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Description of Finance

In: Other Topics

Submitted By ag126
Words 902
Pages 4
1.

The goal of finance is to use financial information, tools, and models to search for and implement optimal enterprise solutions that balance expected value and expected risk.
We strive to increase expected value and decrease risk, or a combination of the two
We get paid to take risk, the more the better, if we do not get paid enough, we take less risk and may even short it
Value is the future expected cash flows
Risk is the possible deviations from those these cash flows
Discounted cash flows is the most common way to measure value and risk, it is the most important tool of finance. * Projected cash flows is our measure of value * The rate we choose to use to discount these cash flows is how we incorporate risk

The value creation process: 1. Future expected cash flows 2. Select a rate in which to discount these cash flows that reflect the perceived risks of the cash flows 3. Sum up the cash flows (the intrinsic value of the cash flows) 4. Compare the intrinsic value with their current market price 5. If the intrinsic value is greater, buy, if not, short it or avoid it * Project cash flows that are more reliable and provide useful insights into value * Determine the rate to use and give insights into risk
Discount rate: risk free + risk premium
Risk free: current yield on treasury security with a maturity comparable to the time horizon of the cash flows you are evaluating
Risk premium: the amount we get paid to compensate us for the perceived risks in realizing these cash flows.
Other tools used are:
WACC: determining the discount rate to use to value a firm and managements impact on that value
CAPM: determining the discount rate to use to evaluate individual stocks and to establish the cost of equity for each capital with WACC
NPV: incremental future cash flows
H Models, Value at risk, alpha, Ratios,

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