Essay Description of Finance

890 Words Jul 8th, 2012 4 Pages

The goal of finance is to use financial information, tools, and models to search for and implement optimal enterprise solutions that balance expected value and expected risk.
We strive to increase expected value and decrease risk, or a combination of the two
We get paid to take risk, the more the better, if we do not get paid enough, we take less risk and may even short it
Value is the future expected cash flows
Risk is the possible deviations from those these cash flows
Discounted cash flows is the most common way to measure value and risk, it is the most important tool of finance. * Projected cash flows is our measure of value * The rate we choose to use to discount these cash flows is how we incorporate risk

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2. An investment portfolio is a collection of asset classes (assets) that have a specific purpose. Each portfolio has a strategy (long term), possible a tactical (short term to take advantage of the opportunity, what to under-weight and over-weight relative to strategy) allocation, and security selections (choosing securities for each asset). The four asset classes are:
Cash and Cash equivalents: * Less than one year * Lending money * US treasury bills: US government borrowing short term (very liquid) * Money market accounts: investment firms; banks that provide accounts that allocate t-bills and commercial paper * Commercial paper: lending short term to HIGH quality corporations
* Low returns that move with short term interest rates * Credit risk is usually very low * The main concern is the rates for opportunity in the near future
Fixed income: * More than one year * Longer term lending to governments and corporations * Governments include US Federal Treasury, US Inflation Indexed Treasury (TIPS), non-US Debt, and Sovereign Debt. * Municipals * Corporates * Asset- backed bonds
* Interest rates: if you expect them to rise, reduce maturities and duration. When rates rise, bond prices fall. * Credit Risk: if you expect a recession, move to HIGHER quality bonds, “flight to quality”, extend Duration.

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