Question

Week 1 What are the five basis principles of finance? Briefly explain them (no more than 250 words) (10 marks)

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Answer 1

Answer to the question :

Five basic principles of finance are:

a) Time Value of money: We all know that as a time passes the value of money dereases with passing of time. therefore the value of amount received today is more valuable then the amount recieved in future.

b) Risk - Return relationship : In general scenario a person can take risk only if he get something in return, same concept is applicable in finance too. That,s why it's said that higher the risk taken higher will be the return recieved in future. Therefore an investor get higher return if he take higher calculated risk.

c) Cash flow is what matters: Accounting profits are not equal to the cash flows of a firm. Sometimes it may be happen that there is accounting profit but there is no cash flow with the firm. Therefore in finance we must considered incremental cash flows (i.e. diffrence in cash flow if an investment is selected vs cash flow if investment is not selected) while making any financing decisions.

d) Market Prices : Market prices are the prices of the companies stock on the stcok exchange. These market price are generally right as compare to price which was shown in accounting, because the prices shown by the stock market are the prices which reflect the true image of a company based on the expected future cash flows of the company on the basis of trends and decisions of the company.

e) Conflict of interest : Someties there are conflict of interest arise between the two stakeholders of the company i.e. management and shareholders. because management may take decision which was against the goal of maximising shareholder's wealth. These conflicts may reduced through monitoring and market mechanism.