Finance (Basics)
Petr Malek
Department of Finance
Office 533
malek.petr@seznam.cz
99563@mail.muni.cz

Structure of lectures
n1.Introduction to finance - ok
n2.Financial markets - ok
n3.Banks and bank systems - ok
n4.Other financial institutions - ok
n5.Present value of money - now
n6.Private finance;
n7.Investments;
n8.Corporate finance;
n9.International finance;
n10.International financial system;
n11.Macroekonomic and financial indicators and informations;
n12.History of financial science;
n13.Latest trends on financial markets.
n
n

Money – Meaning of Money
nTo understand the effects of money on the economy, we must understand exactly what money is.
n„Money“ is used in everyday conversation, it can mean many things, but to economists, it has a
very specific meaning.
nEconomists define money as anything that is generally accepted in payment for goods or services or
in the repayment of debts.
qCurrency, consisting of bills and coins, fits this definition and is one type of money.
qWhen most people talk about money, they‘re talking about currency (paper money and coins)

Money – Meaning of Money
Very difficult to define money
nFor example checks are also accepted as payment for purchases; checking account deposits are
considered money as well.
nWord „money“ is used synonymously with wealth.
nEconomists make a distinction between money in the form of currency, demand deposits, and other
items that are used to make purchases and wealth, the total collection of pieces of property that
serve to store value.
qWealth includes not only money but also other assets such as bonds, common stock, art, land,
furniture, cars and houses.

Meaning of money
nSome people also use the word „money“ to describe what economists call „income“.
qIncome is a flow of earnings per unit of time.
qMoney, by contrast, is a stock: it is a certain amount at a given point in time.
nFor you: Money refers to anything that is generally accepted in payment for goods and services or
in the repayment of debts and is distinct from income and wealth.

Functions of money
nMedium of exchange
nUnit of account
nStore of value

Medium of Exchange
nIn almost all market transaction in our economy, money in the form of currency or checks is a
medium of exchange.
n… it is used to pay for goods and services.
nThis function promotes economic efficiency by minimizing the time spent in exchanging goods and
services
q… to see why, let‘s look at a barter economy, in which goods and services are exchanged directly
for other goods and services. (example 45)
n…the time spent trying to exchange goods or services is called a transaction cost. (example in a
barter economy)

Unit of Account
nIt is used to measure value in the economy.
qWe measure the value of goods and services in terms of money, just as we measure weight in terms
of kilograms or distance in terms of kilometers.
nIf there were only three goods in the economy, this would not be a great advantage over the barter
system, because we would still need three prices to conduct transactions.
nWe can see that using money as a unit of account reduces transactions costs in an economy by
reducing the number of prices that need  to be considered
qExample (barter 46)

Store of Value
nMoney also functions as a store of value; it is repository of purchasing power over time.
nA store of value is used to save purchasing power from the time income is received until the time
it is spent.
nMoney is not unique as a store of value; any asset-whether money, stocks, bonds, land-can be used
of store of value….but…
n…it relates to the important economic concept of liquidity, the relative ease and speed with which
an asset can be converted into a medium of exchange.
qMoney is the most liquid asset.
nHow good a store of value money is depends on the price level, because its valueis fixed in terms
of the price level.

Understanding Interest Rates
nInterest rates are among the most closely watched variables in the economy.
nThey affect personal decisions such as whether to consume or save, whether to buy a house, and
whether to purchase bonds or put funds into a savings account.
nInterest rate definition
q

The Concept of present value
nThe concept of present value (or present discounted value) is based on the commonsense notion that
a dollar paid to you one year from now is less valuable to you than a dollar paid to you today.
nExample
qLoan – in the loan the lender provides  the borrower with an amount of funds (called the
principal) that must be repaid to the lender at the maturity date, along with an additional payment
for the interest.

Example – present value
nIf you made your friend a simple loan of 10000 CZK for one year, you would require him to repay
the principal of 10000 CZK in one year‘s time along with an additional payment for interest: say,
1000 CZK.
qThe interest payment divided by the amount of the loan is natural and sensible way to measure the
interest rate
qi= 1 000 CZK / 10 000 CZK = 0,1 =10%
qIf you make this loan, at the end of the year you would have  10 000 CZK, which can be rewritten
as :
q 10 000 CZK x (1 + i ) = 10 000 CZK x 1,1 = 11 000 CZK
qIf you make this loan, at the end of second year you would have:
q 11 000 CZK x (1 + i ) = 11 000 CZK x 1,1 = 12 100 CZK
q 10 000 CZK x (1 + i )n = 10 000 CZK x (1 + 0,1)2 = 12 100 CZK

Present value
nDiscounting the future
nWe can generalize this process by writing  today‘s present value
nPV = FV / (1 + i)n

Present value
nIn terms of the timing of their payments, there are four basic types of credit market instruments:
qA simple loan
qA fixed-payment loan (fully amortized loan) in which the lender provides  the borrower with an
amount of funds, which must be repaid by making the same payment every period (such as a month),
consisting of part of the principal and interest for a set number of years. (example 63)
qA coupon bond pays the owner of the bond a fixed interest payment every year until the maturity
date, when a specified final amount is repaid.
qA discount bond (zero coupon bond) is bought at a price below its face value (at a discount), and
the face value is repaid at the maturity date.

Simple loan, fixed payment loan
nPresent value
nFixed payment loan
qLV = FP/(1+i) + FP/(1+i)2 + FP/(1+i)3 + FP/(1+i)4 + …+ FP/(1+i)n
q where LV = loan value
q         FP = fixed yearly payment
q           n = number of years until maturity

Coupon Bond
qP = C/(1+i) + C/(1+i)2 + C/(1+i)3 + C/(1+i)4 + …+ C/(1+i)n + F/(1+i)2
where P = price of coupon bond
     C = yearly coupon bond
     F = face value of the bond
     n = years to maturity date
q

Discount bond
ni = (F – P) / P
qWhere F = face value of the discount bond
q       P = current price of the discount bond

The Distinction Between Real and Nominal Interest Rates
nInterest rates – don‘t ignore the effects of inflation on the cost of borrowing
nNominal interest rates must be distinguished from real interest rates; the interest rate that is
adjusted by subtracting expected changes in the price level (inflation) so that it more accurately
reflects the true costs of borrowing
ni = ir + πe (The Fischer equation)
n where ir = real interest rate
n   πe = expected inflation

Interest rates – IBOR vs IBID
nThe Prague Interbank Offered Rate, or PRIBOR, is the average interest rate at which term deposits
are offered between prime banks in the Czech wholesale money market or interbank market.
nThe London Interbank Bid Rate (LIBID) is a bid rate; the rate bid by banks on Eurocurrency
deposits (i.e., the rate at which a bank is willing to borrow from other banks). It is "the
opposite" of the LIBOR (an offered, hence "ask" rate, the rate at which a bank will lend). Whilst
the British Bankers' Association set LIBOR rates, there is no correspondent official LIBID fixing.
qConventional wisdom used to assert that a LIBID rate could be calculated by subtracting a fixed
amount (often given as ⅛th of 1%) from the prevailing BBA LIBOR rate, however this is no longer the
case as bid/offer spreads have tightened in recent years. Additionally, it cannot be the case that
the LIBOR / LIBID spread is always ⅛th of 1% for all maturities and all currencies all the time.

nEuribor is short for Euro Interbank Offered Rate. The Euribor rates are based on the average
interest rates at which a panel of more than 50 European banks borrow funds from one another. There
are different maturities, ranging from one week to one year.
nThe Euribor rates are considered to be the most important reference rates in the European money
market. The interest rates do provide the basis for the price and interest rates of all kinds of
financial products like interest rate swaps, interest rate futures, saving accounts and mortgages.
That’s the exact reason why many professionals as well as individuals do monitor the development of
the Euribor rates intensively.
nIn total, there are 15 different Euribor rates. See current Euribor rates for an overview of all
15 rates. Next to that there is also a 1-day European interbank interest rate called Eonia.
nOn this site you will find lots of information about Euribor and the different Euribor rates. We
do offer background information, the current Euribor rates as well as historical data.
nFurthermore, we do offer information about the ECB interest rate, also called main refinancing
rate or minimum bid rate, as well.

ECB
nThe Eurosystem offers credit institutions two standing facilities:
nMarginal lending facility in order to obtain overnight liquidity from the central bank, against
the presentation of sufficient eligible assets;
nDeposit facility in order to make overnight deposits with the central bank.

Effective interest rate
ieffec= (1+i/m)m -1
nThe effective interest rate, effective annual interest rate, annual equivalent rate (AER) or
simply effective rate is the interest rate on a loan or financial product restated from the nominal
interest rate as an interest rate with annual compound interest payable in arrears. It is used to
compare the annual interest between loans with different compounding terms (daily, monthly,
annually, or other).
n
nThe effective interest rate differs in two important respects from the annual percentage rate
qthe effective interest rate generally does not incorporate one-time charges such as front-end
fees;
qthe effective interest rate is (generally) not defined by legal or regulatory authorities.
n
nEffective annual interest or yield may be calculated or applied differently depending on the
circumstances, and the definition should be studied carefully. For example, a bank may refer to the
yield on a loan portfolio after expected losses as its effective yield and include income from
other fees, meaning that the interest paid by each borrower may differ substantially from the
bank's effective yield.
qwhere m is number of compounding periods per year

nThank you for your attention