Finance and Economics Lecture Notes

Jul 18, 2024

Lecture Notes on Finance and Economics

Introduction

  • Instructor: Sriram Chundi
  • Course Objective:
    • Understand key concepts in economics and finance relevant for businesses.
    • Topics: Business concepts, capital markets, stock and company valuation, strategies, financial statements analysis, capital budgeting, cash flow, business cycle, industry analysis, ESG, macroeconomics, portfolio diversification, and alternative investments.
  • Resources: Changemakers Media on YouTube.

Opening Thought Experiment

  • Scenario: Magic box producing $1 forever.
  • Question: How much would you pay for such a box?
  • Analogous Example:
    • Savings account providing 1.05% interest annually needs $34,761 investment to generate $1/day.
  • Mortgage Example:
    • House price: $100,000
    • Down payment: $20,000; Mortgage: $80,000
    • $9,396 annual repayment, 10% interest rate leads to 20-year payoff due to high interest costs.

Key Concepts

  1. Return on Investment (ROI)
    • Formula: (Current Value - Cost) / Cost
    • Importance: Compare different investments (apples to oranges).
    • Example: House bought for $100,000, now $150,000: ROI = 50%
  2. Time Value of Money
    • Concept: Money today > Money future due to earning potential and inflation.
  3. Net Present Value (NPV)
    • Formula: Present value of cash inflows - cash outflows using a discount rate.
    • Positive NPV = Good investment.
    • Example: Vending machine investment considering $10,000 cost and subsequent cash flows.

Capital and Financial Markets

  • Types of Markets: Physical (grocery stores) vs. Virtual (Netflix subscription page).
  • Importance:
    • Facilitate trade of goods/services, critical for company growth and consumer satisfaction.
  • Stock and Bond Markets:
    • Stocks: Ownership in company, public (e.g., Amazon) vs. private companies.
    • Bonds: Loans from investors to entities like companies/governments with fixed payments and return dates.
    • Differences: Stocks (ownership, dividends) are riskier; Bonds (loan, interest payments) are safer.

Business Strategy and Financial Documents

  • Key Elements: Mission statement, SWOT analysis (Strengths, Weaknesses, Opportunities, Threats).
  • Tools: BCG Matrix (Stars, Cash Cows, Question Marks, Dogs), Porter's Generic Strategies (Cost Leadership, Differentiation, Focus).
  • Financial Statements:
    • Statement of Profit or Loss: Revenues - Costs through to retained profits.
    • Statement of Financial Position: Assets, liabilities, shareholder equity.
    • Cash Flow Forecasts: Inflows, outflows, net cash flow month by month.

Financial Statement Analysis

  1. Ratios:
    • Profitability: Gross profit margin, net profit margin.
    • Liquidity: Current ratio, quick ratio.
    • Activity: Inventory turnover.
    • Leverage: Debt ratio.
  2. Horizontal Analysis: Compare performance over time.
  3. Common Size Analysis: Express items as percentages of a base figure for comparison.

Capital Budgeting

  • Purpose: Evaluate and select long-term investments.
  • Methods: Payback period, NPV, Internal Rate of Return (IRR).
  • Example: Solar panel investment considering costs and projected savings.

Macroeconomics

  • Key Aspects: GDP, unemployment types (cyclical, structural, frictional), inflation, business cycles (trough, expansion, peak, contraction).
  • Policies:
    • Monetary: Central bank actions (interest rate changes).
    • Fiscal: Government spending and taxation.

ESG (Environmental, Social, Governance)

  • Importance: Enhances sustainability, innovation, risk management, and reputation.
  • Assessment: ESG ratings, transparency, stakeholder engagement.
  • Modern Impact: Influences investment choices, driven by social media, regulatory needs.

Portfolio Diversification

  • Definition: Spread investments across various asset classes to mitigate risk.
  • Types of Risks: Systematic (market-wide) vs. Unsystematic (specific to company/industry).
  • Management:
    • Passive: Replicating indices like S&P 500.
    • Active: Security selection, market timing, typically more costly.
    • Hybrid Approach: Combine both passive and active strategies for balancing risks.

Alternative Investments

  • Types: Real estate, equipment leasing, hedge funds, commodities, cryptocurrencies, NFTs.
  • Characteristics: High risk, high reward, mostly illiquid, geared towards accredited investors.

Summary

  • Course Wrap-Up: Covered finance, economics, interconnection of disciplines, strategy, practical applications.
  • Encouragement: Further exploration and application of concepts.
  • Call to Action: Subscribe to Changemakers Media on YouTube.