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برنامج توعية الوسطاء. د. منذر بركات العمري هيئة الاوراق المالية والسلع. Interest Rates and Money Supply أسعار الفائدة والكتلة النقدية. Interest is the rent of money

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slide1
برنامج توعية الوسطاء

د. منذر بركات العمري

هيئة الاوراق المالية والسلع

interest rates and money supply
Interest Rates and Money Supplyأسعار الفائدة والكتلة النقدية
  • Interest is the rent of money
  • Equal to the real growth rate of GDP plus the expected inflation rate plus a premium to compensate for the riskness of the company being analyzed.
  • Money supply is the amount of liquidity that is being allowed by the UAE central bank. The company being analyzed benefits if the amount of liquidity is near the healthy level.
  • Both interest rates and money supply have a great effect on the performance and value of the company and need to be taken into consideration in any financial analysis.
function of financial markets and institutions
Function of Financial Markets and Institutionsوظيفة الأسواق والمؤسسات المالية
  • Allows transfers of funds from person or business without investment opportunities (i.e., “Lender-Savers”) to one who has them (i.e., “Borrower-Spenders”)
  • تحويل الاموال ممن يملكونها الى من يحتاجونها
  • Improves economic efficiency
  • زيادة الفاعلية الاقتصادية
segments of financial markets
Segments of Financial Markets
  • Direct Finance
    • Borrowers borrow directly from lenders in financial markets by selling financial instruments which are claims on the borrower’s future income or assets
    • التمويل المباشر
  • Indirect Finance
    • Borrowers borrow indirectly from lenders via financial intermediaries (established to source both loanable funds and loan opportunities) by issuing financial instruments which are claims on the borrower’s future income or assets
    • التمويل غير المباشر
function of financial markets
Function of Financial Markets رسم توضيحي لفكرة انتقال الاموال

Flow of Funds Through the Financial System

classifications of financial markets
Classifications of Financial Marketsتصنيف الأسواق حسب الإصدار
  • Primary Market السوق الأولية
    • New security issues sold to initial buyers
  • Secondary Market السوق الثانوية
    • Securities previously issued are bought and sold
classifications of financial markets1
Classifications of Financial Marketsتصنيف الأسواق حسب التنظيم
  • Exchanges الاسواق المنظمة (البورصات)
    • Trades conducted in central locations (e.g., ADSM, DFM, ….)
  • Over-the-Counter Markets الاسواق الغير منظمة
    • Dealers at different locations buy and sell
function of financial intermediaries
Function of FinancialIntermediariesدور الوساطة المالية
  • Financial Intermediaries الوسطاء الماليين
    • Engage in process of indirect finance
    • More important source of finance than securities markets
    • Needed because of transactions costs and asymmetric information
function of financial intermediaries1
Function of FinancialIntermediariesدور الوساطة المالية
  • Transactions Costs تكاليف التحويلات
    • Financial intermediaries make profits by reducing transactions costs
    • Reduce transactions costs by developing expertise and taking advantage of economies of scale and scope.
function of financial intermediaries2
Function of FinancialIntermediariesدور الوساطة المالية
  • A financial intermediary’s low transaction costs mean that it can provide its customers with liquidity services, services that make it easier for customers to conduct transactions توفير السيولة دون الحاجة الى انهاء المشروع الانتاجي
    • Banks provide depositors with checking accounts that enable them to pay their bills easily
    • Depositors can earn interest on checking and savings accounts and yet still convert them into goods and services whenever necessary without having to discontinue and liquidate investments
function of financial intermediaries3
Function of FinancialIntermediariesدور الوساطة المالية
  • Another benefit made possible by the FI’s low transaction costs is that they can help reduce the exposure of investors to risk, through a process known as risk sharing
  • ادارة المخاطر
    • FIs create and sell assets with lesser risk to one party in order to buy assets with greater risk from another party (e.g. banks)
    • This process is referred to as asset transformation, because in a sense risky assets are turned into safer assets for investors
function of financial intermediaries4
Function of FinancialIntermediariesدور الوساطة المالية
  • Adverse Selection الامتناع عن الاستثمار
    • Before transaction occurs
    • Potential borrowers most likely to produce adverse outcome are ones most likely to seek loan and be selected – brokers and financial analysts can prevent that by studying the credit worthiness of the borrowers
function of financial intermediaries5
Function of FinancialIntermediariesدور الوساطة المالية
  • Moral Hazard المخاطرة بأموال الغير
    • After transaction occurs
    • Hazard that borrower has incentives to engage in undesirable (immoral) activities making it more likely that won't pay loan back
function of financial intermediaries6
Function of FinancialIntermediariesدور الوساطة المالية
  • Financial intermediaries reduce adverse selection and moral hazard problems, enabling them to make profits. How they do this is covered in many of the topics to come.
  • المؤسسات المالية تقلل من هذه المخاطر
regulation of financial markets
Regulation of Financial Markets
  • Reasons for Regulation اسباب التشريع المالي
    • Increase Information to Investors
    • Protect investors and their investments
    • Ensure the Soundness of Financial Intermediaries
    • Improve Monetary Control
regulation reason increase investor information
Regulation Reason: Increase Investor Informationزيادة توفر المعلومات
  • Asymmetric information in financial markets means that investors may be subject to adverse selection and moral hazard problems that may hinder the efficient operation of financial markets and may also keep investors away from financial markets
  • The Securities and Commodities Authority (SCA) requires corporations issuing securities to disclose certain information about their sales, assets, and earnings to the public and restricts trading by the largest stockholders (known as insiders) in the corporation.
regulation reason increase investor information1
Regulation Reason: Increase Investor Informationزيادة توفر المعلومات
  • Such government regulation can reduce adverse selection and moral hazard problems in financial markets and increase their efficiency by increasing the amount of information available to investors
regulation reason ensure soundness of financial intermediaries
Regulation Reason: Ensure Soundness of Financial Intermediaries رُشْد الوسطاء
  • Because providers of funds to financial intermediaries may not be able to assess whether the institutions holding their funds are sound or not, if they have doubts about the overall health of financial intermediaries, they may want to pull their funds out of both sound and unsound institutions, with the possible outcome of a financial panic that produces large losses for the public and causes serious damage to the economy
regulation reason ensure soundness of financial intermediaries1
Regulation Reason: Ensure Soundness of Financial Intermediaries رُشْد الوسطاء
  • To protect the public and the economy from financial panics, six types of regulations are needed:
    • Restrictions on Entry - soundness
    • Disclosure – transparency
    • Restrictions on Assets and Activities – no dummies
    • Deposit Insurance – peace of mind
    • Limits on Competition – no price wars
    • Restrictions on Interest Rates – no usury
regulation restriction on entry
Regulation: Restriction on Entry موانع الدخول
  • Restrictions on Entry
    • Very tight regulations as to who is allowed to set up a financial intermediary
    • Individuals or groups that want to establish a financial intermediary, such as a bank or an insurance company, must obtain a charter from the government
    • Only if they are upstanding citizens with impeccable credentials and a large amount of initial funds will they be given a charter.
regulation disclosure
Regulation: Disclosure الافصاح
  • Disclosure Requirements
  • There are stringent reporting requirements for financial intermediaries
    • Their bookkeeping must follow certain strict principles,
    • Their books are subject to periodic inspection,
    • They must make certain information available to the public.
regulation restriction on assets and activities
Regulation: Restriction on Assets and Activities تحديد النشاطات
  • There are restrictions on what financial intermediaries are allowed to do and what assets they can hold
  • Before you put your funds into a bank or some other such institution, you would want to know that your funds are safe and that the bank or other financial intermediary will be able to meet its obligations to you
regulation restriction on assets and activities1
Regulation: Restriction on Assets and Activities تحديد النشاطات
  • One way of doing this is to restrict the financial intermediary from engaging in certain risky activities
  • Another way is to restrict financial intermediaries from holding certain risky assets, or at least from holding a greater quantity of these risky assets than is prudent
regulation deposit insurance
Regulation: Deposit Insuranceالتأمين
  • The government can insure people providing funds to a financial intermediary from any financial loss if the financial intermediary should fail
regulation past limits on competition
Regulation: Past Limits on Competition حدود للتنافس
  • Although the evidence that unbridled competition among financial intermediaries promotes failures that will harm the public is extremely weak, the government needs to impose many restrictive regulations
  • The purpose is to prevent financial intermediaries from competing to the point where the integrity of the financial system is compromised.
regulation past restrictions on interest rates
Regulation: Past Restrictions on Interest Rates حدود لأسعار الفائدة
  • Competition must also be inhibited by regulations that impose restrictions on interest rates that can be paid on deposits
  • These regulations need to be instituted because of the widespread belief that unrestricted interest-rate competition help encourage bank failures
regulation reason improve monetary control
Regulation Reason: Improve Monetary Control التحكم بالكتلة النقدية
  • Because banks play a very important role in determining the supply of money (which in turn affects many aspects of the economy), much regulation of these financial intermediaries is intended to improve control over the money supply
  • One such regulation is reserve requirements, which make it obligatory for all depository institutions to keep a certain fraction of their deposits in accounts with the central bank (the PMA)
  • Reserve requirements help the PMA exercise more precise control over the money supply – well, we do not have a currency nor can we control the used ones
the cost of money
The cost of moneyتكلفة رأس المال
  • The price, or cost, of debt capital is the interest rate.
  • The price, or cost, of equity capital is the required return. The required return investors expect is composed of compensation in the form of dividends and capital gains.
what four factors affect the cost of money
What four factors affect the cost of money?العوامل التي تؤثر في تكلفة رأس المال
  • Time preferences for consumption (sacrifice)
  • Expected inflation (loss in purchasing power)
  • Risk (worry)
nominal vs real rates
“Nominal” vs. “Real” ratesالعائد الاسمي والحقيقي

k = represents any nominal rate

k* = represents the “real” risk-free rate of interest, if there was no inflation. Typically ranges from 1% to 4% per year.

kRF = represents the rate of interest on Treasury securities.

determinants of interest rates
Determinants of interest ratesمحددات سعر الفائدة (العائد)

k = k* + IP + DRP + LP + MRP

k = required return on a debt security

k* = real risk-free rate of interest

IP = inflation premium

DRP = default risk premium

LP = liquidity premium

MRP = maturity risk premium

premiums added to k for different types of debt
Premiums added to k* for different types of debtمقارنة علاوات المخاطر المختلفة
yield curve and the term structure of interest rates
Yield curve and the term structure of interest ratesمنحنى العائد وعلاقة الفائدة بالاستحقاق
  • Term structure – relationship between interest rates (or yields) and maturities.
  • The yield curve is a graph of the term structure.
hypothetical yield curve

Interest

Rate (%)

15

Maturity risk premium

10

Inflation premium

5

Real risk-free rate

Years to

Maturity

0

1 10 20

Hypothetical yield curveمنحنى عائد افتراضي
  • An upward sloping yield curve.
  • Upward slope due to an increase in expected inflation and increasing maturity risk premium.
the yield curve
The Yield Curveمنحنى العائد
  • Corporate yield curves are higher than that of Treasury securities, though not necessarily parallel to the Treasury curve.
  • The spread between corporate and Treasury yield curves widens as the corporate bond rating decreases.
the yield curve1

BB-Rated

AAA-Rated

The Yield Curveمنحنى العائد

Interest

Rate (%)

15

10

Treasury

Yield Curve

6.0%

5.9%

5

5.2%

Years to

Maturity

0

0

1

5

10

15

20

the term structure of interest rates
The Term Structure of Interest Ratesعلاقة سعر الفائدة بالوقت
  • The Yield Curve
  • Spot and forward rates
  • Theories of the Term Structure
the term structure of interest rates1
The Term Structure of Interest Ratesعلاقة سعر الفائدة بالوقت
  • bonds with the same characteristics,

but different maturities

  • focus on Treasury yields
    • same default risk
    • similar liquidity
    • many choices of maturity
treasury securities
Treasury securitiesأوراق الخزينة المحددة لأسعار الفائدة وهيكلها الزمني
  • Tbills:
    • 4, 13, 26, and 52 weeks
    • zero coupon
  • Tnotes:
    • 2, 5, and 10 years
  • Tbonds:
    • 30 years
    • Tnotes and Tbonds are coupon
slide40

Relationship between yield & maturity is NOT constant

تتغير العلاقة ما بين سعر الفائدة والوقت بتغير الأوضاع الاقتصادية المتوقعة

  • sometimes short-term yields are highest,
  • most of the time long-term yields are highest
the yield curve2
The Yield Curveمنحنى العائد
  • plot of maturity vs. yield
  • slope of curve indicates relationship between maturity and yield
upward sloping

yield

maturity

Upward Sloping
  • yields rise w/ maturity (common)
downward sloping inverted

yield

maturity

downward sloping (inverted)
  • yield falls w/ maturity (rare)
slide44

yield

maturity

flat
  • yields similar for all maturities
humped

yield

maturity

humped
  • intermediate yields are highest
theories of the term structure
Theories of the term structureمحددات العلاقة يبن الوقت وأسعار الفائدة
  • explain relationship between yield and maturity
  • what does the yield curve tell us?
the pure expectations theory
The Pure Expectations Theory
  • Assume:

bond buyers do not have any preference about maturity

i.e.

bonds of different maturities are perfect substitutes

  • LT = long-term
  • ST = short-term
the pure expectations theory1
The Pure Expectations Theory
  • if assumption is true,

then investors care only about expected return

    • if expect better return from ST bonds, only hold ST bonds
    • if expect better return from LT bonds, only hold LT bonds
the pure expectations theory2
The Pure Expectations Theory
  • but investors hold both ST and LT bonds
  • so,
  • must EXPECT similar return:

LT yields =

average of the expected

ST yields

the pure expectations theory3
The Pure Expectations Theory
  • slope of yield curve tells us direction of expected future ST rates
slide51
why?
  • if expect ST rates to RISE,

then average of ST rates will be >

current ST rate

    • so LT rates > ST rates
    • so yield curve SLOPES UP
the pure expectations theory4
The Pure Expectations Theory
  • if expect ST rates to FALL,

then average of ST rates will be <

current ST rate

    • so LT rates < ST rates
    • so yield curve slopes DOWN
the pure expectations theory5
The Pure Expectations Theory
  • if expect ST rates to STAY THE SAME,

then average of ST rates will be =

current ST rate

    • so LT rates = ST rates
    • so yield curve is FLAT
is this true
Is this True?
  • not quite.
  • FACT: yield curve usually slopes up
  • but expectations theory would predict this only when ST rates are expected to rise
    • 50% of the time
what went wrong
what went wrong?
  • back to assumption:

bonds of different maturities are perfect substitutes

  • but this is not likely
    • long term bonds have greater price volatility
    • short term bonds have reinvestment risk
  • assumption is too strict
  • so implication is not quite correct
liquidity theory
Liquidity Theory
  • assume:

bonds of different maturities are imperfect substitutes,

and investors PREFER ST bonds

liquidity theory1
Liquidity Theory
  • so if true,

investors hold ST bonds

UNLESS

LT bonds offer higher yield as incentive

higher yield = liquidity premium

liquidity theory2
Liquidity Theory

IF LT bond yields have a liquidity premium,

then usually LT yields > ST yields

or yield curve slopes up.

problem
Problem
  • How do we interpret yield curve?
  • slope due to 2 things:

(1) exp. about future ST rates

(2) size of liquidity premium

  • do not know size of liq. prem.
slide60

yield

maturity

  • if liquidity premium is small,
  • then ST rates are expected to rise

yield curve

small liquidity premium

slide61

yield

maturity

yield curve

  • if liquidity premium is larger,
  • then ST rates are expected to stay the same

large liquidity premium

preferred habitat theory
Preferred Habitat Theory
  • assume:

bonds of different maturities are imperfect substitutes,

and investor preference for ST bonds OR LT bonds is not constant

slide63
liquidity premium could be positive or negative
  • yield curve very difficult to interpret
    • do not know size or sign of liquidity premium
segmented markets theory
Segmented Markets Theory
  • assume:

bonds of different maturities are NOT substitutes at all

slide65

Segmented Markets Theory

  • if assumption is true,
    • separate markets for ST and LT bonds
    • slope of yield curves tells us nothing about future ST rates
  • unrealistic to assume NO substitution bet. ST and LT bonds
  • unrealistic to assume NO substitution
the annual report
The Annual Reportالتقرير السنوي
  • Balance sheet – provides a snapshot of a firm’s financial position at one point in time.
  • Income statement – summarizes a firm’s revenues and expenses over a given period of time.
  • Statement of retained earnings – shows how much of the firm’s earnings were retained, rather than paid out as dividends.
  • Statement of cash flows – reports the impact of a firm’s activities on cash flows over a given period of time.
balance sheet assets

2006

7,282

632,160

1,287,360

1,926,802

1,202,950

263,160

939,790

2,866,592

2005

57,600

351,200

715,200

1,124,000

491,000

146,200

344,800

1,468,800

Balance Sheet: Assetsقائمة المركز المالي - الاصول

Cash

A/R

Inventories

Total CA

Gross FA

Less: Dep.

Net FA

Total Assets

balance sheet liabilities and equity

2006

524,160

636,808

489,600

1,650,568

723,432

460,000

32,592

492,592

2,866,592

2005

145,600

200,000

136,000

481,600

323,432

460,000

203,768

663,768

1,468,800

Balance sheet: Liabilities and Equityقائمة المركز المالي – الخصوم وحقوق الملكية

Accts payable

Notes payable

Accruals

Total CL

Long-term debt

Common stock

Retained earnings

Total Equity

Total L & E

income statement
Income statementقائمة الدخل

Sales

COGS

Other expenses

EBITDA

Depr. & Amort.

EBIT

Interest Exp.

EBT

Taxes

Net income

2006

6,034,000

5,528,000

519,988

(13,988)

116,960

(130,948)

136,012

(266,960)

(106,784)

(160,176)

2005

3,432,000

2,864,000

358,672

209,328

18,900

190,428

43,828

146,600

58,640

87,960

other data

2006

100,000

-$1.602

$0.11

$2.25

2005

100,000

$0.88

$0.22

$8.50

Other dataمعلومات أخرى

No. of shares

EPS

DPS

Stock price

did the expansion create additional net operating after taxes nopat
Did the expansion create additional net operating after taxes (NOPAT)?حسابات الدخل التشغيلي بعد الضريبة

NOPAT = EBIT (1 – Tax rate)

NOPAT06 = -$130,948(1 – 0.4)

= -$130,948(0.6)

= -$78,569

NOPAT05= $114,257

what effect did the expansion have on net operating working capital
What effect did the expansion have on net operating working capital?حسابات صافي رأس المال العمل

NOWC = Current - Non-interest

assets bearing CL

NOWC06 = ($7,282 + $632,160 + $1,287,360) – ( $524,160 + $489,600)

= $913,042

NOWC05 = $842,400

what effect did the expansion have on operating capital
What effect did the expansion have on operating capital?حسابات رأس المال التشغيلي

Operating capital = NOWC + Net Fixed Assets

Operating Capital06 = $913,042 + $939,790

= $1,852,832

Operating Capital05 = $1,187,200

what is your assessment of the expansion s effect on operations
What is your assessment of the expansion’s effect on operations?ملاحظات من حسابات التشغيل

Sales

NOPAT

NOWC

Operating capital

Net Income

2006

$6,034,000

-$78,569

$913,042

$1,852,832

-$160,176

2005

$3,432,000

$114,257

$842,400

$1,187,200

$87,960

what was the free cash flow fcf for 2002
What was the free cash flow (FCF) for 2002?حساب التدفق النقدي الحر

FCF06 = NOPAT – Net capital investment

= -$78,569 – ($1,852,832 - $1,187,200)

= -$744,201

Is negative free cash flow always a bad sign?

economic value added eva
Economic Value Added (EVA)حساب القيمة المضافة

EVA = After-tax __ After-tax

Operating Income Capital costs

= Funds Available __ Cost of

to Investors Capital Used

= NOPAT – After-tax Cost of Capital

eva concepts
EVA Conceptsمفهوم القيمة الاقتصادية المضافة
  • In order to generate positive EVA, a firm has to more than just cover operating costs. It must also provide a return to those who have provided the firm with capital.
  • EVA takes into account the total cost of capital, which includes the cost of equity.
slide78

What is the firm’s EVA? Assume the firm’s after-tax percentage cost of capital was 10% in 2000 and 13% in 2001.حساب القيمة الاقتصادية المضافة

EVA06 = NOPAT – (A-T cost of capital) (Capital)

= -$78,569 – (0.13)($1,852,832)

= -$78,569 - $240,868

= -$319,437

EVA05 = $114,257 – (0.10)($1,187,200)

= $114,257 - $118,720

= -$4,463

did the expansion increase or decrease mva
Did the expansion increase or decrease MVA?حساب القيمة السوقية المضافة

MVA = Market value __ Equity capital

of equity supplied

It measures the value added to the company from its activities since its inception.

Can not tell who did what.

calculating key multipliers
Calculating Key Multipliersحساب المضاعفات - مثال

P/E = Price / Earnings per share

= $12.17 / $1.014 = 12.0x

P/CF = Price / Cash flow per share

= $12.17 / [($253.6 + $117.0) ÷ 250]

= 8.21x

calculating key multipliers1
Calculating Key Multipliersحساب المضاعفات - مثال

M/B = Mkt price per share / Book value per share

= $12.17 / ($1,952 / 250) = 1.56x

analyzing the multipliers
Analyzing the multipliersتحليل المضاعفات
  • P/E: How much investors are willing to pay for $1 of earnings.
  • P/CF: How much investors are willing to pay for $1 of cash flow.
  • M/B: How much investors are willing to pay for $1 of book value equity.
  • For each ratio, the higher the number, the better.
  • P/E and M/B are high if ROE is high and risk is low.
trend analysis
Trend analysisتحليل النمطية
  • Analyzes a firm’s financial ratios over time
  • Can be used to estimate the likelihood of improvement or deterioration in financial condition.
potential uses of freed up cash
Potential uses of freed up cashاستخدامات التدفق النقدي الحر
  • Repurchase stock
  • Expand business
  • Reduce debt
  • All these actions would likely improve the stock price.