Topics MONEY AND BANKING production, from buying seedlings to marketing of

their produce.
Types of Money
Commodity money is a good whose inherent value serves as
the value of money – gold or silver being one good example.
Fiat money is currency that a government has declared to
be legal tender, but it is not backed by a physical
commodity. The value of fiat money is derived from the
relationship between supply and demand rather than the
value of the material from which the money is made
Bank money consists of accounting credits that can be
drawn on by the depositor – checking accounts, for
instance.
Rural banks and cooperative banks are
differentiated from each other by ownership.
While rural banks are privately owned and
managed, cooperative banks are
organized/owned by cooperatives or federation
of cooperatives.
 Non-Bank Thrift Institutions
Institutions that borrow funds from 20 or more
lenders for the purposes of relending or purchasing
receivables and other obligations.
 Mutual building and loan association  Non-
stock savings and loan association

Philippine Financial System  Financial Intermediaries persons or entities

whose principal functions include lending,
 Financial Intermediation a financial activity(process)
investing or placement of funds among others
that distributes the surplus funds of a sector in an
economy to a sector of an economy that needs it
 Investment house  Financing companies 
Security dealer / broker
 Financial Institution is an organization through which
funds in the form of money or claims in money are
TIME VALUE OF MONEY
assembled and transferred from individuals and firms
Simple Interest – only the principal earns interest
having surplus of economic goods to those that need it
Interest Payment = The amount of interest to
be paid by the debtor
 Financial Market is where borrowers and lenders or = Principal x Interest x Time
investors are regulated and where the price of funds Maturity Value = Total amount received by
(interest rate) is determined creditor by the maturity date when
borrowed amount is paid only upon
Financial Institutions in Philippine Financial Markets  maturity. = Principal +
Banking Institutions Interest Payment Compound Interest – both the
 Universal and Commercial Banks - represent the principal and interest earn interest
largest single group, resource-wise, of financial
institutions in the country. They offer the widest
variety of banking services among financial Future Value – the amount to which a present
institutions. In addition to the function of an ordinary cash cash flow or series of cash flows will grow over
commercial bank, universal banks are also authorized a given period of time when compounded at a
to engage in underwriting and other functions of given interest rate.
investment houses, and to invest in equities of non-
allied undertakings. Compounding – the process of
 Thrift banks are engaged in accumulating savings of determining the final value of cash flow
depositors and investing them. They also provide or series of cash flows when compound
short-term working capital and medium- and long- interest is applied.
term financing to businesses engaged in agriculture,
services, industry and housing, and diversified
Future Value of One – the value of a one time
financial and allied services, and to their chosen
payment cash flow in the future using compound
markets and constituencies, especially small- and
interest.
medium- enterprises and individuals.
FV of 1 = Present Value of Cash flow x FVof1 Factor
 Rural and Cooperative Banks’ role is to promote and
Where, FV of 1 factor = (1 + i)n
expand the rural economy in an orderly and effective
manner by providing the people in the rural
Therefore, FV of 1 = PV(1 + i)n
communities with basic financial services. Rural and
cooperative banks help farmers through the stages of
 Future Value of Ordinary Annuity - the value of
ordinary annuity cash flow in the future using
compound interest
Ordinary Annuity – series of
payment that occur at the end of
each period. FV of OA = cash flow x FV of
OA factor
Where, FV of OA = [(1 + i)n – 1]/i
Therefore, FV of OA = CF{[(1 + i)n – 1]/i}
Future Value of Annuity Due – the value of annuity
due payments in the future using compound interest.
Annuity Due – An annuity whose payments
occur at the beginning of each period.
FV of AD = FV of OA (1+i)
Present Value - the value of future cash flows today
Present Value of One – The value today of a
lumpsum amount in the future.
PV of 1 = FV(1 + i)-n
Present Value of Ordinary Annuity - the value
of ordinary annuity cash flow in the present
using compound interest
PV of OA = CF{[1-(1 + i) -n ]/i}
Present Value of Annuity Due
PV of AD = CF({[1-(1 + i) -n-1 ]/i}+1)
FS ANALYSIS – (AT THE BACK)
FINANCE22 Topics WORKING CAPITAL MANAGEMENT
Is concern about the management current assets and current
liabilities and the trade-off of liquidity and profitability.
2 Types of Current Assets
 Temporary – current assets needed during peak seasons
 Permanent – current assets needed even during idle
seasons. Normal level of current assets
2 Types of Liabilities
 Spontaneous – Automatically incurred when current
assets are increased. Accounts Payable and Accrued
Expenses(ex. wages and taxes)
 Non-spontaneous – requires effort from company just to
be increased.
Types of Investment Policies
Relaxed – Large current assets – liberal credit
policies (High Current Ratio)
Moderate – Mid-level assets – moderate credit
policies
Restricted – Lean current assets – strict credit
policies (Low Current Ratio)
Types of Financing Policies
Conservative – even a portion of temporary asset is
financed by LTD, spontaneous liab and equity.
Higher cost of debt but lower liquidity risk.
Maturity Matching – Temporary assets are financed
by short-term(nonspon) liab.
Aggressive – a portion of permanent asset is
financed by short-term(nonspon) debt. Lesser cost
of debt but higher liquidity risk.
Cash Management
 Cash Conversion Cycle – length of time funds(cash)
is tied up in working capital (from paying AP to
collection of AR)
Purchases of RM FG/Sold Collect
Inventory Conversion Period Average Collection Period(DSO)
Payment of Payable
Cash Conversion Period
Cash Inventory Average Payables
conversion = conversion + collection + deferral
period period period period
Inventory AR AP
= COGS/365 or 360 Sales/365 or 360 COGS/365 or 360
365 365 365
= COGS/Ave.Inv. Sales/Ave.AR COGS/Ave.Inv
(Inv. turnover) (Rec. turnover) (Inv. turnover)
 Optimum Cash Balance (Baumol’s Model) -
optimum cash transaction size which will result to
lowest total relevant cash cost(TTC+TCC)
= √ 2 x Annual Demand x cost to order(transact)
Cost to carry(in %)
 Float – the delay in conversion of receivables into
cash(collection float) net of delay in conversion of
payables into disbursements(disbursement floats).
 Lockbox System - A lockbox is a bank-operated
mailing address to which a company directs its
customers to send their payments.
Increase in Cash = Decrease in float x Ave. Daily Cash Receipts
Net Savings = (Increase in Cash x Interest Rate)-Cost of using Lockbox
 FA With Excess Capacity
Inventory Management 1.) Separate Current Asset and Fixed Asset
 Economic Order Quantity – optimum order size 2.) AFNCA = GS(CA -SL) – REA
which will result to lowest total relevant inventory 3) Full Capacity Sales = Current Sales(S0)/Current Capacity
cost cost(TCC+TOC). At EOQ, TCC=TOC. 4) Fixed Asset CIR = Current FA0/Full Capacity Sales
5) AFNFA = (Target Sales x FA CIR) – Current FA
Or
Total Carrying Cost(TCC) = (Quantity/2) (CC per Unit)
Total Ordering = (Annual Demand/Quantity)(OC per unit) AFNFA = (Target Sales – FC Sales) x CIR
Cost (TOC)
What size to order? 6) Total AFN = AFNCA + AFNFA
TCC = TOC
(Q/2) (CC ) = (AD/Q)(OC) FINANCE33 Topics INTEREST RATES
Nominal Rate/rCorporate Bond = r* + IP + MRP
Q = √ 2 x AD x OC
CC (in Pesos) + DRP + LP
rTreasury Bond = r* + IP + MRP
When to order? rTreasury Bills = r* + IP

Corporate Bond Yield Spread = DRP + LP

Reorder Point = Lead Time(LT) Usage + Safety Stock(SS)
where, Mark Industries, a corporation, has a real risk-free rate of 4%
 Ave. Usage = Annual Demand/Working Days and since they are planning to issue 10 year bonds, their
 Lead Time Usage = Normal LT x Ave. Usage maturity risk premium will be computed as .20(t1)%. Their
 Safety Stock = SS in LT + SS in Usage
economy is experiencing 3% inflation rate currently but it is
>SS in LT = (Max. LT-Normal LT)(Ave. Usage)
expected to increase by 2% after 4 years. Default risk
>SS in Usage =(Max. Usage-Ave. Usage)(Normal LT)
premium and liquidity risk premium assigned by the
Receivable and Payable Management company financial analysts to Mark Industries are 3% and
Effective Discount = Days in a year x Discount rate 4% respectively.
Rate(EDR) remaining credit time 100% - Discount Rate
= Discount Time TO Periodic Discount %
a) What is Mark’s Maturity Risk Premium?
Ex. Credit Term is 2/10, n30 b) What is Mark’s Inflation Premium?
EDR = 365 x 2% . = 36.73% c) What is Mark’s nominal rate?
30-10 100% - 2% d) Using this information, what is the estimated treasury
Note, EDR is the COST OF DISCOUNT to SELLER while it is the rate?
BENEFIT(OPPORTUNITY COST) to BUYER.
Magsolve gurow? Dili kay magtan-aw ras solution (-.-)

Cash Freed
Cash Freed(AR) = Decrease in ACP(DSO) x Daily Sales
Or Cash Freed(INV)= Decrease in ICP x Daily Cogs
Or Cash Freed (AP) = Increase in PDP x Daily COGS
Net Saving = Cash Freed x Investment Int. %
a) MRP = .20(10-1) % = 1.8%
b) IP = ( 3%(4yrs) + 5%(6yrs))/10 = 4.2%
do not forget to average inflation
c) rCorporate Bond = 4% + 4.2% + 1.8% + 3% + 4% = 17%
d) rTreasury Bond = 4% + 4.2% + 1.8% = 10% therefore, the
CBYS= 3% + 4% = 7%

Financial Planning and Forecasting

Pure Expectations Theory = treasury securities will have
the same return in a given period though their terms
Additional Financing Needed(AFN or EFN or RFN) Amount
are different. Based on assumption that there is no
of nonspontaneous funding of asset needed to support the
MRP.
increase in sales.
8% ?%
FA Without Excess Capacity 9%
1.) Increase in Sales in % = Increase in Asset in % 9%
Sales Growth = Asset Growth Ex:

2.) AFN = Increase in Asset - Inc. in SL – RE (1+.09)2 = (1+.08)(1+x)

Addition 1.1881 = 1.08 + 1.08x
= GS(TA) - GS(SL) – REA = GS(TA -SL) – .1081 = 1.08x
REA .1001= x or 10.01%

VALUATION TECHNIQUES
Note: Securities valuation/price investors should be Required Return(CAPM)/ = rRF + B(rm - rRF)
willing to pay is the present value of the cash flow  rRF = Risk Free rate = r* + IP
they are going to receive.
 rm = Market rate
Stock Valuation
Bond Valuation Price Computation
Bond Price = PV of Principal + PV of interest Since  Discounted Cash Flow Formula
we assume that Principal is paid on lumpsum and • Preferred Stock
interest(coupon) payment is paid on ordinary V = D/r (Dividend is fixed, perpetuity formula)
annuity,
• Common Stock
 When dividend grow at a constant rate
Bond Price = PVof1(Principal) + PVofOA(Interest Payments)
P 0 = D 1 /(r -g) where D1 = Dividend after a year
PV Factors use the effective/going/current market rate
P0 = Price Today g =growth%
aka Yield to Maturity(YTM)

Face Value – Bond Price

YTM = Interest Payment + no. of payments ‘til maturity P0 = D1 + D2 + … + Dn+1 /(r-
Face Value + Bond Price g)
2 (1+r)1 (1+r)2 (1+r)
 When Dividends are non constant for a time
Ex: Horizon value n n = horizon yrs

Marlon Co. is planning to purchase 10-year term IML

Bonds with a face value of P5,000 and coupon rate of
 Using the corporate value
12%. Current market rate for IML’s type of bond is
CV0 = Free Cash Flow – CapEx Budget – WC
14%.
WACC – g
What price should Marlon pay for IML’s bonds?

PV of Principal = .2697(5,000) = P 1,348.72 Rate Computation

PV of Interest = 5.2161(5,000 x .12) = 3,129.67  Using Discounted Cash Flow Formula
PV of future cash flows(BOND PRICE) = 4,478.39 • Preferred Stock r v = D/V (Dividend is fixed, perpetuity
formula)
Note that Marlon should be willing to pay less than the Face
• Common Stock
Value(at a discount) since he should be earning 14%(P700)
interest payment if he will invest in currently issued bonds r = (D1 / P0 ) + g
of the same type(same bond grade).

 Using CAPM Formula

Now use the computed Bond Price and using the = rRF + B(rm - rRF)
formula, compute for the YTM. It should be
approximately 14%(13.76%).  Bond Yield Plus Risk Premium
r = Bond Yield(YTM) + Risk Premium RP= 2 to 4%
If the bonds are callable
Remember, Stocks always have a higher rate than Bonds since they
Call Price – Bond Price are riskier than bonds which has a fixed interest return.
YTC = Interest Payment + no. of payments ‘til called
Face Value + Bond Price Cost of Capital
2 is calculated by multiplying the cost of each capital source (debt
and equity) by its relevant weight, and then adding the products
together to determine the value.
Remember to adjust interest and n to payment terms. Risk
and Returns
Long Term Liab weight x After-tax Cost of Debt(YTM x (1-Tax%) = xx%
Preferred Equityweight x Preferred Equity Cost (rv) = xx%
Single/Stand-Alone Investments Common Equity weight x Common Equity Cost (r ) = xx%
Expected Return/r ̂ = Σ ( ri x probability of each return) Weighted Average Cost of Capital(WACC) XX%
Risk = Standard Deviation = √(Σ ( r ̅-ri )2/n
Capital Structures and Leverage
Multiple Asset/ Portfolio Investments Business Risk – inherent to business, incur loss
Risk = Portfolio Beta = Weighted Ave. of each stock’s beta 2 Types of Risk Finance Risk – due to use of debt
capacity(LTD)
If there’s no LTD, Total Risk = Business Risk
Beta is UNLEVERED BETA (Bu)

If there’s LTD, Beta should be LEVERED BETA (BL). As company uses

LTD, total risk increases and therefore, beta should increase so as
to compensate stockholders for the additional risk born.

BL = Bu [ 1 + (1-Tax%)(Debt/Equity)]

Ex. Queenie Co. currently has a capital structure that

consists of 40% debt and 60% common equity. The
company has a 40% tax rate. Current beta of the company
is 1.44.

a) What is the Unlevered Beta?

b) What would the company’s levered beta(bL) if Barnes
changed its capital structure to 20% debt ad 80% common
equity.

a) bU = 1.4 /[1+(.6)(.4/.6)] = 1.0

b) bL = 1[1+(.6)(.2/.8)] = 1.15
As debt portion decreases, so as levered beta.

Capital Budgeting (Powerpoint presentation on LMS)