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THE BASIC TOOLS OF

FINANCE
ECON 101: ECONOMIC DEVELOPMENT
 slidesmania.com

Presented to:
Joan Grace Tolentino

Presented by:
GROUP 5
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Table of contents.

00 01 02
We will talk about: The relationship The Effects of
between Present Value Compound Growth
and Future Value

03 04
How Risk-Adverse How asset prices are
people reduce the determined
risk they face
 slidesmania.com

Understanding the Concept of the

Time Value of Money
ItIt connotes
connotes aa relationship
relationship between
between thethe
value
value of of money
money andand time.
time. Time
Time Value
Value of
of Money
Money
(TVM)
(TVM) surmises
surmises thatthat money
money is is worth
worth more
more than
than
at
at aa future
future date date based
based on on its
its earning
earning potential.
potential.
Because
Because money money can can grow
grow when
when invested,
invested, any
any
delay
delay is is aa lost
lost opportunity
opportunity forfor growth.
growth. The
The TVM
TVM
is
is aa corecore financial
financial principle
principle known
known as as the
the
present
present discounted
discounted value.
value. TheThe concept
concept ofof TVM
TVM
can
can helphelp guide guide in in investment
investment decisions.
decisions.
 slidesmania.com

What is Present Value and Future Value?

💵 Future Value (FV) is the value of a current asset at a future date
based on an assumed rate of growth. The future value is important
to investors and financial planners, as they use it to estimate how
much an investment made today will be worth in the future. It
answers the question, “If I deposit 1 peso in the bank, how much
will it be worth in the future?”.

Future Value Formula:

FV=PV x (1+r)n Solution:
Example: FV of p1= (1+10%)3
Given: FV of p1 = 1.331
PV=10,000
R=10%
Future Value of Deposit
N=3 = (10,000 x 1.331) = 13, 310
 slidesmania.com

What is Present Value and Future Value?

💵 Present Value (PV) is the current value of a future sum of
money. It reflects how much a future amount of money is worth
today, considering factors like interest and inflation. Present
Value calculations can be useful in investing and in strategic
planning for businesses. It answers the question, “How much
do I have to deposit today to receive this 1 peso in the future?”.

Present Value Formula (Derived from FV formula):

PV = FV/(1+r)n
Given: Solution:
PV=13,310 PV of p1= (1+10%)3
R=10% PV of p1 = 0.751315
N= 3 Present Value od future withdrawal
= (13, 310 x 0.751315) = 10,000
 slidesmania.com
The Relationship Between Present Value and Future Value

The
The fundamental
fundamental relationship
relationship between
between PV PV and
and FV
FV isis based
based on
on
the
the concept
concept of
of the
the time
time value
value ofof money
money (TVM),
(TVM), which
which states
states that
that money
money
today
today is
is worth
worth more
more than
than the
the same
same amount
amount in
in the
the future
future due
due to
to its
its potential
potential
earning
earning capacity.
capacity. This
This principle
principle is
is mathematically
mathematically expressed
expressed using
using the
the
following
following formulas:
formulas:
Factors Influencing Present Value and Future Value
Several
Several keykey factors
factors affect
affect the
the relationship
relationship between
between PVPV and
and FV:
FV:
1.Interest
1.Interest Rate
Rate (r)
(r) -- The
The rate
rate of
of return
return or or discount
discount rate
rate plays
plays aa crucial
crucial role.
role. AA higher
higher
interest
interest rate
rate leads
leads to
to aa higher
higher FV
FV for
for aa given
given PVPV and
and aa lower
lower PV
PV for
for aa given
given FV.
FV.

2.
2. Time
Time PeriodPeriod (n)-
(n)- The
The longer
longer the
the time
time period,
period, the
the greater
greater the
the FVFV due
due to
to
compounding.
compounding. Similarly,
Similarly, the
the longer
longer the
the time
time horizon,
horizon, the
the lower
lower the
the PV
PV for
for aa given
given FV
FV
since
since itit is
is discounted
discounted over
over aa more
more extended
extended
period.
period.

3.Compounding
3.Compounding Frequency
Frequency -- IfIf interest
interest is
is compounded
compounded more
more frequently
frequently (e.g.,
(e.g., monthly
monthly
instead
instead of
of annually),
annually), the
the FV
FV increases.
increases. Conversely,
Conversely, the
the PV
PV of
of aa given
given FV
FV decreases
decreases
as
as compounding
compounding frequency
frequency increases.
increases.

4.
4. Inflation
Inflation and
and Risk
Risk -- Inflation
Inflation erodes
erodes the
the purchasing
purchasing power
power of
of money,
money, affecting
affecting the
the
real
real FV
FV and
and PV.
PV. Higher
Higher risk
risk usually
usually demands
demands aa higher
higher discount
discount rate,
rate, reducing
reducing PV
PV and
and
increasing
increasing FV FV requirements
requirements for for investment
investment viability.
viability.
 slidesmania.com

The Effects of
Compound Growth
Compound growth, or compound interest, helps money grow
faster by earning interest on both the original amount and the
Application In Finance
previously earned interest.
and Investment: The formula is:
1. Investment and Where:
Decisions a = Future Value
2. Loan and Mortgage p = Initial Amount (Principal)
Calculation r = Interest Rate (Annual)
3. Retirement Planning n = Number of times interest is added per year
4. Business Valuation t = Number of years
Example: Investing 1,000 at 5% annual interest, compounded yearly
for 10 years, results in 1,628.89. The earlier you start investing, the
greater your growth due to compounding.
 slidesmania.com

How Risk-Adverse People Reduce the Risk They Face

Risk
Risk aversion
aversion is is the
the tendency
tendency of of people
people to to prefer
prefer outcomes
outcomes with
with
low
low uncertainty
uncertainty over
over those
those withwith high
high uncertainty,
uncertainty, even even ifif the
the average
average
outcome
outcome of of the
the latter
latter isis equal
equal to to or
or higher
higher in in monetary
monetary value value than
than the
the
more
more certain
certain outcome.
outcome. Additionally,
Additionally, risk-averse
risk-averse individuals
individuals have
have aa
concave
concave utility
utility function,
function, meaning
meaning they they experience
experience diminishing
diminishing marginal
marginal
utility
utility of
of wealth.
wealth. This
This implies
implies that
that asas their
their wealth
wealth increases,
increases, the the additional
additional
satisfaction
satisfaction theythey gain
gain fromfrom each
each extra
extra unitunit of
of wealth
wealth decreases.
decreases. To To
minimize
minimize riskrisk and
and maintain
maintain aa stablestable level
level ofof utility,
utility, they
they adopt
adopt strategies
strategies
such
such as as insurance,
insurance, the the useuse of of standard
standard deviation,
deviation, and and diversification.
diversification.
These
These methods
methods help help them
them avoid
avoid large
large financial
financial losses
losses and and ensure
ensure aa more
more
predictable
predictable financial
financial outcome,
outcome, aligning
aligning with with their
their aversion
aversion to to risk.
risk.

Measuring Risk
1.
1. Measuring
Measuring Risk
Risk with
with Insurance
Insurance
2.
2. Measuring
Measuring Risk
Risk with
with the
the Standard
Standard Deviation
Deviation
3.
3. Reducing
Reducing Risk
Risk Through
Through Diversification
Diversification
 slidesmania.com

Measuring
Measuring Risk
Risk With
With
Insurance
Insurance
Measuring Risk with Insurance
Insurance is an investment in the stability and future growth of a
new business. It plays a pivotal role in a comprehensive risk
management strategy, providing financial protection, liability
management, and support for business continuity.

Two Problems in the Insurance Market

1. Adverse Selection
- A high-risk person benefits more from insurance and is, therefore,
more likely to purchase it.
2. Moral Hazard
- People with insurance have less incentive to avoid risky behavior.
 slidesmania.com

Measuring Risk with Standard Deviation

-- Standard
Standard deviation
deviation helps
helps determine
determine market
market volatility
volatility or
or the
the
spread
spread of
of asset
asset prices
prices from
from their
their average
average price.
price. When
When prices
prices
move
move wildly,
wildly, the
the standard
standard deviation
deviation is
is high,
high, meaning
meaning an an
investment
investment isis riskier.
riskier. A
A low
low standard
standard deviation
deviation indicates
indicates that
that
prices
prices are
are more
more stable,
stable, making
making investments
investments less
less risky.
risky.

-- Diversification
Diversification is
is the
the process
process of
of allocating
allocating capital
capital in
in aa way
way
that
that reduces
reduces exposure
exposure to to any
any one
one particular
particular asset
asset oror risk.
risk.

Reducing Risk through Diversification

1.
1. Diversification
Diversification can
can reduce
reduce firm-specific
firm-specific risk.
risk.
2.
2. Diversification
Diversification cannot
cannot reduce
reduce market
market risk.
risk.
 slidesmania.com

How Asset Prices Are Determined

Asset
Asset prices
prices areare determined
determined by by thethe
interaction
interaction between
between buyers
buyers and
and sellers
sellers in
in the
the
market,
market, where
where the the price
price reflects
reflects the
the present
present
value
value of of future
future cash
cash flows
flows an an asset
asset is is
expected
expected to to generate,
generate, considering
considering factors
factors like
like
risk,
risk, time
time value
value ofof money,
money, and and the
the subjective
subjective
beliefs
beliefs of
of investors
investors about
about the
the asset's
asset's potential
potential
future
future value.
value. Essentially,
Essentially, it'sit's the
the price
price at at
which
which aa buyer
buyer is is willing
willing to
to pay
pay and
and aa seller
seller isis
willing
willing to
to accept
accept based
based on on their
their assessment
assessment
of
of the
the asset's
asset's worth.
worth.
 slidesmania.com

Factors Influencing Asset Prices

1.
1. Future
Future Cash
Cash Flows
Flows -- The
The most
most fundamental
fundamental factor,
factor, where
where investors
investors
estimate
estimate the
the expected
expected future
future income
income (dividends,
(dividends, interest
interest payments,
payments, etc.)
etc.)
an
an asset
asset will
will generate
generate and
and discount
discount them
them to
to their
their present
present value
value using
using aa
discount
discount rate
rate that
that reflects
reflects the
the risk
risk associated
associated with
with the
the asset.
asset.

2.
2. Risk
Risk Perception
Perception -- Investors
Investors demand
demand aa higher
higher return
return for
for riskier
riskier assets,
assets,
leading
leading to
to aa lower
lower price
price for
for assets
assets with
with higher
higher perceived
perceived risk.
risk.

3.
3. Market
Market Sentiment
Sentiment -- The
The overall
overall mood
mood ofof the
the market,
market, including
including investor
investor
confidence
confidence and
and expectations,
expectations, can
can significantly
significantly impact
impact asset
asset prices.
prices.

4.
4. Supply
Supply and
and Demand
Demand -- The
The basic
basic economic
economic principle
principle where
where higher
higher
demand
demand relative
relative to
to supply
supply pushes
pushes prices
prices up
up and
and vice
vice versa.
versa.

5.
5. Discount
Discount Rate
Rate -- The
The rate
rate used
used to
to calculate
calculate the
the present
present value
value of
of future
future
cash
cash flows,
flows, which
which is
is influenced
influenced by
by factors
factors like
like the
the risk-free
risk-free rate
rate and
and thethe
market
market risk
risk premium.
premium.
 slidesmania.com

Common Asset Pricing Models:

1.
1. Capital
Capital Asset
Asset Pricing
Pricing Model
Model (CAPM)
(CAPM) -- A A widely
widely used
used model
model that
that
calculates
calculates the
the expected
expected return
return of
of an
an asset
asset based
based on
on its
its beta
beta (a
(a
measure
measure of of its
its volatility
volatility relative
relative to
to the
the market)
market) and
and the
the market
market risk
risk
premium.
premium.

Cost
Cost ofof Equity
Equity (Ke)
(Ke) == r,r, ++ B
B (rm
(rm -- rf)
rf)
-r,
-r, →
→ Risk-Free
Risk-Free Rate
Rate
-ß
-ß →→ Beta
Beta
-rm
-rm →→ Market
Market Return
Return
(rm
(rm -r*)
-r*) →
→ Equity
Equity Risk
Risk Premium
Premium (ERP)(ERP)

2.Discounted
2.Discounted Cash
Cash Flow
Flow (DCF)
(DCF) Analysis
Analysis -- A
A method
method to
to value
value an
an
asset
asset by
by calculating
calculating the
the present
present value
value of
of its
its future
future cash
cash flows.
flows.

3.
3. Option
Option Pricing
Pricing Model
Model (OPM)
(OPM) -- AA model
model used
used toto value
value options
options
contracts
contracts based
based onon the
the underlying
underlying asset
asset price,
price, volatility,
volatility, time
time to
to
expiration,
expiration, and
and risk-free
risk-free interest
interest rate.
rate.
 slidesmania.com

References:
References:
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https://www.investopedia.com/ask/answers/021915/how-standard-deviation-used-determine-risk.asp

Corporate Finance Institute (CFI) (n.d.). Time Value of Money. Retrieved from HTTP://corporatefinanceinstitute.com
Definition & Formula. Retrieved from https://www.investopedia.com

Fernando, J. (2024, August 21). Time Value of Money: What it is and how it works. Investopedia.
https://www.investopedia.com/terms/t/timevalueofmoney.asp

Hafizsamiullah. (n.d.). The basic tool of finance. SlideShare.

https://www.slideshare.net/slideshow/the-basic-tool-of finance/260377141

Khan Academy (n.d.). Future Value & Present Value Concepts. Retrieved from https://www.khanacademy.org

Mark. (2024, July 30). Capital Asset Pricing Model (CAPM): Definition, formula, and examples. Capital City Training Ltd.
https://www.capitalcitytraining.com/knowledge/capital-asset-pricing-model-capm/

Robinson, H. (2022, May 23). Moral hazard and adverse selection. Lewis & Ellis.
https://lewisellis.com/specialties/health-care-reform-policy/moral-hazard-and-adverse-selection/

Tamplin, T. (2023, July 13). Present Value (PV) | Definition, Formula, Factors, Applications.Finance Strategists.
https://www.financestrategists.com/wealth-management/valuation/present-value- pv/#:~:text=Factors%20Affecting
%20Present%20Value%201%20Intere st%20Rates%20Interest,in%20PV%20calculations.%20. . .%204%20Time
%20Horizon%20

Tatum, M. (2024, May 16). What factors influence asset prices? SmartCapitalMind.
https://www.smartcapitalmind.com/what-factors-influence-asset-prices.htm

Team, I. (2024, September 30). Fair Value: definition, formula, and example. Investopedia.
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