Question

a) Explain the concept of time value of money

b) Distinguish between risk and uncertainty in the context of finance

c) Discuss the objective of working capital management

d) Distinguish between overtrading and overcapiatlisation

e) Distinguish between interest rate risk and currency risk

Answer 1

a]

The concept of time value of money is that money in hand is worth more than money receivable. In other words, money received today is worth more than the same amount of money received in the future. This is because of opportunity cost. Funds that are received today can be invested, and a return earned. Hence, the same amount of money received in the future is less valuable due to opportunity cost.

b]

Risk is quantifiable whereas uncertainty is qualitative and cannot be quantified. For example, VaR is a measure of risk that is applied to investment portfolios to quantify the maximum possible loss the the portfolio with a specified confidence level. Uncertainty, for example may refer to political uncertainty such as Brexit.

c]

The objective of working capital management is efficient use of working capital while ensuring that there are sufficient funds available to meet short-term obligations

d]

Overtrading is when there is insufficient working capital to finance the level of production/sales.

Overcapitalization is when there is excess working capital for the given level of production/sales