Important Finance Questions and Answers

Sanjay Kumar PhD

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5 min read

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Oct 27, 2024

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What is the time value of money?

• The time value of money (TVM) is a financial concept that suggests that a dollar today is worth more than a dollar in the future because the money you have today can be invested and earn interest or returns. TVM accounts for the opportunity cost of holding money over time, factoring in inflation and interest rates.

· What is the difference between NPV and IRR?

• NPV (Net Present Value): The difference between the present value of cash inflows and outflows over a period of time. It measures how much value or loss a project will create. A positive NPV means the project is profitable.
• IRR (Internal Rate of Return): The discount rate that makes the NPV of a project zero. It represents the annualized rate of return on an investment or project. If the IRR exceeds the cost of capital, the project is considered viable.

· What is CAPM?

· What is WACC?

· What is the difference between a balance sheet and an income statement?

• Balance Sheet: Shows a company’s assets, liabilities, and shareholders’ equity at a specific point in time. It provides a snapshot of financial health by listing what the company owns (assets) and owes (liabilities).
• Income Statement: Displays a company’s financial performance over a specific period (quarterly, annually). It reports revenues, expenses, and profits, reflecting the profitability of the business.

· What is financial modeling?

• Financial modeling involves creating a spreadsheet-based model that represents the financial performance of a business, project, or investment. It typically forecasts a company’s future earnings and cash flows by analyzing past data and assumptions about growth rates, cost structures, and other factors.

· What is EBITDA?

· What is a DCF analysis?

· What are working capital and its components?

· What is accrual accounting?

• Accrual accounting records revenues when they are earned and expenses when they are incurred, regardless of when cash is exchanged. This method gives a more accurate picture of a company’s financial position compared to cash-based accounting.

· What is a liquidity ratio?

• A liquidity ratio measures a company’s ability to meet its short-term financial obligations. Common ratios include:
• Current Ratio: Current Assets / Current Liabilities
• Quick Ratio: (Current Assets — Inventory) / Current Liabilities

· What is the debt-to-equity ratio?

· What is free cash flow (FCF)?

· What is a leveraged buyout (LBO)?

• A leveraged buyout is when a company is acquired using a significant amount of borrowed funds, often with the acquired company’s assets serving as collateral. The purpose is to generate returns by increasing the value of the company through operational improvements and debt repayment.

· What is beta in finance?

• Beta measures the volatility of a stock or portfolio in relation to the overall market. A beta of 1 means the asset moves in line with the market, greater than 1 indicates higher volatility, and less than 1 indicates lower volatility.

· What is the efficient market hypothesis (EMH)?

• The EMH suggests that asset prices fully reflect all available information, making it impossible for investors to consistently outperform the market through stock selection or market timing. It implies that stocks always trade at their fair value.

· What is a bond?

• A bond is a fixed-income security where an investor loans money to an entity (government or corporation) that borrows the funds for a defined period at a fixed interest rate. The bondholder receives regular interest payments and the principal at maturity.

· What is the payback period?

• The payback period is the amount of time it takes for an investment to generate cash flows sufficient to recover the initial cost of the investment. It’s calculated by dividing the initial investment by annual cash inflows.

· What are retained earnings?

• Retained earnings are the portion of a company’s net income that is kept or reinvested in the business rather than being paid out as dividends to shareholders. They appear in the equity section of the balance sheet.

· What is capital expenditure (CapEx)?

• Capital expenditure (CapEx) refers to funds used by a company to acquire, upgrade, or maintain physical assets like property, buildings, or equipment. CapEx is necessary for maintaining operational efficiency and expanding the company’s asset base.

· What is ROI?

· What is portfolio diversification?

• Portfolio diversification is the practice of spreading investments across various asset classes, sectors, or regions to reduce risk. The goal is to balance risk and reward by ensuring that the underperformance of some investments is offset by the performance of others.

· What is the Sharpe ratio?

• The Sharpe ratio measures the risk-adjusted return of an investment. It is calculated by subtracting the risk-free rate from the investment return and dividing by the investment’s standard deviation. A higher ratio indicates better risk-adjusted returns.

· What is the Altman Z-score?

• The Altman Z-score is a formula that predicts the likelihood of a company going bankrupt within the next two years based on financial ratios. It is commonly used in corporate credit analysis.

· What is operational risk?

• Operational risk refers to the risk of loss resulting from inadequate or failed internal processes, people, systems, or external events. This type of risk can include everything from IT system failures to human error or external disruptions like natural disasters.