Question

Analysis of five basis principles of finance Define the five basic principles finance and justify your analysis by illustrating examples: Choose one or more events described by media (CNN Business, Financial Times, Dow Jones financial news etc.) about companies and financial market. Analyse that event (s) applying the five basis principles of finance. Note: Each principle is to be illustrated by at least one event. Example of an event in media that reflect one of five basic principle of finance: “The Dow Jones Industrial Average was clinging to a small gain, while the S&P 500 and Nasdaq Composite slipped back into negative territory after The Wall Street Journal said U.S.-China trade talks hit a snag over purchases of agricultural products. The Dow DJIA, +0.33% was up 24 points, or 0.1%, at 27,716, while the S&P 500 SPX, +0.07% edged down 0.1% to 3,089. The Nasdaq Composite COMP, -0.05% was off 0.3% at 8,464. The report said that while President Donald Trump has agreed to buy $50 billion a year of U.S. soybeans, pork and other farm products, China is wary of making a numerical commitment in the text of the agreement.”

Answer 1

The Five Basic principles of Finance are

1)Cash Flow : Cash flow is the money that the business earns that can be redeployed to earn more money. Some businesses are cash flow positive and some are cash flow negative during a period . The aim of every business is to be cash flow positive. In financial analysis of a business it is the cash flow and not the profits that determine the value of the business. Consider a film production company that makes a franchise movie , while evaluating and projecting its cash flow one has to consider the box office collection along with this one should also consider the merchandise sales for the same.

2)Hedging principle: In finance , the use of financial instruments to offset any investment risk is known as hedging. Example a home buyer in California buys a home owners insurance to mitigate the risk of natural disasters like forest fires.

3)Time Value of Money: A Dollar today is worth more than a dollar post a year. Besides inflation the other factor that makes this true is that if you have a dollar today you can invest it and earn net positive returns and you will have more than a dollar after a year.For Example lets say you have $ 1 million today and you pass the opportunity to invest it in Govt bonds or a business vis a vis if you would have , then you would have had $1.15 million say if the business gave a 15% return

4)Risk and Return matrix: The Capital budgeting decision risk along with returns is a major consideration. The business must evaluate the investment return with the risk associated with it and whether it is fully compensated with the investors understanding.

5)Diversification : Diversification is the process of reducing risk/volatility by investing across asset classes. it is to have financial prudence of not putting all your eggs in one basket. For eg. An investor has $1million . he puts $400000 in equity $200000 in govt bonds and rest in rent yielding real estate.