MASSEY TEXTS An imprint of Massey University Press First published in 2000 by Pearson Education New Zealand This updated and revised edition published in 2017 by Massey University Press Massey University Press, Private Bag 102904 North Shore Mail Centre, Auckland 0745, New Zealand www.masseypress.ac.nz Text and figures copyright © Andrea Bennett, Jenny Parry and Carolyn Wirth, 2000, 2017 Design by Kate Barraclough. Text correction by Sarah Elworthy Text design updated from original design by Marie Low and BookNZ Cover photograph from iStock (reference number: 58834068) Back cover photographs (top four) from One Shot (oneshot.co.nz) Back cover photograph (bottom) from Getty Images (reference number: 519100048) The moral right of the authors has been asserted All rights reserved. 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A catalogue record for this book is available from the National Library of New Zealand Ebook conversion 2020 by meBooks ISBN: 978-0-9941325-2-9 (print) ISBN: 978-0-9951378-4-4 (ebook) Contents Preface PART 1: FINANCIAL SYSTEMS Chapter 1: An overview of finance Introduction Definition of finance The financial system Finance as a discipline for study The interdisciplinary nature of finance Finance and business The business environment and stakeholder protection • The four levels of financial decision-making • Personal level •Sole proprietorship level • Partnership level • Corporation level The ethics dilemma Agency problems • Conflict of interest Financial markets The existence of private wealth • Freedom of choice • Incentives • Efficient markets • The role of government Careers in finance Conclusion Self-test question and answer Questions and problems Chapter 2: Financial markets Introduction Financial assets Debt versus equity claims • Prices of financial assets • The roles of financial assets Financial markets The roles of financial markets • Market participants • Types of financial market Money markets Market operation and participants • Types of instruments traded Capital markets The debt markets • The equities market Foreign exchange (FX) market Market operations and participants • Types of instruments traded Derivative markets Types of derivative instruments • The operation of the market • Participants in the futures market • Forward contracts • Options contracts • Participants in the options market Conclusion Self-test questions and answers Questions and problems Chapter 3: Financial institutions Introduction The development of the modern financial system The modern role of government in the financial intermediation process • Regulations to control the soundness of the financial system Credit creation Credit multiplier Monetary policy – three control mechanisms The official cash rate • The inflation problem Modern financial intermediaries Depository institutions • Non-depository institutions • The benefits of financial intermediation Ethics and financial institutions Classifying types of financial transfers Conclusion Self-test questions and answers Questions and problems PART 2: FINANCE TOOLS Chapter 4: Time value of money – Single payments Introduction Simple interest and future value Simple interest and calculating the present value Compound interest and future value Other methods of calculation • The present value of a single payment • Compounding frequency • Continuous compounding/discounting Nominal and effective interest rates Solving for an unknown interest rate Solving for an unknown time period Conclusion Self-test questions and answers Questions and problems Chapter 5: Time value of money – Multiple payments Introduction Multiple cash flows Future value of multiple cash flows • Present value of multiple cash flows Level cash flows: Annuities and perpetuities Future value of an annuity • Present value and annuities Finding the amount of a regular payment Annuity due Perpetuities Asset valuation: Calculating the price of a bond Loan types Conclusion Self-test questions and answers Questions and problems PART 3: PERSONAL FINANCE Chapter 6: Risk and return Introduction Risk-free assets The two components of a return • Nominal interest rate Term structure of interest rates Shape of yield curves Risky assets Risk and return – the trade-off Measuring historical risk and return Returns from investment • Holding period returns and yields • Standard deviation as a measure of risk Measuring future risk and return The benefit of diversification The capital asset pricing model and the security market line relationship Conclusion Self-test questions and answers Questions and problems Chapter 7: Personal financial management Introduction The personal financial planning activity Money management Gathering financial information • Preparing an income statement • Budget preparation • Developing a personal balance sheet Financial planning for life Financial goal attainment Funding a retirement plan Retirement income gap • KiwiSaver • Choosing a KiwiSaver fund Residential property and mortgages Criteria for choosing residential property • Financing the purchase of residential property Starting or buying a business Personality traits • Preliminary evaluation • Business plan Conclusion Self-test question and answer Questions and problems PART 4: FINANCIAL MANAGEMENT Chapter 8: Financial management Introduction Role of financial management Financial managemen • Organisational context Objective of financial management What about profit maximisation? • Time value of money • Cash flows • Risk • Managers as agents • Economic implications of wealth maximisation The external environment Financial markets • Regulatory environment Risk and return Conclusion