Finance exercises and solutions

A supplier of capital refers to an individual, business, or government that has excess capital at a point in time that they would like to invest. The investment period could be as short as overnight or it could be several years. A couple of examples where I have acted as a supplier of capital in the past year would include investments into my retirement account and deposits into a checking account at my bank. A demander of capital refers to an individual, business, or government that needs additional capital at a point in time.

It also includes situations where an individual uses previous capital acquired as a supplier of capital for a purchase or purchases in this time period. The period for using that capital could be as short as overnight or it could be several years. A couple of examples where I have acted as a demander of capital in the past year would include credit card purchases and obtaining a loan for the purchase of a van. Yes, most of us will act as both suppliers and demanders of capital within a given time period.

If you make a deposit into a checking account supplier of capital and, within the same period, use a credit card demander of capital you are engaging in both activities. If you add money to a retirement plan at work supplier of capital and borrow money to purchase a home demander of capital you are engaging in both activities.

You can probably think of several different situations from your own experience where you operated on both sides of the system within a given time period.

Question 1

First, imagine a situation where there was no financial system in place. If you wanted to borrow money to purchase a new home, you would have to approach friends and family, take out a classified ad, or set up a web page asking to borrow money. Or consider the flip side. You are working and earning a good salary.

You want to set aside some money for retirement. Without a financial system, you can go dig holes in the back yard and start burying your extra money in jars. Or you could go around to local businesses asking if they wanted to borrow money from you or let you invest in their business. Or possibly even hang out at car dealerships seeing if someone needed a loan to buy a new car. Obviously none of these are very attractive options. Having an efficient financial system in place allows you to approach a financial intermediary such as a bank when you need to obtain a loan.

It allows you to pool purchases on a credit card and if you pay your cards off on time without carrying a balance, you can earn rewards such as cash back. It allows you to become a part owner in attractive businesses by purchasing shares of stock or set aside money for retirement through a mutual fund. Essentially, by having a system in place that allows convenient trading of securities the financial markets and processing of transactions that require special structuring or credit evaluation financial intermediariesboth suppliers and demanders of capital benefit.

The reduced costs of finding someone to take the other have of the transaction and the specialization of financial institutions mean that suppliers of capital receive higher effective returns on their investments while at the same time demanders of capital are able to raise money at lower effective rates.

This win-win situation is caused by the huge reduction in transaction costs monetary costs and time costs along with the availability of far more opportunities provided by financial markets and financial intermediaries.

Stocks are what we refer to as homogeneous securities. What that means is that one share of stock in Google is the same as the next. This homogeneity is one of the primary reasons why financial markets are efficient for stock transactions. That means that by having a central location either a physical location or even a network where buyers and sellers are brought together, I can find someone willing to take the other side of my transaction very quickly.

When we have homogeneous securities and a large number of potential buyers and sellers, we have ideal conditions for financial markets. Give the potential buyers and sellers access to each other and they will collectively determine the optimal pricing. An auto loan is a very specialized security. The appropriate rate of return is dependent on the specific borrower what is his credit history, employment history, income, other debts, etc.In what respects would you agree with this description?

How might you argue that this description is deficient? On what aspect of a business does the balance sheet provide information? On what aspect of a business does this statement provide information? At the first meeting you attend, mention is made of building a new church. What accounting information would the board need in deciding whether or not to go ahead? At what amount should the equipment be recorded? How is the cost to acquire an asset determined?

finance exercises and solutions

Royals Palm, Inc. Dan and Den, Inc. Exercise 3. Complete missing amounts in fundamental accounting equation for several businesses:. Prepare a transaction analysis for the January transactions. Remember to prove the accounting equation at the end. Exercise 5. Exercise 6. Exercise 7. Using the information from Exercises 5 and 6, prepare the Balance Sheet for December Skip to main content. Chapter 1: What is Accounting. Search for:. How are they similar?

How are revenues measured?The earlier I get the money, the more time I have to make it work in my favor. An annuity refers to an equal periodic cash flow stream.

finance exercises and solutions

Present Value and Future values are just flip sides of the same coin. Present value tells us what the cash flow is worth to us today while future value tells us what the cash flow will grow to over time. Once we have one, we can find the other. The appropriate discount rate to use when finding present value is the rate of return we can earn on other investments of similar risk.

finance exercises and solutions

The idea of present value is that it tells us how much a future cash flow is worth to us today. The value of this future cash flow is exactly equal to what we would have to invest today to duplicate it. However, we need to control for risk. Riskier cash flows should be discounted at a higher rate because they are worth less to us. Note that the appropriate discount may change over time as market rates of interest change over time. This will play a large part in our valuation chapters starting with Chapter 6 on bond valuation.

Compounding on a monthly basis is better than annual because it allows us to start earning interest on interest sooner. Not only does the principle work for us, but so does the interest. With the HP, you just press what you want to solve — for instance in Problem 1a, your last step would be FV. Step 2: Enter the given information in the following format:. Step 1: 30 N Step 2: 8. Note that I made both the 15, and the negative. Also, note that the PV needs to be negative we are setting aside theHow much must he save each year to accomplish this?

Solutions to CH 3 Exercises by Dr. Kevin Bracker, Dr. Fang Lin and Jennifer Pursley. Previous: Solutions to CH 2 Exercises.

Next: Solutions to CH 4 Exercises. Share This Book Share on Twitter.The three-step valuation process for stocks differs from bonds due to the differences in the structure of the cash flow stream. Conceptually, the process is different. However, the cash flow stream for stocks dividends has a variable, infinite time horizon which makes forecasting all expected cash flows impossible to do without some simplifying assumptions.

When forecasting dividends, we use one of three assumptions. First, we can assume that dividends exhibit no growth over time. The dividend will remain the same forever. Second, we can assume dividends grow at a constant rate over time. Third, we can assume dividends will grow at a non-constant rate for a specific number of years and then a constant rate after that.

Financial Management and Bookkeeping Exercises

The assumption that we make about the dividend stream will determine how we solve for present value in step three of the 3-step valuation method. The process of choosing an appropriate discount rate is similar at least until we introduce the Security Market Line in Ch. We need to determine the riskiness of the security and then select a discount rate based on the rate of return we can earn on other similar risk investments. One item of note is that the discount rate for stocks will tend to be higher than the discount rate for bonds due to the fact that stocks on average are riskier than bonds.

With bonds, solving for PV was simply to use the 5-key approach to find PV. With stocks, we need to either use a formula for dividend assumptions one and two or a process involving the CF worksheet for dividend assumption three.

The formula for the no-growth model is:. Par value is the value stated on the stock certificate and is essentially a meaningless number. This reflects the minimum amount of capital that must be supplied by stockholders to meet the limited liability characteristic of stock ownership.

If the stock is originally issued for less than par value, the stockholders are liable for the difference in the event of bankruptcy. Book value represents the accounting value of each share of stock based on the balance sheet. Book value tends to understate the true value of the firm because of the historical cost bias and the omission of most intangible assets.

This is the price at which investors are willing to buy and sell shares. No one individual determines market value, instead it is set by the equilibrium price in the financial markets in other words, the price at which both buyers and sellers agree that they are getting their best price. Market value changes constantly based on new information.

Any information that causes investors to change their perception on the magnitude, riskiness, or timeliness of expected cash flows will result in changes in the market value. When you look at a stock quote in the Wall Street Journal or online, this represents the market value. The right to information — Stockholders have a right to know what is going on in the firm.

At a minimum, firms must prepare quarterly and annual audited financial statements that are made available to the stockholders and have annual meetings which stockholders can attend. Most firms make significant information available on their company web page in an investor relations section.

Most of the information made available is detailed financial performance information and general firm strategy information.

Limited Liability — Stockholders can lose no more than their initial investment in common stock. This is a function of the separation of ownership and decision making within the corporate form of ownership.The following trial balance is prepared after preparation of income statement for F.

Green as at 31 March Prepare balance sheet for F. Green as at 31 March in both horizontal and vertical style. In the absence of information about the date of repayment of a liability, then it may be assumed that loan is a non-current liability and a trade payable is a current liability.

As mentioned earlier that vertical style of balance sheet is in fact another way of expressing accounting equationi. We can see in the above balance sheet that total of current assets is not directly added to non-current assets rather this is shown in the inner column. It is to provide a subtotal from which we could deduct total of current liabilities, and so identify net current assets working capital.

If we have more than one current liability, then the individual current liabilities would have to be inserted into a third column and then total amount would be carried and deducted from the subtotal of current assets.

We can see a new item in the vertical style of balance sheet labeled as net current assets because it represents the net worth of current assets after settling outstanding current liabilities. This is also called working capital as this is the amount available to a business for meeting its working operational needs of the business. This is called capital employed, however, from examination point of view there is no need to name it as such in the balance sheet.

The following balances are taken from the books of George Anderson at the end of his first year trading on 31 December Example 1: Preparation of Balance Sheet — Horizontal and Vertical Style: The following trial balance is prepared after preparation of income statement for F. Required: Prepare balance sheet for F. Note: In the absence of information about the date of repayment of a liability, then it may be assumed that loan is a non-current liability and a trade payable is a current liability.

Solution: Balance Sheet Horizontal Style As at 31 March As mentioned earlier that vertical style of balance sheet is in fact another way of expressing accounting equationi. Example 2: Preparation of Income Statement and Balance Sheet: The following balances are taken from the books of George Anderson at the end of his first year trading on 31 December Required: a Prepare income statement for the year ended 31 December In Finance terms, risk refers to the possibility of earning less than expected on a particular investment over a given time period.

The two factors that determine the degree of risk are A the extent to which I can earn less than expected and B the likelihood that I will earn less than expected. A high risk investment means that there is both a significant chance of earning less than expected and the amount less that I can earn is relatively large. This is a false comment. You can avoid losing money and still earn less than expected.

While both activities use risk in an attempt to earn a profit, there are several important differences. First, the risk-return profile is different. Even games where you might argue that some people have a positive expected return sports betting, poker, etc.

On the other hand, investing typically offers a positive rate of return. While stocks and bonds have both had periods of negative returns, the long-run rate of return on both is significantly positive. Another difference is that investing provides capital to a variety of businesses.

Without stock and bond markets, there would be far fewer jobs and product innovation as the stock and bond markets provide the capital for businesses to operate. Gambling on the other hand tends to transfer wealth instead of create it.

Note that the above discussion does not imply that gambling is wrong and investing is right. Instead, the point is to illustrate that the combination of positive expected returns to investors and providing capital to businesses makes investing a net positive to society while gambling tends to transfer wealth from gamblers to gambling institutions and is thus neutral in creating wealth.

Correlation measures the extent to which two variables returns move together. If two securities have a high positive correlation say somewhere between 0. When one security increases in value, it is likely that the other will as well. When one decreases in value, it is likely that the other will as well.

However, since the correlation is less than 1. Two securities with high positive correlations could be any two securities in the same industry. Industry pressures will lead the securities to move in a similar direction most of the time. However, firm specific factors will keep the correlation less than 1. If two securities have a low positive correlation 0.

While they move in the same direction up or down more frequently than not, it is not uncommon for one to be up while the other is down. Two securities with low positive correlations could be any two companies without a specific connection for instance, Amazon and Exxon. Both will be exposed to the same general economic factors leading to a positive correlationbut the different industry and firm specific issues will keep the correlations low.

In general, most stocks should have low positive correlations. If two securities have a negative correlation, that means that they tend to move in opposite directions the closer to Due to general economic factors, few stocks will have negative correlations at least as an expectation. One possible example might be oil producers and trucking firms.

Since an increase in oil prices will improve the value of assets and profits for the oil firms and lower profits for trucking firms, we might see negative correlations. However, the ability of trucking firms to pass along higher prices and periods with low oil price volatility will mean that even here we may not see that significant of an inverse relationship.

Diversifiable Firm Specific risk is risk that can be virtually eliminated by holding a large portfolio of securities from a variety of industries. An example of a diversifiable risk would be the success or failure of a new product introduction by a firm.Exercises are attached to each chapter, and the software used to get the numbers in the tables and the curves in the figures is available.

All the solutions to exercises are available for lecturers upon request: L. Grzelak tudelft. If you would like to contribute to the solutions please use the repository. Selected mainly odd solutions to Chapter 1 you can find here. Selected mainly odd solutions to Chapter 2 you can find here.

Selected mainly odd solutions to Chapter 3 you can find here. Skip to content. Chapter 1. Chapter 2. Chapter 3. Chapter 4. Selected solutions to Chapter 4 you can find here. Chapter 5. Selected solutions to Chapter 5 you can find here. Chapter 6. Selected solutions to Chapter 6 you can find here. Chapter 7. Selected solutions to Chapter 7 you can find here. Chapter 8. Selected solutions to Chapter 8 you can find here.

Chapter 9. Selected solutions to Chapter 9 you can find here. Chapter Selected solutions to Chapter 10 you can find here. Selected solutions to Chapter 11 you can find here. Selected solutions to Chapter 12 you can find here. Selected solutions to Chapter 13 you can find here. Selected solutions to Chapter 14 you can find here.


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