PAPER NO. 6 INTRODUCTION TO FINANCE AND INVESTMENT
UNIT DESCRIPTION
This paper is intended to equip the candidate with knowledge, skills and attitudes that will enable him/her to apply the principles of finance in investment decision making under non- complex scenarios.
LEARNING OUTCOMES
A candidate who passes this paper should be able to:
• Select and apply the techniques and concepts of the time value of money, compounding, discounting, and annualising
• Analyse the risks and returns offered by short-term, liquid instruments
• Calculate non-complex risk and return measures
• Calculate the cost of capital of a firm
• Apply the basic valuation models to determine value of financial securities
• Evaluate the viability of capital investments using appropriate appraisal
CONTENT
1. Nature and purpose of finance
1.1 Nature and scope of finance and investment
1.2 Financial decision-making process
1.3 Relationship between accounting and finance
1.4 Goals of a firm
1.5 Roles of a finance manager
1.6 Agency theory; conflicts and resolutions
2. Financial markets and systems
2.1 Market organisation and structure
2.1.1 The role of financial services industry
2.1.2 Financial system and intermediaries; components of financial system, characteristics of well-functioning financial system and the role of financial system in the economy; financial intermediaries, differences between financial intermediation and financial disintermediation, roles of financial intermediaries
2.2 Equity markets
2.2.1 Structure of the equity markets
2.2.2 Primary and secondary markets for securities
2.2.3 Types of equity securities; ordinary shares and preference shares, private versus public equity securities
2.2.4 Features and benefits of investing in equity securities
2.2.5 The risks of owning equity: Price risk; liquidity risk; issuer risk; foreign exchange risk
2.3 Fixed income securities markets
2.3.1 Characteristics and terminology of bonds: coupon; redemption; nominal value
2.3.2 Types of fixed income securities
2.3.3 Advantages, disadvantages and risks of investing in bonds
2.3.4 Fixed-income indices; types and construction
2.4 Alternative investments markets
2.4.1 Distinction between alternative investments from traditional investments
2.4.2 Categories of alternative investment (real assets, hedge funds, commodities, private equity, mutual funds, open-ended funds, closed – ended funds, collective investment trusts, exchange traded funds, and structured products)
2.4.3 Structures of alternative investments
2.4.4 Goals of alternative investing
2.5 Derivative markets and instruments
2.5.1 Overview of derivatives
2.5.2 Types of derivatives: forwards, futures, options and swaps
2.5.3 Role, structure and regulation of global derivatives markets
2.5.4 Derivatives market terminology
2.5.5 Key market participants and roles
2.5.6 The purposes of derivative markets
2.5.7 Criticisms of derivative markets
2.6 Foreign exchange market
2.6.1 Function and structure of the foreign exchange market
2.6.2 Mechanics of foreign exchange: The market for foreign exchange; exchange rates (direct and indirect quotations, cross-rate calculations, bid-ask quotes and spreads, cross-rate calculations with bid-ask spreads), exchange rate determination
2.6.3 Parity relationship: interest rate parity, purchasing power parity; international fisher effects
2.6.4 Forecasting exchange rates
2.7 Mortgage Markets
2.7.1 Overview of mortgage markets
2.7.2 Mortgage products: consumer and investor perspectives Loan structures
2.7.3 Loan quality and securitization
2.7.4 The business of mortgage financing, opportunities and challenges
2.7.5 Financing affordable housing
3. The investment environment
3.1 Types of investments
3.2 The investment processes
3.3 Sources of financial and market data: costs and charges: key investor information documents; prospectuses; financial statements; financial data
3.4 Asset classes: Cash Instruments (Cash Deposits, Money Markets); Bonds, Equities, Property, Foreign Exchange (FX) – to cover computation aspects of exchange rate such as spot rates, forward rates
3.5 Investment management function
3.6 Globalisation and investment
4. The financing decision
4.1 Nature and objectives of the financing decision
4.2 Factors to consider when making financing decisions
4.3 Sources of finance for enterprises: Internally generated (retained earnings) and externally generated finance (equity, loan stock, bank lending, leasing, hire purchase, venture capital, franchising; Short term (trade credit, bank financing,
customer advances, factoring, accruals, credit cards, medium (issue of debentures, issue of preference shares, bank loans, fixed deposits, hire purchase, lease financing and long term sources of finance (ordinary shares, preference share capital, retained earnings, debentures, term loans, mortgages, venture capital, asset securitisation, international financing-Euro bonds).
4.4 Advantages and disadvantages of each source of finance
4.5 Factors to consider when selecting the source of finance
5. Valuation of Assets
5.1 Concept of value; book value, going concern value, substitution value, replacement value, conversion value, liquidation value, intrinsic value and market value
5.2 Reasons for valuing financial assets/business
5.3 Theories on valuation of financial assets; fundamental theory, technical theory, random walk theory and the efficient market hypothesis
5.4 Valuation of redeemable, irredeemable and convertible debentures, corporate and treasury bonds
5.5 Valuation of redeemable, irredeemable and convertible preference shares
5.6 Valuation of ordinary shares; net asset basis, price earnings ratio basis, capitalisation of earnings basis, Gordon’s model, finite earnings growth model, Super-profit model, Walter’s model
6. Cost of capital
6.1 Significance of cost of capital to firms
6.2 Factors influencing a firm’s cost of capital
6.3 Components of cost of capital
6.4 Weighted average cost of capital (WACC)
6.5 Weighted marginal cost of capital (WMCC)
7. Time-value of money
7.1 Concept of time value of money
7.2 Relevance of the concept of time value of money
7.3 Time value of money versus time preference of money
7.4 Compounding techniques
7.5 Discounting techniques
7.6 Simple interest and compound interest computations
7.7 Loan amortisation
8. Introduction to risk and return
8.1 Sources of risk
8.2 Components of risk and return
8.3 Relationship between risk and return on investments
8.4 Realised and expected rates of return and risk
8.5 Geometric and Arithmetic rates of return
8.6 Measures of risk and return for a single and two assets case
8.7 Risky and risk-free assets
9. Capital budgeting
9.1 The nature, importance, characteristics and types of capital investment decisions
9.2 Investment appraisal techniques: accounting rate of return (ARR), payback period; internal rate of return(IRR); net present value(NPV), and profitability index(PI)
9.3 Strengths and weaknesses of the investment appraisal techniques
10. Introduction to Islamic Finance
10.1 Principles and trends in Islamic banking
10.2 Differences between Islamic and conventional banking
10.3 The concept of interest (riba) and how returns are made by Islamic financial securities
10.4 Sources of finance in Islamic financing
Sample reading and reference material
1. Pandey, I. M. (2015). Financial Management (11th edition). New Delhi: Vikas Publishing.
2. Brigham, E. F., & Daves, P. R. (2021). Intermediate Financial Management (14th edition). Australia: Cengage Learning.
3. Madura, J. (2021). Financial Markets & Institutions (13th edition). Australia: Cengage Learning.
4. Saunders, A., & Cornett, M. (2018). Financial Markets and Institutions (7th edition). New York: McGraw-Hill Education.
5. Frederic S. Mishkin, S. E. (2017). Financial Markets and Institutions (9th edition). Harlow: Pearson.
6. Kasneb e-learning resources (link on the Kasneb website).
7. Kasneb approved study packs.