Handout

Országok listájaHungaryBudapesti Corvinus EgyetemGazdálkodástudományi KarNemzetközi gazdálkodás (angol nyelven)FinanceJegyzetekHandout

Budapest Corvinus University
Finance Department




Handout for Finance
B.A. in International Business
2008.









Authors:
Novák, Zsuzsanna
Sági, Judit




Contents

 TOC \o "1-3" \h \z \u I. Seminar exercises  PAGEREF _Toc156980628 \h 3
 HYPERLINK \l "_Toc156980629" First exercise – financing relations, flow of funds  PAGEREF _Toc156980629 \h 3
 HYPERLINK \l "_Toc156980630" Second exercise – Balance of Payments, FX rate  PAGEREF _Toc156980630 \h 7
 HYPERLINK \l "_Toc156980631" Third exercise – Public finances, tax system  PAGEREF _Toc156980631 \h 11
 HYPERLINK \l "_Toc156980632" Fourth exercise – Credit institutions (banks), banks’ balance sheet  PAGEREF _Toc156980632 \h 15
 HYPERLINK \l "_Toc156980633" Fifth exercise – Securities, security markets  PAGEREF _Toc156980633 \h 19
 HYPERLINK \l "_Toc156980634" II. Questions and exercises for practice  PAGEREF _Toc156980634 \h 23
 HYPERLINK \l "_Toc156980635" Questions that follow the course book/material  PAGEREF _Toc156980635 \h 23
 HYPERLINK \l "_Toc156980636" Questions and answers to exercise upon the exam  PAGEREF _Toc156980636 \h 25
 HYPERLINK \l "_Toc156980637" III. Exercise book  PAGEREF _Toc156980637 \h 27







Seminar exercise

First exercise – financing relations, flow of funds

The following macroeconomic data are available about an economy:
Private sector consumption is: 900, fixed (capital) investment is: 110, inventory accumulation is 30
The government sector consumes at a value of 530 units, transfer payments made by the government is 130, tax revenue 310 units
The export income of the interior sector is 1030, import expenditure is 960 units.
The repatriated income of foreign productive factors operating in the domestic economy is 165, the repatriated income of domestic productive factors operating in abroad is 25 units
10 more units of transfer payment arrived in the internal economy from abroad than sent from the home country to abroad

question-group
What is the gross national income?





What is the gross national disposable income?




What is the disposable income of the private sector?




What is the non-financial (real) balance of the various sectors?
















Check your work and evaluate your results.









question group
Without knowing the financial relationships and forms try to imagine what kind of transactions may take place in the financial markets of the above economy.

















































For the above exercise the following additional data are known for the review of the financing processes in the economy:
The foreign sector granted 80 units of credit to the internal sector
The domestic private sector bought government securities (bonds) at a value of 280 units
The monetary balance sheet at the end of the previous and the current year looked as follows:

Monetary balance sheet, 2006:
Assets Liabilities Loans 1000 Notes and coins 360 in which: to the private sector 700 Sight deposits 400 to the public sector 300 Quasy-money 480 Foreign Currency assets 240 1240 1240
Monetary balance sheet, 2007:
Assets Liabilities Loans 1150 Notes and coins 380 in which: to the private sector 790 Sight deposits 420 to the public sector 360 Quasy-money 550 Foreign currency assets 200 1240 1240


Let us trace the financial relationships between the various sectors! Let us summarise the results with the help of the flow of funds matrix!

Macroeconomic sectors Sð Non-financial balance Financing Sð
















Second exercise  Balance of payments, FX rate

question-group

Try to book the following economic events in the Balance of Payments chart below!

An internal merchant buys clothes from an external factory at a value of HUF 800 Mn and pays the whole sum in euro;
An internal factory sells boxes to an external merchant at a value of HUF 900 Mn, who pays half of the sum immediately, and gives a promise to pay for the other half of the sum;
An internal bank borrows a 5 Mn loan from a foreign credit institution;
A foreign investor buys shares in the internal stock exchange at a value of HUF 10 Mn;
The government borrows 10 Mn euro long-term credit for infrastructural investment;
USD 100 000 transfer flows in, for supporting the aggrieved people of the spring flood.
a foreign enterprise – operating internally – repatriates USD 2 Mn profit;
a company from the Far East carries out a greenfield investment in USD 100 Mn.

Additional information:
Euro exchange rate: 250 HUF/EUR
Dollar exchange rate: 200 HUF/USD



200X inflow outflow balance Current Account Balance Goods Services Income Current transfers Capital Account Balance Financial Account Balance Direct investments Portfolio investments Financial derivatives Other investments Reserve assets Errors and omissions




The following figures are known about Hungary’s Balance of Payment for the year 2005:

export of goods in amount of EUR 50 120 Mn
import of services in amount of EUR 9 584 Mn
EUR 2 092 Mn current transfer flowed in the country
the amount of the direct investment has been EUR 4 144 Mn, the portfolio investment EUR 3 616 Mn
other records concerning the Balance of Payments are included in the table bellow:


2005 inflow outflow balance Current Account Balance 64 286 Goods Services 730 Income -5 442 Current transfers 1 920 Capital Account Balance 810 94 Financial Account Balance 7 163 Direct investment Portfolio investment Financial derivatives -109 Other investment 3 423 Reserve Assets Errors and omissions -1 882
Fill in the empty cells!



The chart bellow is to show Hungary’s Current Account and Capital Account Balance in aggregate, since 2000 until 2005. Draw the graph of the Financial Account Balance (including the Foreign Reserves) for the same period! (Let us leave the row called Errors and ommissions.)






question-group

Highland and Ironland have commercial links with each other. Their currencies are: crone (HLC) for Highland and pound (ILP) for Ironland. The exchange rate between the two eligible countries is determined by market demand and supply, and no intervention exists either in legal or in economic policy terms. The diagram bellow shows the demand and supply curves of the pound, whereas e0 is the current equilibrium rate.


 SHAPE \* MERGEFORMAT 
The following events are to happen:

In Ironland foot-and-mouth disease is raging among animals, therefore the authorities in Highland prohibit the import of cattles from Ironland; the highlanders are compelled to eat carrots instead of cattles.
The world brand toil producer company located in Highland introduces a new product, and begins to sell it with great success and in large quantities in Ironland.


Draw the effects of the above events into the diagram! What has happened to the foreign exchange rate?


Following the move in the foreign exchange rate, what kind of change can be expected in the

demand for imported goods in Ironland?



Iron exporters’ income position?



inflation trends in Ironland?



If all other conditions remained unchanged, is there any further change in the foreign exchange rate to be expected?








The economic policy makers in Ironland deem the pursued movements in the foreign exchange rate to be contrary to their aims. They are aware of modifying the foreign exchange rate regime, so they come to the conclusion of changing the short term interest rates. What are they going to do? What will be the effect of the decision on the foreign exchange rate

in the short run?



in the long run, assuming that the problems of the real economy could not be solved?



in the long run, assuming that the problems of the real economy could be solved?




On the basis of the above events and conditions, draw the FX rate curve into the following diagram!



 SHAPE \* MERGEFORMAT 






Third exercise – Public finances, tax system

In an economy the volume of GDP is 10 000 units, the 80% of which accounts for the gross wage cost, 20% for the earning (before taxes) of the enterprise sector. The government is just planning the budget taking the following data into account:
The employer is obliged to deduct tax at source from a salaried worker (and to allocate a certain sum for social insurance):
The employer’s social security contribution is 25% of the gross wage cost
The social security contribution paid by the employee is 10%

Direct tax rates
Corporate income tax rate is 20%
Rate of tax paid on capital gains is (profit on sale of securities and dividend) 10%
Individual income tax
1. alternative: poll tax (lump-sum tax) – 10 units/head
2. alternative: proportional tax: 20%
3. alternative: progressive tax1: 0 – 40 income units: 0%
41 income units: 50%
4. alternative: progressive tax2: 0 – 20 income units: 10%
21 – 40 income units: 20%
41 – 60 income units: 30%
61 – 80 income units: 40%
over 81 income units: 50%

Indirect tax (VAT) rate is 25%

Government’s transfer-like payments (in currency) as a percentage of GDP:
pensions – 20%
health care expenditures – 5%
social expenditures – depending on the social policy alternative to be asserted
1. alternative: 4% of GDP is spent on this
2. alternative: only the most needy social strata get support:
In the case of 0 – 20 units gross income 10 units/head
In the case of 21 – 40 units gross income 5 units/head
3. alternative: everybody gets as much that his/her disposable income achieves the level of subsistence

Further public expenditure as a percentage of GDP
defence – 6%
education – 8%
health care – 7%
innovation – 12%

The public debt-to-GDP ratio is 60%, the average interest repayment on public debt is 8%

The subsistence level is defined by experts as 30 income units

100 persons dispose about labour income and the following income categories are known:
100 income units are earned by 10 persons
80 income units are earned by 20 persons
60 income units are earned by 40 persons
40 income units are earned by 20 persons
20 income units are earned by 10 persons


During the budget approval process the government takes the following aspects into consideration:
- the government deficit should not an not exceed 3% of GDP
- the planned income from individual income tax will be realised with greater probability the simplier and the more transparent is the taxing system
- income differences should be diminished

questions – group
Calculate the income gained from individual income tax in the case of different taxing alternatives.



























How much is the disposable income in the various income categories in the case of different social policies?




















How much is the amount of the social transfer expenditure in the above cases?





















Frame the budget plan taking the results of the previous point into account!
























Which budget plan should be approved considering the above listed governmental aspects?







question-group

A econometrician, expert in tax theory, has reckoned that the volume of measurable and taxable GDP can be estimated with the following formula:
 EMBED Equation.3 , where T denominates the average tax rate imposed on the aggregate gross wage income.

Calculate the average tax rate imposed on the total (aggregate) labour income in the case of different taxing alternatives!








If the above formula is right, how should the government revise its plans?





question-group
In a country the volume of GDP of the previous year was estimated as 40000 the debt-to-GDP ratio 60%. This year the GDP growth reached 5% and the average interest repayment on public debt is 7%.
a. What should the primary balance of the government budget be so that the Maastricht fiscal criteria are met by the end of this year?










b. Let us presume that in the same year the primary balance is absolutely in equilibrium (0). What primary balance should be targeted next year if we intend to fulfil the convergence criteria? (the growth is still 5%, the interest payment: 7%).


Fourth exercise – Credit institutions (banks), banks’ balance sheet

The table bellow lists the balance sheet items of a bank in alphabetical order. Comprise them into a balance sheet formula! Explain the meaning of the eligible balance sheet items!

ABC Bank’s Balance Sheet, Dec 31, 2007. (in HUF Mn) Accruals 24 992 Accumulated profit reserve 7 601 Capital reserve 10 417 Cash and bank deposits 138 144 Debts on the issue of bonds 28 345 Debt securities, including the fix interest bearing securities 8024 in which a., debt securities issued by local municipalities and other state authorities (less government bonds) 0 b., debt securities issued by other entities 7 895 Deferrals 17 630 General reserves 3 015 Government securities 168 961 Intangible assets 3 811 Obligations to credit institutions 532 643 in which a., Sight obligations 192 b., time obligations incurring from financial services 532451 in which ba., due within 1 year 197 455 bb., due above 1 year 334 996 c., obligations incurring from investment services Obligations to customers (households and non-financial corporations) 729 044 in which a., Deposits 3 954 in which aa., sight deposits 3 924 ab., time deposits (due within 1 year) 25 ac., time deposits (due above 1 year) 5 b., other obligations incurring from financial services 705 960 in which ba., Sight obligations 240 363 bb., due within 1 year 444 405 bc., due above 1 year 21 192 c., obligations incurring from investment services 19 130

Other assets 16 401 Other liabilities 29 897 Own shares 0 Provisions 3 441 Receivables from credit institutions 93 962 in which a., Sight receivables 5 582 b., other receivables incurring from financial services 88 380 in which ba., due within 1 year 85 450 bb., due above 1 year 2 930 c, receivables incurring from investment services Receivables from customers (households and non-financial corporations) 971 915 in which a., receivables incurring from financial services 971 874 in which aa., due within 1 year 160 208 ab., due above 1 year 811 666 b., receivables incurring from investment services 41 Reserves for special purposes (repurchased shares, reorganisation etc.) Retained profit of the year (+-) 13 454 Revaluation reserve 698 Shares, participating interests (aimed for re-sale) 0 Shares, participating interests and other assets (aimed for investments) 306 Shares, participating interests in affiliated undertakings 9 392 Subordinated debt 28 039 Subscribed capital 39 410 Tangible assets 7 726 TOTAL ASSETS 1 443 634 TOTAL LIABILITIES 1 443 634










ASSETS



LIABILITIES


Fifth exercise – Securities, security markets

exercise-group

Five investors place their savings in different manners: one of them buys OTP shares, the other one buys BUX index investment fund shares, the third one buys investment fund shares investing into short-term government securities, the fourth one buys investment fund shares investing into long-term government securities and the fifth buys euro. On 1st January 2006 let us regard the value of all investments as 100%. The diagrams below show the value change of the various investments during 2006.

Find out which diagram belongs to which investment!

Which factors may explain the value change of various investments and the change of their relative value?

Try to give investment advice to the following individuals!
Liquid Louise – wants to get to his money very quickly
Long Ludmilla – can securely spare her money in the next few years
Safe Sam – does not like taking risk, is averse to capital loss
Square Stephen – is a brave turf gambler

Knowing the 2006 economic processes, what investment strategy would you choose for 2007?










question group

You can buy a share today for 1000 Ft. The one-year maturity futures price of the same share is 1200 Ft. The banks in this economy grant credit at 15% interest and provide a 10% interest rate on deposits.

What steps should a market actor take who reckons that one year later the prompt share price will deviate from the futures price? What will be the consequence of his steps?










An investor has 10 000 shares and he will need 11 000 000 million forints for buying a flat next year. What should he do?










Is there a safe way of becoming rich in this market?








Questions and exercises for practice

Questions that follow the course book/material


I. chapter: Money – Money creation – Money flow

To what extent and direction do the volume of the various money aggregates change depending on the way of money creation and the type of the institute creating money?

Describe the relationship between the various monetary aggregates and the motives in demand for money!

Explain the financing relations between the various macroeconomic sectors!

What roles do the temporary institutions of money redistribution (financial intermediaries) play in the debtor and creditor relationship?

What are the causes of inflation and its consequences?


II. chapter: FX rate – International monetary system – Monetary Union

Assuming that the internal inflation rate exceeds the external one, what will be the impact on the Balance of Payments and on the foreign exchange rate?

Let’s assume that the internal inflation rate exceeds the external one, and the foreign exchange rate is fixed within a narrow intervention margin. What kind of monetary interventions are to be carried out? What is the boundary of these interventions?

What kind of economic relations can be mentioned in relation to the main items of the Balance of Payments (goods, services, financing, foreign reserves, etc.) and the rate of the Foreign exchange?

Describe the role of the International Monetary Fund (IMF) and the Word Bank Group within international finances!

What are the nominal and real criteria of introducing the common currency (euro)?


III. chapter: Public finances – Tax system

What is the role of the different subsystems of the public sector finances?

What is characteristic of the Southern and the Northern type of municipal governments?

Explain the different phases of budgetary planning!

What does progressive taxation mean?

Introduce the most important criteria towards a good tax system!



IV. chapter: Banking system – Central bank – Bank activities

Characterise the risks of the sole credit institutions and the risk of the banking sector as a whole! What kind of institutional, legal and financial solutions can be mentioned as appropriate means to handle the eligible risks?

Describe the main channels in the transmission mechanism between the targets and the tools of the monetary authorities!

List and describe the main commercial bank services!

What is the similarity and difference between the bill of exchange, the cheque, the transfer through accounts and the letter of credit!

Describe the advantages and the disadvantages of the banking services (e.g. asset management, investment services, insurance, factoring, leasing, etc.)


V. chapter: Securities – Security markets – Financial markets

Describe the most important characteristics of securities (legal relation, maturity, interest payment etc.). What is the similarity and difference between shares, bonds and investment fund shares?

Characterise the primary and secondary markets of securities!

Introduce the representative products and deals of the money and capital markets!

What is the difference between trading on and outside the exchanges?

Describe the motivations of the various actors of futures markets! What is the market consequence of their activity?



Questions and answers to exercise upon the exam


Money – Money creation – Money flow
How do the actives and passives of commercial banks change during money creation?
The stock of both actives and passives change (by the same amount)
Depending on the way of money creation, credit / security / foreign currency will appear among the actives and money among the passives

What does the flow of funds matrix show?
The financing relations between the various macroeconomic sectors: the places where financing needs and opportunities emerge and the specific forms of financing


FX rate – International monetary system – Monetary Union
What determines the demand for the foreign currencies?
import of goods
export of capital (the intention of investing abroad)

What is the convergence criterion for the government’s financial position?
the ratio of the planned or actual government deficit to gross domestic product should not exceed 3% (reference value)


Public finances – Tax system
List the most important economic functions of the state (according to the interpretation of Musgrave)!
Allocation, (re)distribution and stabilisation function

Define the notion of tax
The tax is a legally binding commitment, a mandatory payment to the government, where the tax payer does not get any direct compensation in return (or: A tax is a financial charge or other levy imposed on an individual or a legal entity by a state or a functional equivalent of a state source: Wikipedia)


Banking system – Central bank – Bank activities
What are the monetary policy operations?
direct tools: refinancing facility, minimum and/or maximum interest rate fixing
indirect tools: swap contract, rediscounting, reverse transactions (sale and repurchase agreement, repo), issuance of debt certificates, collection of deposits, collateralised refinancing operations, minimum reserve system

Sort the international loans by creditors!
corporate loans, loans of credit agencies, bank loans, loans of international financial institutions, government loans, co-financing


Securities - Security markets – Financial markets
What does the right of subscription preferences mean among the property rights of share-holders?
At the increase of (auxiliary) capital the share-holders are entitled to buy new stocks in proportion to their present holding in the existing share capital

Classify the exchanges according to their scope of activity.
Currency and foreign exchanges, bullion exchanges, stock exchanges, commodity exchanges


Appendix

A financial statement that summarizes the value assets, liabilities and ownership equity for an organization or individual at a specific point in time. Therefore it is the only financial statement that applies to a single point of time and not to a period of time. The three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by the owners. It contains stock variables Records of the values of each  HYPERLINK "http://en.wikipedia.org/wiki/Account" \o "Account" account or line in the balance sheet are usually maintained using a system of accounting known as the  HYPERLINK "http://en.wikipedia.org/wiki/Double-entry_bookkeeping_system" \o "Double-entry bookkeeping system" double-entry bookkeeping system.


The balance sheet must follow the following formula:


Assets = Liabilities + Ownership Equity


For example: Balance sheet of Robbers’ Ltd., 31st December 2007, (Mn Forint)

Assets Liabilities and owners’ equity
Long-term assets: 10.000 Equity: 12.000 Current assets: 5.000 Current liabilities: 1.000 - in which: cash 1.000 Long-term liabilities:2.000 Total: 15.000 Total: 15.000

It's called a balance sheet because the two sides balance out. This makes sense: a company has to pay for all the things it has (assets) by either borrowing money (liabilities) or getting it from shareholders (shareholders' equity). No ecomomic event can make the balance sheet upset as one such either affects both sides of the balance sheet or is accompanied by a rearrangement of items on one side.

Each of the three segments of the balance sheet will have many accounts within it that document the value of each. Accounts such as cash, inventory and property are on the asset side of the balance sheet, while on the liability side there are accounts such as accounts payable or long-term debt. The exact accounts on a balance sheet will differ by company and by industry, as there is no one set template that accurately accommodates for the differences between different types of businesses.

The most important assets of banks are loans (credit) and the most important liabilities are deposits:

For example: Balance sheet of Worthy Bank, 31st December 2007, (Mn Forint)


Assets Liabilities and owners’ equity
Loans 20.000 Deposits 20.000
Source: Wikipedia, The Free Encyclopedia


III. Exercise book



First seminar

Question 1.













Question 2.





Second seminar

Question 1.













Question 2.





Third seminar

Question 1.













Question 2.





Fourth seminar

Question 1.













Question 2.





Fifth seminar

Question 1.













Question 2.


Note: The handout is a translation and therefore similar in content with the handout (ref. n.: ISBN 978-963-503-359-1), written in Hungarian by the teachers of the Finance Department of the Corvinus University.









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time

FAB/FIT

e0

e0

HLC/ILP

ILP

D

S

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