FINANCIAL MARKET 5.

​ Commodities
Module 4 a.​ Basic goods used in commerce that are
interchangeable with other goods of the
same type.
REVIEWER b.​ Hard and soft commodities.
6.​ Index Funds
Investment a.​ Aims to replicate the performance of a
●​ Allocation of money or resources into an asset specific market index
with the expectation to generate an income. b.​ They are typically passively managed,
following a buy-and-hold strategy instead
Rate of Return of attempting to outperform the market.
●​ Gain or loss from an investment. c.​ Investors benefit from exposure to broad
●​ Expressed as percentage. market movements with relatively low risk
●​ Measures investment performance and expenses.
7.​ Annuities
Risk a.​ insurance product where you make an
●​ Potential of losing from uncertainties that can upfront or periodic payment in exchange
affect the value of the investment. for regular payments, typically in
●​ Often measured by the volatility or variability of retirement.
returns b.​ Due to low growth, annuities are often
used as a supplement to other retirement
Leverage savings plans rather than as the main
●​ Use of fixed assets or borrowed money to source of income.
increase potential return. 8.​ Certificate of Deposit
a.​ A person deposits a set amount of money
with a bank for a fixed period in exchange
WHY DO WE NEED TO INVEST? for interest.
1.​ Financial Security 9.​ Derivative
2.​ Financial Independence a.​ It’s an agreement between two parties to
3.​ Wealth Accumulation buy or sell the asset at a specific price in
4.​ Goal Attainment the future.
b.​ Three most common types
i.​ Option
TYPES OF INVESTMENT 1.​ Right to buy/ sell an asset
1.​ Stock/ Equities at a specific price
a.​ Purchasing of stocks/ shares. ii.​ Futures
b.​ What influences stock values? 1.​ commitment to buy/ sell
i.​ Company size an asset on a set date.
ii.​ Profitability iii.​ Swaps
iii.​ Financial Stability 1.​ Agreement to exchange
2.​ Bonds cash flows.
a.​ Fixed-income security that represents a 10.​ Cryptocurrencies
loan. a.​ Crypto assets are digital assets that use
b.​ Lower returns and lower risks, compared cryptography and a public ledger to
to stocks. facilitate and secure transactions.
c.​ Junk Bonds b.​ Not covered by protection funds, such as
i.​ High-yield, high risk the Canadian Investor Protection Fund.
3.​ Mutual Funds
a.​ Diversified portfolio due to many
investments. BUSINESS OPERATION RISKS
4.​ Exchange Traded Funds (ETFs) 1.​ Process Risks
a.​ Similar to mutual funds due to many 2.​ Human Resource Risks
investments; however, they are traded on a.​ Mistakes made by employees.
stock exchanges 3.​ Technological Risks
 4.​ Environmental Risks ●​ An index of the degree of movement of an asset’s
5.​ Supply Chain Risks return in response to a change in the market
a.​ Interruption in the flow of goods and return.
materials necessary for production or
service delivery. ​ Higher Beta = Higher Return
​ Lower Beta = Lower Return

FINANCING RISK Beta Coefficient = 1

●​ Risks originating from how a company raises and 1.​ If Beta = 1, it has roughly the same volatility as the
manages its funds. market as a whole
2.​ If Beta < 1, it has a volatility less than the market.
1.​ Financial Risks 3.​ If Beta > 1, it has a volatility greater than the
a.​ The uncertainty introduced by the method market.
by which the firm finances its Investments. 4.​ If Beta = 0, it has no correlation with the market
b.​ Systematic Risks 5.​ If Beta < 0, it has inverse relation with the market
i.​ Affects entire economic markets.
c.​ Unsystematic Risks
i.​ Only affects a particular industry HOW TO GET THE REQUIRED RATE OF RETURN?
or business
2.​ Liquidity Risks Required Rate of Return = Risk Free Rate + beta (Market
3.​ Exchange Rate Risks Risk or Market Portfolio x Risk Free Rate)
4.​ Country Risks/ Political Risks
a.​ The uncertainty of returns caused by the Risk-free rate
possibility of a major change in the ●​ a rate of return that is associated with no risk or
political or economic environment of a minimum risk (such as return from Treasury Bond
country. or Government Bond)
5.​ Business Risks Market Risk Premium
●​ additional return that is expected on an index of
portfolio of investments above the given risk-free
STRATEGIES FOR FINANCING AND BUSINESS rate.
OPERATIONS Equity Risk Premium
1.​ Diversification ●​ pertains only to stocks and represents the
2.​ Hedging expected return of a stock above the risk-free rate
a.​ Use financial instruments to offset the risk
of adverse price movements.
3.​ Insurance HISTORICAL RATES OF RETURN
4.​ Contingency Planning ●​ It is calculated based on actual data from previous
5.​ Regular Monitoring and Review years or periods.

Holding Period
CAPITAL ASSET PRICING MODEL(CAPM) ●​ The period during which you own an investment.
●​ links nondiversifiable risk and return for all assets.
●​ It tells us how much return we will require for Holding Period Return (HPR)
holding an asset relative to the risk-free rate and ●​ Indication of return during the holding period.
market portfolio. ●​ Must always be zero or greater.
●​ It allows us to estimate the required return on the ●​ HPR = 0 means that all money is lost
stock once we have determined the stock’s beta
coefficient, risk-free rate, and market-risk
premium.

HOW TO GET THE HOLDING PERIOD YEAR?

BETA
●​ shows how much systematic risk a company has. HPY = HPR - 1
NOTE: NOTE:
●​ The formula is used with the assumption that the ●​ When there are more possible outcomes, the
investment grows at a constant rate each year, range between the highest and lowest returns
which is compound. For a two-year investment, becomes wider.
this method implies an 18.32% return per year, ○​ This makes it harder to predict exactly
ignoring the possibility of varying yearly returns, what will happen, leading to increased
uncertainty
HOW TO GET THE ANNUAL HPR?
STATISTICAL TECHNIQUES TO MEASURE RISK
Annual HPR = HPR^1/n
1.​ Variance
Wherein: a.​ measures how much individual returns
​ n = number of holding period in years differ from the expected return.

Larger Variance
SUMMARY MEASURES OF RETURN PERFORMANCE ●​ More Uncertainty from Expected
Outcome.
1.​ Arithmetic Mean (AM) ●​ More dispersed.
a.​ Added values
b.​ Can overestimate returns because it Smaller Variance
ignores how volatility affects the ●​ Lower Uncertainty from Expected
compounding. Outcome.
●​ Less dispersed
AM = ∑HPY/n
Variance = Summation of Probability x (PR - ER)^2
Where:
∑HPY = the sum of annual holding period yields Where:
n = number of values ●​ PR = Possible Return
●​ ER = Expected Return
2.​ Geometric Mean (GM)
a.​ Values that are compounded or multiplied. 2.​ Standard Deviation
b.​ Better for evaluating long-term returns, a.​ Square root of Variance
such as volatile investments. b.​ it gives a clearer picture of risk because
it’s measured in the same units as the
GM = (П HPR)^1/n - 1 return

NOTE: Higher standard deviation

●​ When the rates of return are the same each year, ●​ investment's returns are more
the GM = AM. unpredictable and riskier.
●​ However, if the returns change each year,
GM<AM. Lower standard deviation
●​ Greater volatility in annual returns leads to a ●​ investment's returns are more
larger difference between the two means. predictable and less risky

3.​ Coefficient of Variation

EXPECTED RATES OF RETURN OF WEIGHTED a.​ Measures risk per unit of return
VALUES
●​ calculated as a weighted average of possible Higher CV = Higher Risk per unit
returns, where each return is weighted by its Lower CV =Lower Risk per unit
probability of occurrence.
CV = Standard Deviation / Expected
EP = Summation of Possible Return x Probability of Return
Return
RISK OF HISTORICAL RATES OF RETURN a.​ Indicates how a business is dependent on
borrowed money.
LEVERAGE b.​ Measures the effect of the changes in the
●​ Using fixed assets or borrowed money to amplify EBIT to the business’ EPS.
business or investment outcomes.
DFL (at base level) = EBIT / [EBIT -
increase in leverage = increased return and risk Interest - (Preferred Dividend x {1 / 1 - Tax
decrease in leverage = decreased return and risk. Rate})]
●​ Used when there is no historical
Advantages: data.
1.​ More buying power c.​ s
2.​ Higher potential profits DFL = % Change in EPS / % Change in
3.​ Wider asset range EBIT
4.​ Tax Perks ●​ Used when there is historical data
3.​ Total Leverage
Disadvantages: a.​ reflects the overall sensitivity of a
1.​ Large losses company's profits to changes in sales
2.​ More risk volume and changes in financial structure.
3.​ Margin Calls
Total Leverage = % Change in EPS/ %
Change in Sales
TYPES OF LEVERAGES
1.​ Operational Leverages Or
a.​ Refers to the degree to which a
company's fixed costs outpace its variable Total Leverage = DOL (DFL)
costs
b.​ Measures sensitivity of the change in sale
to the EBIT

DOL (at base sales level Q) = Q x (P-VC)

/ Q x (P-VC) - FC
●​ This is used when there is no
historical data of the company.

Where:
Q = Units
P = Price Per Unit
VC = Variable Cost Per Unit
FC = Fixed Costs

DOL = % Change in EBIT/ % Change in

Sales
●​ Used when there is a historical
data

2.​ Financial Leverage