Overview
This lecture presents foundational concepts in finance, economics, and business, including investment analysis, capital markets, business strategy, macroeconomics, ESG, portfolio management, and alternative investments.
Core Finance Concepts: Investment & Value
- Time value of money states a dollar today is worth more than a dollar in the future due to earning potential and inflation.
- Compound interest grows investments exponentially over time.
- Return on Investment (ROI) compares the efficiency of different investments using: (Current Value - Cost) / Cost.
- Net Present Value (NPV) discounts future cash flows using a discount rate to measure an investment’s profitability; positive NPV indicates a good investment.
- The discount rate reflects the interest rate used to compute present value, often influenced by inflation and central bank policy.
Capital & Financial Markets
- Financial markets enable exchange of goods, services, stocks, and bonds, facilitating business growth and consumer access.
- Stocks represent company ownership (equity), and are issued to raise funds for expansion, inventory, etc.
- Bonds are debt instruments with fixed payments, issued by firms or governments, repaid at maturity, and usually less risky than stocks.
- Stocks are riskier and more volatile but may offer higher returns; bonds offer predictable returns but no ownership or voting rights.
Asset Valuation Techniques
- Discounted Cash Flow (DCF) values assets by projecting future cash flows and discounting them to present value.
- Comparable (Comps) analysis uses industry ratios (P/E, EV/EBITDA) to compare a company against peers for valuation.
- DCF is accurate but time-consuming; comps are faster but depend on reliable industry data.
Business Strategy & Analysis Tools
- Business strategy defines company goals and methods for achieving them.
- Mission statements express a company's purpose, audience, uniqueness, and values.
- SWOT analysis examines strengths, weaknesses (internal), opportunities, and threats (external).
- BCG Matrix classifies products as stars, cash cows, question marks, or dogs based on market share and growth.
- Porter’s Generic Strategies: cost leadership, differentiation, cost focus, and differentiation focus for competitive advantage.
Financial Statements & Analysis
- Three key financial documents: income statement (profit/loss), balance sheet (financial position), and cash flow forecast.
- Assets and liabilities are split into current (<1 year) and non-current (>1 year) items.
- Profitability, liquidity, activity, and leverage ratios analyze company financial health.
- Horizontal (trend) analysis tracks changes over multiple periods; common size analysis expresses entries as percentages of a base (e.g. sales or assets).
Capital Budgeting & Investment Decisions
- Capital budgeting evaluates long-term investments using NPV, IRR (internal rate of return), and payback period.
- Investments are funded by cash flow, debt, or equity.
- IRR represents expected annualized return; compare it to cost of capital to decide on projects.
Macroeconomics & Business Cycles
- Macroeconomics studies overall economies: GDP, inflation, unemployment, and policy impacts.
- Business cycle phases: trough, expansion, peak, contraction (recession).
- GDP = Consumption + Investment + Government Spending + (Exports – Imports).
- Types of unemployment: cyclical (economic downturn), structural (skills mismatch), frictional (transitional).
- Inflation reduces purchasing power, requiring real GDP adjustments.
Policy & Market Influence
- Monetary policy (central banks) manages money supply and interest rates to influence economic activity.
- Fiscal policy (governments) adjusts taxes and spending to manage economic growth or contraction.
- Expansionary policy encourages spending; contractionary policy controls inflation.
ESG (Environmental, Social, Governance)
- ESG evaluates a company's environmental impact, social responsibility, and governance practices.
- ESG integration can enhance risk management, reputation, compliance, and potentially financial performance.
- ESG performance is assessed using rating agencies, sector standards, and transparent reporting.
- Strong ESG practices attract investment and align companies with long-term sustainability goals.
Portfolio Construction & Diversification
- Diversification reduces unsystematic risk by investing across asset classes, industries, and companies.
- Systematic risk (market-wide) cannot be diversified away; unsystematic (company-specific) risk can.
- Portfolio performance is measured using benchmarks; risk is often assessed via standard deviation.
- Passive management tracks indices; active seeks above-benchmark returns through security selection.
Alternative Investments
- Alternatives include real estate, equipment leasing, hedge funds, commodities, cryptocurrencies, and collectibles.
- These investments are often less liquid and riskier but can offer high rewards.
Key Terms & Definitions
- Compound Interest — Interest calculated on both the principal and previous interest.
- Discount Rate — Interest rate used to discount future cash flows to present value.
- Stock (Equity) — Ownership share in a company.
- Bond — Debt instrument with fixed repayment schedule.
- Net Present Value (NPV) — Present value of future cash flows minus initial investment.
- Internal Rate of Return (IRR) — Discount rate that makes NPV zero; expected annualized rate of return.
- SWOT Analysis — Tool evaluating strengths, weaknesses, opportunities, and threats.
- BCG Matrix — Categorizes products by market growth and share.
- Standard Deviation — Statistical measure of investment volatility.
- ESG — Environmental, Social, and Governance criteria for evaluating companies.
Action Items / Next Steps
- Review and practice calculating ROI, NPV, and key financial ratios.
- Analyze sample financial statements for ratio, trend, and common size analysis.
- Explore case studies on business strategy, SWOT, and BCG Matrix.
- Investigate current events for applications of monetary/fiscal policy and ESG considerations.
- Prepare questions for further discussion on alternative investments and portfolio diversification.