GROUP 5: BASIC TOOLS OF FINANCE
MEMBERS:
Arcuna, Jean Rica
Bagion, Khen John
Dejanio, Carl James
Monteza, Suzette
Razon, Mary Angel
Susaya, Jeneca
RELATIONSHIP BETWEEN PRESENT VALUE AND FUTURE VALUE
Finance is a field that studies how people make decisions about allocating
resources over time and handling risk. Basic tools of finance help individuals and
businesses make informed financial decisions.
Basic Tools:
• Present Value it is the current value of a future amount of money, or a series of
payments, evaluated at a given interest rate.
• Future Value it is the value at some future time of a present amount of money or a
series of payments, evaluated at given interest rate.
The relationship between PV and FV is expressed by the formula:
FV = PV* (1+r)^n
where "r" is the interest rate and "n" is the number of the time periods.
Formula for Present Value of Ordinary Annuity (PVOA):
PV = PM * [1 - (1 + r)^-n] / r
Where:
PV = Present Value of the annuity
PM = The amount of each annuity payment
r = The interest rate per period (expressed as a decimal)
n = The number of periods over which payments are made
The formula for the Present Value of Annuity Due (PVAD) is:
PV = PMT * [(1 - (1 + r)^-n) / r] * (1 + r).
PV = Present Value
PMT = Periodic Payment Amount
r = Interest Rate per Period
n = Number of Periods
*(1 + r) is the factor that accounts for the payments being made at the beginning of each
period.
EFFECTS OF COMPOUND GROWTH
Compound Growth
- the increase (or decrease) in value is being applied to the changing value of an
asset, such as its year-end value, not just to its starting value. A common type of
compound growth is Compound Annual Growth Rate or CAGR
Compound Annual Growth Rate (CAGR)
- is the average annual growth rate over a specified time period when taking into
account only the number of years and the starting and ending values of an investment
or company valuation.
Potential Benefits
Exponential Growth: Compound growth allows your initial investment to grow
not just on the original amount invested, but also on the accumulated earnings
over time.
Long-Term Perspective: Compound growth is most effective over the long term.
Snowball Effect: As your investment grows due to compounding, the
subsequent returns become larger in absolute terms.
Reinvestment of Dividends: Many shares pay dividends to their shareholders.
Risk Mitigation: Compound growth can help mitigate the impact of market
downturns.
Importance of early investing: One of the most compelling aspects of
compound growth is the concept of the "time value of money."
Consideration for Long-Term Goals: Investors with long-term financial goals,
such as retirement planning, can benefit greatly from compound growth.
Diversification: Diversifying your share-based investments can enhance
compound growth by reducing the risk of a single investment significantly
impacting your portfolio.
Consistent Contributions: Regularly adding funds to your investment, such as
through monthly contributions, can amplify the compounding effect.
Potential Downsides
Market Volatility: Compound growth relies on consistent, positive returns over
time.
Inflation: Inflation erodes the purchasing power of money over time.
Tax Considerations: Taxation can have a significant impact on investment
returns. Capital Gains Tax (CGT) and income tax can eat into your investment
gains.
Fees and Costs: Managing investments often involves fees and costs, such as
management fees, adviser charges, initial set up fees, and administrative
expenses.
Long Time Horizon: Compound growth works best over a long time horizon.
HOW RISK-AVERSE PEOPLE REDUCE THE RISK THEY FACE
Risk- Averse is the tendency to avoid risk while Risk- Averse Individuals
prioritize minimizing uncertainty in their financial decisions.
To achieve this, they employ various fundamental financial tools and strategies
designed to mitigate potential losses.
Tools in Managing Financial Risk:
1. Diversification – spreading investments across various asset classes to
reduce exposure to any single risk. This approach reduces overall risk
because losses in one investment may be offset by gains in another.
Example:
UnionBanks of the Philippines that offers various investment products
including mutual funds and unit investment trust funds allowing investors to
diversify their portfolios across different asset classes.
2. Hedging – financial strategy used to protect against adverse price
movements in an asset, often through derivatives like interest rate swaps. It
reduces uncertainty by ensuring a predetermined return despite market
volatility.
Example:
PH Financial Markets has limited derivatives compared to more developed
markets. For instance, certain banks provide foreign exchange forwards to
hedge currency risk.
3. Insurance – transfer risk to an insurance company in exchange for periodic
premium payments. It reduces the financial burden in the events of illness,
accidents or disasters, ensuring stability.
Example:
Sun Life Philippines offers a range of insurance products including life,
health and accident insurance, providing financial protections to individuals
and families.
4. Asset Allocation – distributing investments across different asset categories
based on an individual’s risk tolerance and financial goals. It minimizes risk
whole maintaining potential returns suited to the investor’s risk preference.
Example:
UnionBank provides digital banking services that include investment
advisory, helping clients tailor their asset allocation according to their risk
tolerance and financial objectives.
5. Emergency Fund Creation – financial cushion set aside to cover
unexpected expenses such as medical emergencies, job losses or sudden
repairs.
Example:
Most Philippine Banks, including UnionBanks, offers regular savings
account with no minimum balance, suitable for building an emergency.
6. Risk – Adjusted Investments – opt for low-risk investments that provide
stable returns rather than highly volatile assets. It provides predictable
returns, reducing uncertainty and financial assets.
Example:
UnionBanks offers fixed income investment options, such as government
securities and time deposits, catering to conservative investors seeking stable
returns.
HOW ASSET PRICES ARE DETERMINED
1. Supply and Demand
Supply: The amount of an asset available for sale.
Demand: The amount of an asset that buyers want to purchase.
When:
Demand > Supply: Prices rise
Supply > Demand: Prices fall
Demand = Supply: Prices stabilize
2. Market Sentiment
It is the overall attitude and emotions of investors towards an asset, such as:
Optimism (bullish): Buyers dominate, prices rise
Pessimism (bearish): Sellers dominate, prices fall
Neutral: Balanced buyer and seller activity, stable prices
