Business Finance Pre-Finals Supplement /GLAJ

I. Investment Risk

• There are two types of investment risk. These are:

– Stand-alone risk. The risk an investor has to take for holding only one
investment asset.

– Portfolio risk. The risk an investor has to take for holding two or more assets in a
portfolio.

• Investment risk is related to the probability of earning a low or negative actual return.

• The greater the chance of lower than expected, or negative returns, the riskier the
investment.

II. Investor Attitude Towards Risk

• Risk aversion: assumes investors dislike risk and require higher rates of return to
encourage them to hold riskier securities.

• Risk premium: the difference between the return on a risky asset and a riskless asset,
which serves as compensation for investors to hold riskier securities.

III. The Objectives and Rewards of Investing

Definition of Terms:

Investing. The process of placing money in some medium such as stocks or bonds
in the expectation of receiving some future benefit.

Speculating. A form of investing in which future value and the expected returns are
highly uncertain.

Risk Averse. The average investor’s attitude toward risk is such that, when
presented with two investments having the same expected return, the one with the
lowest risk will be chosen.

Investment Plan. A statement preferably written that specifies how investment

capital will be invested to achieve a specified goal.

What are your Investment Objectives?

1. Accumulate funds to today for future retirement.

2. Save for major purchases or expenditures.

3. Enhance current income.

4. Seek shelter from taxes.

Business Finance Pre-Finals Supplement /GLAJ

Types of Investment Risk:

Risk is inherent in calculating the rate of return or the interest rate of a financial security.
Below is how the rate of return on an investment security varies according to the type of
risk present:

R = r* + IP + DRP + LP + MRP

Where:

R = required return on a debt security

R* = real risk-free rate of interest

IP = inflation premium

DRP = default risk premium

LP = Liquidity premium

MRP = maturity risk premium

 Real risk-free rate of interest is the interest rate or rate of return of a security without
inflation premium.

 Inflation premium is an added rate to the real risk-free rate or the base rate due to
the presence of inflation or increase in the prices of financial securities.

 Default risk premium is an added rate to the real risk-free rate or the base rate due to
the presence of the possibility of non-payment of interest of the borrower or issuer of
financial securities.

 Liquidity premium is an added rate to the real risk-free rate or the base rate due to
the possibility of the level of difficulty of converting financial securities into cash that
is how easy a financial security is sold out in the market.

 Maturity risk premium is an added rate to the real risk-free rate or the base rate due
to a longer term of maturity.

The Role of Cash Management in Personal Financial Planning

Cash Management. Cash management is the routine, day-to-day administration of

cash and near-cash resources, also known as liquid assets, by an individual or family.

In personal financial planning, efficient cash management ensures adequate funds for
both household use and an effective savings program. The success of your financial
plans depends on your ability to develop and follow cash budgets.
Business Finance Pre-Finals Supplement /GLAJ

II. Today’s Financial Services Marketplace

Types of Financial Institutions:

1. Depository Financial Institutions. Depository financial institutions differ from their

nonbank counterparts, such as stock brokerages and mutual funds, in their ability to
accept deposits.

Examples of Depository Financial Institutions:

a. Commercial bank. A commercial bank offers checking and savings

accounts and a full range of financial products and service.

b. Savings and Loan Association ( S&L). Channels the savings of

depositors primarily into mortgage loans for purchasing and improving
homes.

c. Deposit Insurance. A type of insurance that protects funds on deposit

against failure of the institutions. It is be insured by the Philippine
Depository Insurance Corporation.

2. Cash Management Products

a. Demand Deposit. An account held at a financial institution from which

funds can be withdrawn on demand by the account holder; same as a
checking account.

b. Time Deposit. A savings deposit at a financial institution; remains on

deposit for a longer time than demand deposit.

c. Negotiable Order of Withdrawal (Now) Account. A checking account

on which the financial institution pays interest; NOW’s have no legal
minimum balance.

d. Money Market Mutual Fund. A mutual fund that pools the funds of many
small investors and purchases high-return, short-term marketable
securities.

e. Asset Management Account. A comprehensive deposit account that

combines checking, investing and borrowing activities and is offered
primarily by brokerage houses and mutual funds.

Examples of Interest-paying Checking Accounts

b. Negotiable order of withdrawal accounts

c. Money Market Mutual Funds

Examples of Electronic Banking Services:

Business Finance Pre-Finals Supplement /GLAJ

a. Electronic Funds Transfer Systems. Systems using the latest

telecommunications and computer technology to electronically transfer
funds into and out of customer’s accounts.

b. Debit Cards and Automated Teller Machines. A remote computer terminal

that customers of depository institutions can use to make basic
transactions 24 hours a day, 7 days a week.

c. Preauthorized Deposits and Payments.

d. Bank-by-Phone Accounts

e. Online Banking and Bill Payment Services

f. Safe-deposit boxes. A rented drawer in a bank’s vault.

g. Cashier’s check. A check payable to a third party that is drawn by a bank

on itself in exchange for the amount specified plus, in most cases, a
service fee.

h. Traveler’s check. A check sold by many large financial institutions around

the world.

i. Certified Check. A personal check that is guaranteed by the bank on

which it is drawn.

j. Certificate of deposit. A type of savings instrument issued by certain

financial institutions in exchange for a deposit; typically requires a
minimum deposit.

k. Treasury Bill. A short-term debt instrument issued at a discount by the

Treasury in the ongoing process of funding the national debt.