Money and Banking Lecture Notes PDF

MONEY AND BANKING Ing. Ondrej Ivančo Week 6, 2024/2025  Why do you study? Gardener (watering system) 60€/hour Annual salary 60€ * 5 hours * 240 days = 72.000€/year 250 000 200 000 Gardener 1%, manage...

MONEY AND BANKING Ing. Ondrej Ivančo Week 6, 2024/2025  Why do you study? Gardener (watering system) 60€/hour Annual salary 60€ * 5 hours * 240 days = 72.000€/year 250 000 200 000 Gardener 1%, manager 3% growth/year 150 000 Manager reaches 100K€/year in year 10 100 000 Is it worth to study? 50 000 Future value G: 3,955m€, M: 5,237m€ - 1 3 5 7 9 1113151719212325272931333537394143 Present value (time value of money): Gardener Manager 2,00% discount rate G: 2,533m€, M: 2,963m€ 4,83% discount rate G: 1,446m€, M: 1,446m€ 7,00% discount rate G: 1,038m€, M: 0,891m€  Financial Instruments as Stores of Value Stocks Holder owns a small piece of the firm and participates on firm‘s profit Manager (owner) of the firm sells shares to finance operations / growth and transfer the risk Value of company – value of assets or value of equity? Leverage. Assets Liabilities + Equity Assets Liabilities + Equity 200.000€ (Flat) 200.000€ (Flat1) 200.000€ (Loan) 200.000€ (Equity) 200.000€ (Flat2) 200.000€ (Equity) Market capitalization = Stock price * Number of stocks issued Enterprise value = Market capitalization + Total Debt – Cash Present value of future dividends or net income or free cash flow  Financial Instruments as Stores of Value Bonds („Fixed income“) Standardized form of loans traded on organized markets, issuance For lender (investor) store of value for borrower the alternative to finance operations Value = Present value of future coupon payments + repayment of nominal value Comparison with stocks – risk, expected return, upside (Howard Marks memo)  Financial Instruments as Stores of Value Bank loans For lender (bank) a store of value, exposure to credit (liquidity, IR, FX...) risk OTC (bilateral) Retail market – consumer loans, home mortgages Collateral – lender can take the real estate (land) in a process called foreclosure Life insurance, change of employment Home mortgages annuity payments (= equal payments until the maturity) PV = P * [1 - (1 + i)-n] / i where P: payment size, i: interest rate, n: years Example: Annual payment 1000€, interest rate 5% p.a., 5 years PV = 1000€ * [1 - (1 + 5%)-5] / 5% = 4329,48€ Example: Monthly payment 1000€, interest rate 0,42% p.m., 60 months PV = 1000€ * [1 - (1 + 0,42%)-60] / 0,42% = 52.939,28€  Financial Instruments as Stores of Value Bank loans – annuity („Ordinary“ vs. „Due“) Perpetuity – infinite stream of equal payments PV=P / (1+r)1 + P / (1+r)2 +... = P / r (Present Value, Payment, discount rate) Perpetuity - company valuation Value = Dividend / (disc.rate – growth)  Financial Instruments as Stores of Value Bank loans – corporate lending Variety of products and pledges (real estate, inventory, accounts receivable) Investment loans – term loan, „bullet“ repayment, amortization Working capital (operations) loans – overdrafts... Golden rule in financing Trade finance – letter of credit (buyer‘s bank guarantees the payment), factoring Guarantees – bid bond, performance bond Interest rate on loan = market rate + credit margin  Credit Ratings Scale – S&P, Fitch, Moody‘s Subgrades e.g. AA+, AA, AA- S&P Moody's Fitch Indicative probability of default AAA Aaa AAA Investment A – about 1% in 5Y, BB up to 10%.. AA grade Aa AA Direct impact on credit margin A A A BBB Baa BBB Banks – proprietary credit BB Ba BB Speculative ratings scale grade B B B US: AA+, SK: A+, Germany: AAA CCC Caa CCC Sovereign and corporate ratings CC Ca CC C C C Bond funds – investment grade D D D  Financial Instruments as Stores of Value Asset-backed securities (ABS) MBS Mortgage-backed securities (MBS) FICO (Fair Isaac Corporation) credit AA score Subprime mortgages A „Financial engineering“ Issuance of bonds rated eg. D, BB.. BB Legal challenges D  Questions 1. At the end of the month you realize that you probably will not be able to pay the next month‘s rent. What formal and informal alternatives you have to solve the situation? 2. You wish to buy annuity that makes monthly payments for as long as you live. Describe what happens to the purchase price of the annuity if (1) your age at the time of purchase goes up, (2) the size of the monthly payment rises, and (3) your health improves. 3. How might broader access to finance benefit a country where access was previously very limited? 4. What risks might financial institutions face by funding long-run loans such as mortgages to borrowers (often at fixed interest rates) with short- term deposits from savers? As the manager of a financial institution, what steps could you take to reduce these risks?  Questions 5. You decide to start a business selling covers for smartphones in a mall kiosk. To buy inventory, you need to borrow some funds. Why are you more likely to take out a bank loan than to issue bonds? 6. Suppose you need to take out a personal loan with a bank. Explain how you could be affected by problems in the interbank lending market such as those seen during the 2007–2009 financial crisis. 7. Jane and Mike purchase identical houses for $400,000. Jane makes a down payment of $80,000, while Mike puts down only $20,000; for each individual, the down payment is the total of his or her net worth and each finances the remainder of the house price with a mortgage. Assuming everything else is equal, who is more highly leveraged? If house prices in the neighborhood immediately fall by 10 percent (before any mortgage payments are made), what would happen to Jane’s and Mike’s net worth?  Self study Document „Money_and_Currency“ to understand differences and common features of money and currency