longer-term debt (generally those with maturi0es greater than one year) and equity (common stock). 20- Direct Finance …. Ans. Funds that directly flow lenders to borrowers with the assistance of ins0tu0ons that provide brokerage services (research and advice, re0rement planning, tax 0ps, execu0on of trades) 21- Indirect Finance … Ans. Funds that flow through financial intermediaries, such as depository ins0tu0ons, insurance companies and mutual funds -4-  PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER Q. 2 : T – F 1- A bond is a certificate of indebtedness that specifies obligations of the borrower to the holder of the bond. (. ) 2- Credit Risk is the probability that the borrower will fail to pay some of the interest or principal. (. ) 3- Stock represents a claim to partial ownership in a firm and is therefore, a claim to the profits that the firm makes. (. ) 4- The sale of stock to raise money is called equity financing. (. ) 5- Compared to bonds, stocks offer both higher risk and potentially higher returns. (. ) 6- Mutual funds allow people with small amounts of money to easily diversify. (. ) 7- Y = C + I + G + NX (. ) 8- National saving is the total income in the economy that remains after paying for consumption and government purchases. (. ) -5-  PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER 9- Private saving is the amount of income that households have left after paying their taxes and paying for their consumption. (. ) 10- Savings is the portion of current income not spent on consumption. (. ) 11- Investing is the purchase of assets with the goal of increasing future income. (. ) 12- Future Value Refers to the amount of money to which an investment will grow over a finite period of time at a given interest rate. (. ) 13- There is no different between trade and investment. (. ) 14- In market we briefer gambling vs investment. (. ) 15- Primary Financial Market IS The financial market in which new issues of a security, such as a bond or a stock, are sold to initial buyers by a corporation or a government. (. ) 16- The financial market in which securities that have been previously issued can be resold (. ) -6-  PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER 17- Secondary markets provide liquidity for previously issued securities. (. ) 18- Money Markets ( The financial markets for short-term debt instruments (generally those with original maturity of one year or less). (. ) 19- Capital Markets ( The financial market for longer-term debt (generally those with maturities greater than one year) and equity (common stock). (. ) 20- Indirect Finance ( Funds that flow through financial intermediaries, such as depository institutions, insurance companies and mutual funds.) (. ) 21- Direct Finance( Funds that flow directly lenders to borrowers with the assistance of institutions that provide brokerage services (research and advice, retirement planning, tax tips, execution of trades). (. ) 22- Value of financial securities = PV of expected future cash flows (. ) -7-  PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER 23- Savings is the portion of current income not spent on consumption. (. ) 24- Investing is the purchase of assets with the goal of increasing future income. (. ) 25- Risk = The chance that the value of an investment will decrease.(. ) 26- Return= The profit or yield from an investment. (. ) 27- Liquidity=The ability of an investment to be converted into cash quickly without loss of value.(. ) 28- Future value ( FV ) refer to the amount of money to which an investment will grow over a finite period of time at a given interest rate.(. ) 29- future value is the cash value of an investment at a particular time in the future. (. ) -8-  PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER 30- Functions of Financial Markets provides financial signals to market participants such as Interest rates, stock prices, exchange rates. (. ) 31- We can use financial market signals as a leading indicator of economic activity. (. ) 32- Stock prices and interest rates may tell us something about the market’s assessment of companies, financial institutions, and even overall financial markets (. ) 33- Primary Financial Market is the financial market in which new issues of a security, such as a bond or a stock, are sold to initial buyers by a corporation or a government. (. ) 34- Secondary Financial Market is the financial market in which securities that have been previously issued can be resold. (. ) 35- Liquidity refers to the ease of conversion of a financial asset into cash (prior to maturity if there is a -9-  PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER maturity date) and how stable the price of the asset is while being held in a form other than cash. (. ) Ans. From 1 to 35 ( True ) - 10 -  PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER Q.3: Draw Circular Flow of Income in A Simple Economy Ans. Q.4: Draw Flow of Funds Through a Financial System - 11 -  PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER Q.5: Invest sum OF ( 1000 LE ) over years ( 2 Y ) , how much will it be worth? Find : 1- Terminal Value ? Ans. TVn = P (1 + r ) n if r1 = r2 = … = rn 2 1000 (1.1) = 1210 2- Discounted Present Value? A: TVn 1210 DPV = = = 1000 (1 + r ) n 2 1.1 B: Discounting is the inverse or mirror image of compounding. - 12 -  PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER Q. 6: If you in charge in a project proposal with current data 11-2023 CF1 = 1100 CF2 = 1210 R= % 10 KC=2100 A- Should you invest ? Ans. Total CF = 1100+1210= 2310 KC= 2100 ( TOTAL CF )2310 > ( KC ) 2100 Invest B- Find NPV ? AND Explain Your Design Opinion? Ans. CF1 CF2 1100 1210 DPVCF = + = + = 2000 (1 + r ) (1 + r ) 1.1 (1.1) 2 2 KC = 2100 - 13 -  PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER DPV ( 2000 ) – KC ( 2100 ) = ( -100 ) < 0 Do not invest, because opportunity cost of capital not compensated for Equivalently. - 14 -  PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER Q.7: Consider a zero-coupon bond, with a face value of $1,000, maturing in 5 years. Suppose that the appropriate discount rate is 8%. What is the current value of the bond? Ans. This is a simple TVM problem: Use the above PV equation to solve: PV = F / (1 + r)T = 1,000 / (1.08)5 = $(. ) - 15 -  PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER Q8: Suppose 6 months have past. What is the bond value now? Ans. use the above PV equation to solve: PV = F / (1 + r)T = 1,000 / (1.08)4.5 = (. _. )$ Note: As we get closer to maturity(T), the z.c. bond value increases (PVm), since we have to wait less time to receive $1,000 Q.9: Compare between ( Saving and Investment ) according to … 1- Risk, 2- Return, 3- and Liquidity Ans. Savings Investments 1- Low risk 1- High 2- Low risk return 2- High 3- High return liquidity - 16 - 3- Low liquidity  PRINCIPLE OF INVESTMENT 3 ACC. DR. MOFIED MAHER Q.10 Why are Financial Intermediaries Important in Financial Markets? Ans. 1- Transaction cost: Refers to the time and money spent in carrying out financial transactions. Financial intermediaries can substantially reduce transaction costs because they have developed expertise in lowering them, and because their large size allows them to take advantage of economies of scale. 2- Risk sharing: Financial intermediaries sell assets with risk characteristics that people are comfortable with and then use the funds to purchase other assets that may have far more risk. This process of risk sharing is called asset transformation, i.e., risky assets are turned into safer assets for investors. Another way of risk sharing provided was through diversification; financial intermediaries invest in a collection of assets whose return do not always move together, with the result that overall risk is lower than for individual assets. 3- Asymmetric information (i.e., where one party has more or better information): Financial intermediaries are usually better at credit risk screening than individuals, therefore reducing losses due to wrong investment decision making. They have developed expertise in monitoring the parties they lend to, thus reducing losses due to moral hazard. - 17 -