No fear finance an introduction to finance and investment for the non-finance professional

265 Pages·2011·14.76 MB·English

by  Fraser-Sampson, Guy

i
No Fear Finance
An introduction to
finance and investment
for the non-finance
professional
ii
THIS PAGE IS INTENTIONALLY LEFT BLANK
iii
No Fear Finance
An introduction to
finance and investment
for the non-finance
professional
THIS PAGE IS INTENTIONALLY LEFT BLANK
Guy Fraser-Sampson
iv
Publisher’s note
Every possible effort has been made to ensure that the information contained in this book is
accurate at the time of going to press, and the publishers and authors cannot accept
responsibility for any errors or omissions, however caused. No responsibility for loss or damage
occasioned to any person acting, or refraining from action, as a result of the material in this
publication can be accepted by the editor, the publisher or the author.
First published in Great Britain and the United States in 2011 by Kogan Page Limited
Apart from any fair dealing for the purposes of research or private study, or criticism or review, as
permitted under the Copyright, Designs and Patents Act 1988, this publication may only be reproduced,
stored or transmitted, in any form or by any means, with the prior permission in writing of the
publishers, or in the case of reprographic reproduction in accordance with the terms and licences
issued by the CLA. Enquiries concerning reproduction outside these terms should be sent to the
publishers at the undermentioned addresses:
120 Pentonville Road 1518 Walnut Street, Suite 1100 4737/23 Ansari Road
London N1 9JN Philadelphia PA 19102 Daryaganj
United Kingdom USA New Delhi 110002
www.koganpage.com India
© Guy Fraser-Sampson, 2011
The right of Guy Fraser-Sampson to be identified as the author of this work has been asserted by him in
accordance with the Copyright, Designs and Patents Act 1988.
ISBN 978 0 7494 6387 8
E-ISBN 978 0 7494 6388 5
British Library Cataloguing-in-Publication Data
A CIP record for this book is available from the British Library.
Library of Congress Cataloging-in-Publication Data
Fraser-Sampson, Guy.
No fear finance : an introduction to finance and investment for the non-finance professional / Guy
Fraser-Sampson.
p. cm.
ISBN 978-0-7494-6387-8 -- ISBN 978-0-7494-6388-5 (ebk.)
1. Finance. 2. Business enterprises--Finance. 3. Investments. I. Title.
HG173.F725 2011
332--dc22
2011010665
Typeset by Saxon Graphics Ltd, Derby
Printed and bound in India by Replika Press Pvt Ltd
Contents
Learning about finance 1
Introduction 1
Who will find this book useful? 1
What is ‘difficult’ about learning finance? 2
Finance and mathematics 3
Open and closed questions – concepts and calculations 4
Finance and reality 5
Problems with language 6
The approach this book will take 6
The numbers 7
v Coping with formulae and calculations 7
The rest of the book 10
Notes 11
Types of business 13
Trading as a sole trader 13
CoNteNts Trading as a partnership 16
Trading as a company (corporation) 18
Other possibilities 20
How business is financed 23
Equity 23
Debt 27
The Miller Modigliani Theory 31
The Theory of the Efficient Firm 31
Notes 34
Accounting basics (1): the balance sheet 35
Financial accounting: the basics 35
Management accounts: the basics 36
Financial accounts 37
01 Learning about finance 1 Balance sheet 39
Valuation 44
Auditing 45
Introduction 1 Notes 47
Accounting basics (2): the profit and loss account 49
Who will find this book useful? 1 Turnover 50
Profit (or earnings) 50
What is ‘difficult’ about learning finance? 2 Profit and cash-flow distinguished 54
Analysing the P&L 57
Finance and mathematics 3 Working capital and further financial analysis 61
The current ratio 61
Open and closed questions – concepts and calculations 4 The acid test ratio 63
Long-term liquidity 63
Finance and reality 5 Working capital 64
Notes 70
Problems with language 6 The time value of money 71
Looking down the time tunnel 71
The approach this book will take 6 Discounting 73
Finding the present value of a cash-flow due in more than one year 76
The numbers 7 Compounding 81
Special uses of discounting 85
Coping with formulae and calculations 7 Annuities 85
Perpetuities 90
The rest of the book 10 The Internal Rate of Return 92
Annuities and DC pension schemes 93
Risk 99
What do we mean by ‘risk’? 100
What does the world of finance mean by ‘risk’? 100
02 types of business 13 Risk 108
The Sharpe Ratio 108
Return 111
Trading as a sole trader 13 Periodic returns 112
What can constitute ‘return’? 112
Trading as a partnership 16 Annualized returns 114
Compound returns 117
Trading as a company (corporation) 18 Bonds (1): basic principles 123
How can we classify bonds? 123
Other possibilities 20 Bond returns 129
Notes 133
Bonds (2): discounting, redemption, pricing and valuation 135
The redemption yield 135
Bond pricing 138
03 How business is financed 23 Bond durations 145
Equities 151
Characteristics of equities: income 152
Equity 23 Characteristics of equities: capital 153
Measurement of equity returns 154
Debt 27 Equity risk 156
Measuring effective diversification 159
The Miller Modigliani Theory 31 A l p h a a n d b e t a :
active and passive investment 163
The Theory of the Efficient Firm 31 What is beta? 164
What is alpha? 166
The arguments in favour of active investment 167
The arguments in favour of passive investment 169
Notes 171
04 Accounting basics (1): the balance sheet 35 Derivatives (1): futures and options 173
Futures 174
Options 177
Financial accounting: the basics 35 Leverage 182
Capital at risk 183
Management accounts: the basics 36 Notes 184
Derivatives (2): swaps, futures, options and how to use them 185
Financial accounts 37 OTC and exchange traded options 185
American and European options 186
Balance sheet 39 The Black-Scholes Model 187
Swaps 190
Valuation 44 Hedging 194
Notes 197
Auditing 45 Capital markets and M&A transactions: events in the corporate life-cycle 199
Merger and acquisition 199
Flotation (IPO) 204
Capital raising: issue of new bonds or shares (stock) 205
Insolvency (bankruptcy) 206
Notes 209
Asset allocation 211
Regulation 212
The truth about bonds 213
Diversification 214
Correlation 216
The challenge: matching theory with reality 220
Notes 221
A p p e n d i x :
key formulae 223
G l o s s a r y o f
financial terms 229
vi Contents
05 Accounting basics (2): the profit and loss account 49
Turnover 50
Profit (or earnings) 50
Profit and cash-flow distinguished 54
Analysing the P&L 57
06 Working capital and further financial analysis 61
The current ratio 61
The acid test ratio 63
Long-term liquidity 63
Working capital 64
07 the time value of money 71
Looking down the time tunnel 71
Discounting 73
Finding the present value of a cash-flow due in more than one year 76
Compounding 81
08 special uses of discounting 85
Annuities 85
Perpetuities 90
The Internal Rate of Return 92
Annuities and DC pension schemes 93
09 Risk 99
What do we mean by ‘risk’? 100
What does the world of finance mean by ‘risk’? 100
Risk 108
The Sharpe Ratio 108
10 Return 111
Periodic returns 112
What can constitute ‘return’? 112
Annualized returns 114
Compound returns 117
11 Bonds (1): basic principles 123
How can we classify bonds? 123
Bond returns 129
Contents vii
12 Bonds (2): discounting, redemption, pricing and valuation 135
The redemption yield 135
Bond pricing 138
Bond durations 145
13 equities 151
Characteristics of equities: income 152
Characteristics of equities: capital 153
Measurement of equity returns 154
Equity risk 156
Measuring effective diversification 159
14 Alpha and beta: active and passive investment 163
What is beta? 164
What is alpha? 166
The arguments in favour of active investment 167
The arguments in favour of passive investment 169
15 Derivatives (1): futures and options 173
Futures 174
Options 177
Leverage 182
Capital at risk 183
16 Derivatives (2): swaps, futures, options and how to use
them 185
OTC and exchange traded options 185
American and European options 186
The Black-Scholes Model 187
Swaps 190
Hedging 194
17 Capital markets and M&A transactions: events in the
corporate life-cycle 199
Merger and acquisition 199
Flotation (IPO) 204
Capital raising: issue of new bonds or shares (stock) 205
Insolvency (bankruptcy) 206
viii Contents
18 Asset allocation 211
Regulation 212
The truth about bonds 213
Diversification 214
Correlation 216
The challenge: matching theory with reality 220
Appendix: key formulae 223
Glossary of financial terms 229
Index 247
The figures contained in this book are also available on the Kogan Page website.
To access, go to http://www.koganpage.com/editions/no-fear-finance/
9780749463878
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