interest rate futures:

step1  buy   Deposite, investment

           sell  borrow money    loan

step2.number of contracts

size of doposite (loan)/size of contract *(duration of deposite(loan)/duration of contract)

lockiong rate= 100-(current future price+expired basis on the transaction)

basis=(100-current LIBOR)-Futures

expected term: today  to future

basis term   transaction date to future date

locked in rate =100-(future+expected term basis )

forward agreement

5-8  FRA     @8%       5%

if the real rate is 7%

Loan(borrow)   maxium payment    ceiling 

deposite (investment)     minium received floor

loser will pay the difference.

pay lender the contract rate,

if FRA  > actual rate   broker pay back 

if FRA   < actual rate   pay broker the different      actually the borrower need to pay the actual rate

lower rate=investor

high rate = borrower

hedge:  1. position  buy or sell  

2. risk exposure: 

offsite the actual interest movement

foreign exchange risk:

1. transaction risk     exchange rate change during the  term of transaction 

mitigation    hedge

2. economic risk     longer time, the exchange rate may change due to the economic issues, 

mitigation by diverse

3. translation  cooliated  financial statement

hedge  technicial: forward contract, money market hedge (borrow and loan) 

IRP interest rate parity: R1=R0*(1+if)/(1+ih)

the steps to solve the question about futures:

step 1. buy or sell  identify contract transaction currency (pay or receive), then back to futures size in which currency. 

step 2. the date no early than transaction date, usually longer than contract term

step 3 number of contacts    = contract due amount/contract size  if the futures is on another currency ,then convert with the curent future price

step 4. do the transaction   using the spot rate

Step 5. close the future contract

risk management: risk is volatility of the all input factors which will influence the project output(result)

risk management is the balance of risk, effort, and cost

manage, mitigation, hedge, diversifications

identify risk: analysis measure interpretation 

management 

strategy

risk framework

sensitivity analysis    probability analysis, and Value at Risk  

level of risk:

strategic     long term    

tactical       medium term

operational    day to day

risk management

mitigation: reduce risk by using control procedure

hedge: take action to ensure a certain outcome

Diversify: build up portfolio

chapter outline:

1. theoritical and rationale of management of risk    both business and financial risk

2. access expodure to business and fanaceial risk

3. develop aframework     comparing and contrasting the following strategies: mitigation , hedging and diverdifying

4. establish capital investment and risk management ystems  

5. understand  application of probability sensitivity analysis and monte carlo similation appraisal

6. project value of risk

option:

value of option = 

definition:

strike price

intrinsic value

volatility

MV

value of option   =? price ?

factor infect the value of option:

strike price         value of option

time to expiry

volatility of the share

P 

working1. asset depreciation 

N      0        1        

excercise price: agreed trade price

strike price:

dividend dicision: appropriate distribution and retension policy

• clientele reaction
• debt converant
• cash amount in bank
• signalling to paydividend (signaficate effection)
• inflation 
• taxation
• investment policy(investment and finance decision)
• legal issues

FCFE   dividend capacity (theoritic approaches)

dividend decision application :

1. capital investment project

2. multinational corporation to plan transfer pricing strategy : parent and subsidiary (overseas) 

M&M theory assumption:

1. the perfact market

2. the value of the investment will not be change by the ways of dividend or retention to reinvestment which will rise the share price

3. no tax  nor transaction cost 

manufacture dividend means to sell share instead get dividend (subsititude ways either by receive dividend or sell share to earn capital return )

financial decision:

dividend decision, investment decision, fiancial management

and risk management

fianncial management: capital MIX structure

source of fiannce (equity, debt, lease finance, venture capital, angel fund, private equity, asset securitsation and Islamic finance)

benefit and deficiencies

factors need to consider about the structure of finance:

1. cost and benefit (by investors and company side)

shares:  for investors more risky 

             for company  more expensive  for investor ask for higher returen

 equity: for company cheaper but more risky

impacts:

ratio, level 

WACC

financing decisions:

investment decision 

dividend decision

fiannce dicision mixture of capital, sourcing to finance peojects with NPV positive

fiancial gearing:

tranditional theory:  with introduce debt, the WACC (cost of capital) will fall, because initial banefit of cheap debt, which lead to arrive the structure in which the minimal cost of capital is accieved. but with the rise of more debt, the riske increased, which outweight the benefit of cheap debt and cause the cost of capital rise.

debt :cheap and pull down the WACC   but  liquidision problem and more risk

equity :WACC will rise and more chance to take higher risk and higher returen projects expensive 

key issues: scenario focus

pecking order theory:optimal gearing rate

size ,

risk and returen investors

current gearing

security

other factor : ta agency cost , control 

islamic finance: manage fee instead of penity or interest 

forms: 

     murabaha= loan

     Ijara  = leasing finance

     sukuk =bond

    Mudaraba=share capital

   musharaka=venture capital

   salam= forward contract

international investment:

market catelog:

free trading  less potential impact on foreign government

barriers to trade protect domestic trader, higher trade cost than demostic 

major trade agreement

common market

WTO  world trade organization

IMF international Money fedurary

the world bank

financial  planning framework 

international investment apppraisal

same technology as normal investment project 

more concern: FX,  double taxation , intercompany cf, remittance restrictions

decision rules: NPV

international investment

diversify: wider range, consumers, service and goods, cost (material and labor), scarcity resources

increase industry competition 

expend (broading) economic scale

specialisation   comparative advantage in special area

PPP purchase power parity in

S1=S0*(1+Hc)/(1+Hb) 

Hc--foreign currency

Hb--demostic currency

IRP  interst rate parity

F0=S0*（1+Ic)/(1+Ib)

Ic--foreign currency

Ib--demostic currency

exercise ：IRP

S0=$1.6/GDP

interest rate Ic=0.05 USA

interest rate Ib=0.02 British 

S1=1.6*1.05/1.02=$1.65/ GDP

S2=1.65*1.05/1.02=$1.6955/GDP

S1=1.6*1.05/1.02

focus on future cash benefit

free cash flow   inflation and taxation

captial constructure   Mixture of capita 

duration   == test on resk    sooner the better to catch the investment back

NPV decision rule:

only accept project with positive NPV at cost of capital

procedure to forecast free cashflow:

1. revenues

2. cost   

3.  investment

4. disposal revenue

5. discount rate  = interest rate, inflation, taxation 

real  (current) not adjusted for inflation  ---discounted in realtate of the capital

norminal 

(1+i) = (1+r)*(1+h)

i  nominal rate of reture

r  real rate of reture

h inflation 

IRR  decision rules

the project should be accepted if the IRR is greater than the cost of capital (required reture of return)

assumption:

1. liner relationship 

2. two or more IRR   patern of the cashflow

MIRR   overcome the shortage (limitations) of IRR 

1. unique MIRR

2. provide accural reture of capital

3. provide a simle percentage easy to 

decision rule: 

MIRR > cost of capital

capital rational model: to solve the shortage of money problem in multi-project selection

financial impact on investment decision

1.  ROI   return on Investment   

     technical: NPV  direct link to shareholder's wealth   how much the shareholder will earn on new investment.

2. share price   significate on investment activities   cost rising, short time profit drop

new project  ---- increase cost     direct cost, interst (cost of capital) 

new project ----- higher risk level 

strategic impact 

investment impact whole business in long term

resource  new finance   

environment  analysis--PESTEL  (policital, economic, social(culture), technology, environment(pullution, legal(ethic))

SWOT (strengths, weakness, oppotuninty and threat)   KEY factors identify 

firm  internal  to identify key strength

ouitside  identify key competitors and their reactions   

risk appetite  of shareholders

working capital:

1. only change in working capital account as CF

2. ignore capital tax allowance

3. at the end of the project period,  treated as inflow, equal the total investment in working capital

scenarios analysis:

roles of fiannacial managers

advance appraisal

acquisition and merge

corporation reconstracture

treasury and risk management