Understanding Bonds, Stocks, and Market Valuation
As time passes, interest rates change in the markets, which affects the present value of a bond. When interest rates increase, the present value of the bond decreases, and when interest rates fall, the bond is worth more. There is an inverse relationship between interest rates and bond prices.
Yield to Maturity (YTM) is the opportunity rate for bonds of similar characteristics, the interest rate required in the market on a bond, and the rate implied by the current bond price. The YTM represents the
Read MoreUnderstanding Liabilities and Equity: A Deep Dive
Liabilities and Equity
Current Liabilities
Current Liabilities: Accounts payable to suppliers, notes payable, various creditors, taxes payable, customer advances.
Long-Term Liabilities
Long-Term Liabilities: Loans payable (bank loans, bonds payable).
Types of Debts
- Accounts Payable to Suppliers: Generated by credit purchases of merchandise for sale or processing.
- Salaries Payable: Wages owed to employees.
- Utilities Payable: Unpaid water, electricity, and garbage collection services.
- Interest Payable: Accrued
Investment Selection Methods: Static vs. Dynamic Criteria
Static Criteria
Static criteria do not account for the time value of money. They treat cash flows as having the same value, even when received at different times. This is unrealistic because it ignores inflation and interest rates. Consequently, static criteria can lead to flawed investment decisions.
Examples of static criteria include:
- Payback period
- Total net cash flow
- Net annual cash flow
Payback Period
The payback period represents the time required to recover the initial investment outlay from the
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Arbitrage and Forward Exchange Rates
Suppose, as of September 16, it was possible to buy 1 Euro for 1.1341 US Dollars, one year USD LIBOR was 0.82615% (simple interest), and one year EURIBOR was 0.128% (also simple interest).
No-Arbitrage Dollar-Euro Exchange Rate
a. What is the no-arbitrage Dollar-Euro exchange rate, one year forward?
If you buy one Euro for 1.1341 US Dollars and invest it at 0.128% for one year, you get 1.00128 Euro. Alternatively, if you invest the 1.1341 US dollars for one year
Read MoreEssential Corporate Finance Formulas and Ratios
Chapter 2: Key Financial Formulas
- Asset Equation:
Assets = Liabilities + Shareholder Equity - Market Capitalization (Market Value of Equity):
Market Price per Share * Number of Shares Outstanding - Net Working Capital (NWC):
Current Assets - Current Liabilities - Net Working Capital to Total Assets Ratio:
NWC / Total Assets - Debt-to-Equity Ratio:
Total Debt / Total Equity - Enterprise Value (EV):
Market Value of Equity + Debt - Cash - Current Ratio:
Current Assets / Current Liabilities - Quick Ratio (Acid-Test Ratio)
Practical Accounting Calculation Examples
Closing Stock Undervaluation Calculation
Calculate the correct value of closing stock when it is undervalued by 10%, and the current book value is Rs. 45,000.
Formula:
Revised Value = Book Value × 100 / (100 – % of Undervaluation)
Calculation:
= 45,000 × 100 / (100 – 10)
= 45,000 × 100 / 90
= Rs. 50,000
Answer: The correct value of the closing stock is Rs. 50,000.
Machinery Depreciation Calculation
Machinery worth Rs. 80,000 was purchased on 01-07-2022. Calculate the depreciation at 4% p.a. for the financial
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