FNCE90065 Fundamentals of Finance
The Complete Exam Bible · S2 2026FNCE90065 Overview
- University of Melbourne
- S2 2026
- 10 chapters
- Finance
FNCE90065 Fundamentals of Finance is a postgraduate University of Melbourne subject about how individuals and firms make financial decisions, how securities carry claims on future cash flows, and how markets turn information and required returns into prices.
- Assessed by Group Assignment 1 20% · Group Assignment 2 20% · 3-hour End-of-semester examination 60%
- Key terms Opportunity cost, Present value, Effective annual rate, Annuity
- How to prepare Start each revision block by rebuilding the diagram from memory: a statement bridge, cash-flow timeline, return distribution, portfolio variance map…
- Most asked What is published about the final exam format?
How FNCE90065 is assessed
| Component | Weight | Format |
|---|---|---|
| Group Assignment 1 | 20% | Group assignment due in Week 6 |
| Group Assignment 2 | 20% | Group assignment due in Week 10 |
| 3-hour End-of-semester examination | 60% | Assessment period, plus 15 minutes reading time; mixture of quantitative and qualitative questions |
What FNCE90065 covers
Follow the subject from financial markets and statements through value, risk, securities, projects, prices and incentives.
Finance Principles and Market Decisions
Fund flows, financial claims, market prices, opportunity cost and decision boundariesFinance connects people and organisations that have funds with those that can use funds productively. This chapter maps savers, firms, financial claims, markets and intermediaries before any formula is selected.
- Funds move from capital providers toward users through markets and intermediaries
- Securities record claims on future cash flows and allocate risk
- Opportunity cost measures the best alternative surrendered by a choice
- Individual and corporate decisions share timing, risk and comparison logic
- Decision boundaries identify the actor, relevant cash flows and benchmark rate
- Market prices compress expectations about cash flow, timing and required return
Financial Statements and Cash Flow
Balance-sheet position, income-statement performance and operating cash reconciliationThe three financial statements describe position, performance and cash movement. This chapter links the balance sheet, income statement and cash-flow statement, then reconciles accrual profit to operating cash.
- The balance sheet records assets, liabilities and residual equity at a date
- The income statement records revenue, expenses and profit over a period
- The cash-flow statement groups operating, investing and financing cash movements
- Depreciation reduces profit without creating a current cash outflow
- Operating assets and liabilities connect accrual results with cash collection and payment
- Leverage can improve immediate cash while adding future commitments
Present Value, Future Value and Rates
Cash-flow timelines, discounting, compounding and effective-rate conversionTime value of money makes cash flows comparable across dates. This chapter shows compounding forward, discounting backward, single-cash-flow valuation and rate conversion.
- Future value compounds present cash by a growth factor
- Present value discounts future cash to a chosen comparison date
- The rate and number of periods must use the same time unit
- APR reports a periodic rate multiplied by periods per year
- EAR reports actual one-year growth after compounding
- The Fisher relationship links nominal return, real return and inflation
Annuities, Perpetuities and Loans
Level and growing streams, payment timing, amortisation and loan structureCash-flow stream formulas are shortcuts for specific timelines. This chapter distinguishes ordinary annuities, annuities due, deferred annuities, perpetuities, growing streams and fixed-rate amortising loans.
- An ordinary annuity has finite equal payments beginning one period after valuation
- An annuity due shifts every payment one period earlier
- A perpetuity continues indefinitely but has finite present value under positive discounting
- Growing perpetuity value requires required return to exceed long-run growth
- A deferred stream is valued near its first payment and then discounted again
- An amortising loan splits each fixed payment between interest and principal
Measuring Investment Risk and Return
Realised returns, probability distributions, expected return and volatilityInvestment return combines price change and cash distributions over a stated holding period. This chapter separates realised return from a forward-looking distribution of possible returns, then calculates expected return, variance and standard deviation.
- Realised return includes both price change and distributions received
- Expected return is the probability-weighted centre of possible outcomes
- Variance measures squared deviations from expected return
- Standard deviation expresses dispersion in the same units as return
- Historical sample statistics estimate rather than guarantee future parameters
- Dominance requires higher return for the same risk or lower risk for the same return
Portfolio Risk and Diversification
Weights, covariance, correlation and the limits of diversificationPortfolio expected return is a weighted average, but portfolio risk depends on component volatility and co-movement. This chapter interprets covariance and correlation, calculates two-asset variance and explains why imperfect correlation can reduce risk.
- Portfolio expected return uses component weights and expected returns
- Covariance measures the direction of joint deviations from each mean
- Correlation standardises covariance between negative one and positive one
- Two-asset variance includes weighted component variances and a cross-term
- Imperfect correlation creates diversification benefit
- Broad portfolios retain risk from common economic factors
Loans, Bonds and Effective Rates
Contractual payments, bond price, market yield and interest-rate sensitivityLoans and bonds package dated contractual cash flows. This chapter values bond coupons as an annuity and face value as a single maturity payment, using the market yield rather than the coupon rate for discounting.
- Coupon rate multiplied by face value determines the contractual coupon
- Market yield discounts the remaining bond cash flows
- Bond price equals coupon-annuity value plus principal present value
- Coupon above yield implies a premium; coupon below yield implies a discount
- Payment frequency changes coupon, periodic yield and number of periods together
- Longer maturity and lower coupons generally increase interest-rate sensitivity
Share Valuation and Growth
Dividend timing, constant growth, changing growth and terminal valueShare value reflects expected shareholder cash flows and required return. This chapter values a constant-growth dividend stream, then extends the method to changing growth by forecasting explicit dividends and a terminal value.
- Dividend valuation discounts expected shareholder cash flows
- The next dividend belongs in the constant-growth numerator
- Required return must exceed perpetual growth for the model to converge
- Changing growth separates explicit forecast dividends from terminal value
- Terminal value is measured one period before the first cash flow it capitalises
- Sensitivity analysis tests required return and growth assumptions
NPV and Project Cash Flow
Incremental cash flow, working capital, tax effects and investment rulesCapital budgeting asks whether incremental project cash flows create value after the required return.
- NPV sums the present values of all incremental project cash flows
- Sunk costs are excluded while opportunity costs are included
- Depreciation affects cash through tax and is added back after tax calculation
- Working-capital increases are outflows and may be recovered at project end
- After-tax disposal proceeds belong in terminal cash flow
- NPV measures dollar value and is preferred for mutually exclusive project ranking
Market Efficiency, Arbitrage and Incentives
Information in prices, equivalent payoffs, governance and behavioural responseMarket efficiency, arbitrage and incentives explain how information becomes action.
- Prices respond to information about future cash flows and required return
- Expected information may already be reflected before an announcement
- Arbitrage requires equivalent payoffs across timing, states and currency
- Trading costs, risk and constraints can explain persistent price differences
- Incentive design links measured outcomes to decision-maker behaviour
- Governance and monitoring address information gaps and agency conflicts
The current teaching sequence begins with individuals, firms and financial markets, then moves through the financial statements and cash flows that describe business activity.
It develops time value of money, interest-rate conversion, annuities, perpetuities and amortising loans before introducing realised and expected returns, volatility, portfolio co-movement and diversification.
The later decision tools apply those foundations to loans, bonds, shares and investment projects. Bond value separates coupons from principal and discounts both at a market yield.
Share valuation separates forecast dividends from terminal value and makes long-run growth assumptions visible. Capital budgeting builds incremental after-tax cash flows, recognises opportunity costs and working-capital commitments, then uses net present value to decide whether the forecast creates value after the required return.
Market efficiency, arbitrage and incentives explain how prices and behaviour adjust around those calculations.
The Semester 2 2026 subject guide publishes two group assignments worth 20 percent each and a three-hour end-of-semester examination worth 60 percent, with an additional 15 minutes of reading time.
It describes the examination as a mixture of quantitative and qualitative questions and states that the subject has no hurdle requirements. The guide does not publish a section split, question count, or open-book condition, so this guide does not invent them.
Revision here focuses on a repeatable answer method: draw the timeline or structure, align the rate and cash-flow units, show substitution and intermediate values, then state the financial decision in words.
Worked example · free
Discount a future goal to the amount needed today
- 1Place the required $24,000 at year four and the unknown deposit at time zero.
- 1Use present value because the future amount must be moved backward: PV = FV divided by the four-year growth factor.
- 1PV = 24,000 divided by 1.05 to the power of four, which is approximately $19,745.
- 1The amount is below the future goal because a positive return compounds for four years.
Key terms
- Opportunity cost
- Opportunity cost is the value of the best alternative surrendered by a financial decision.
- Present value
- Present value is the value today of a future cash flow discounted at a rate matched to its timing and risk.
- Effective annual rate
- Effective annual rate is the actual one-year growth rate after within-year compounding is included.
- Annuity
- An annuity is a finite sequence of equal periodic cash flows with specified payment timing.
- Perpetuity
- A perpetuity is a stream of periodic cash flows that continues indefinitely.
- Expected return
- Expected return is the probability-weighted centre of a possible-return distribution.
- Volatility
- Volatility is the standard deviation of returns and measures dispersion around expected return.
- Correlation
- Correlation is a standardised measure of the direction and strength of co-movement between returns.
- Diversification
- Diversification is the reduction of portfolio risk through holdings that do not move perfectly together.
- Yield to maturity
- Yield to maturity is the discount rate that equates a bond price with its remaining promised cash flows.
- Terminal value
- Terminal value compresses cash flows beyond an explicit forecast horizon into a value at that horizon.
- Net present value
- Net present value is the present-value surplus of incremental project cash flows after the required return.
FNCE90065 FAQ
How is Fundamentals of Finance assessed?
The current subject guide lists two group assignments worth 20 percent each and a three-hour end-of-semester examination worth 60 percent. The first assignment is due in Week 6 and the second in Week 10. The numeric weights total 100 percent, and the guide states that there are no hurdle requirements.
What is published about the final exam format?
The guide publishes a three-hour duration, an additional 15 minutes of reading time, and a mixture of quantitative and qualitative questions. It does not publish a section split, question count, or open-book condition. Check the current LMS examination notice for operational details and permitted materials rather than assuming a format.
Which formulas should I know for the subject?
The teaching materials cover financial ratios, present and future value, rate conversion, annuities and perpetuities, returns and volatility, portfolio risk, amortising loans, bond pricing, dividend valuation, and project evaluation. Learn each formula together with its timeline, unit convention and decision meaning instead of memorising an isolated symbol string.
Is the mathematics difficult?
The arithmetic is mainly percentages, powers, weighted averages, variance, square roots and discounted cash flows. The harder part is choosing the correct structure: matching rate and cash-flow periods, locating the first payment, separating coupon from yield, and deciding which project cash flows are incremental. A diagram before calculation prevents many errors.
Why can diversification lower portfolio risk?
Portfolio variance includes a covariance term, so risk depends on how component returns move together as well as their individual volatility. When correlation is below positive one, deviations can partly offset. Diversification can remove much asset-specific risk, but common market exposure remains and correlations may rise during stress.
Why is NPV preferred for project choice?
NPV measures dollar value created today after incremental project cash flows are discounted at a required return matched to risk. It handles timing directly and gives a clear acceptance rule for an independent project. IRR, payback and profitability index can add context, but they may conflict with value when projects differ in scale or timing.
Questions students ask in each FNCE90065 chapter
- Why should I define the decision maker first?
- The same transaction produces different cash flows for the project, firm, lender and shareholder. Naming the decision maker determines which benefits, costs and alternatives belong in the calculation. It also prevents financing flows from being counted inside project cash flow when financing is already reflected in the discount rate. Chapter 01 · Finance Principles and Market Decisions
- Why can profit and operating cash flow differ?
- Accrual accounting recognises revenue and expenses when economic activity occurs, not only when cash settles. Depreciation is non-cash, receivables can delay collection, inventory can absorb cash and payables can delay payment. The operating cash reconciliation makes those timing and classification differences visible. Chapter 02 · Financial Statements and Cash Flow
- How do I decide between present value and future value?
- Choose the comparison date first. If a current amount must be moved to a later date, compound forward. If a future amount must be expressed at an earlier date, discount backward. The two operations use the same growth factor in opposite directions. Chapter 03 · Present Value, Future Value and Rates
- How do I identify an annuity due?
- Look for the first payment at time zero or the beginning of each period. An annuity due shifts every cash flow one period earlier than an ordinary annuity, so its present value equals the comparable ordinary-annuity value multiplied by one plus the periodic rate. Chapter 04 · Annuities, Perpetuities and Loans
- What belongs in realised share return?
- Include the ending price minus beginning price and any dividend received during the holding period, then divide by beginning price. State the holding period alongside the percentage. Omitting the dividend understates performance, while using ending price as the denominator changes the meaning of the measure. Chapter 05 · Measuring Investment Risk and Return
- Why is portfolio volatility not a weighted average?
- Portfolio returns combine across the same states, so co-movement matters. The variance formula includes a covariance term in addition to weighted component variances. A weighted average of standard deviations ignores offsetting or reinforcing movements and therefore misses the mechanism that creates diversification. Chapter 06 · Portfolio Risk and Diversification
- Why do bond prices fall when yields rise?
- A fixed-coupon bond promises the same cash flows regardless of the new market yield. When investors require a higher return, those payments are discounted more heavily and their present value falls. The inverse relationship is curved because discounting is nonlinear. Chapter 07 · Loans, Bonds and Effective Rates
- Why do I use the next dividend in constant growth?
- Current price is measured immediately before the future dividend stream begins, so the numerator must be the first dividend expected after valuation. If the most recent dividend has just been paid, grow it once to obtain the next dividend before dividing by required return minus growth. Chapter 08 · Share Valuation and Growth
- Which cash flows belong in project NPV?
- Include cash flows changed by accepting the project: operating inflows and costs, tax effects, capital expenditure, opportunity costs, side effects, working capital and terminal proceeds. Exclude sunk costs. Financing cash flows are normally excluded when financing cost is already reflected in the discount rate. Chapter 09 · NPV and Project Cash Flow
- Does market efficiency mean prices are always correct?
- No. Efficiency concerns how information is incorporated and whether easy excess profits persist, not access to an observable perfect value. Prices can change when expectations about cash flows, risk or required return change. A new price is still an estimate formed under uncertainty. Chapter 10 · Market Efficiency, Arbitrage and Incentives
How to study for the exam
Start each revision block by rebuilding the diagram from memory: a statement bridge, cash-flow timeline, return distribution, portfolio variance map, bond cash-flow split, dividend horizon, or project timeline. Then write the formula with named inputs and units before inserting numbers. Work the example once with the solution visible, once from a blank page, and once after changing a timing or rate assumption.
Keep an error ledger organised by mechanism rather than chapter: wrong comparison date, APR confused with EAR, first payment misplaced, variance reported without a square root, coupon rate used as yield, terminal value double counted, sunk cost included, or working-capital recovery omitted. Finish every quantitative problem with one sentence that states the decision and direction.
In the final week, use mixed practice so the topic label no longer tells you which formula to choose. For exam logistics, rely on the current LMS notice; the subject guide publishes the duration, reading time and broad question mix but not a complete section or permitted-materials specification.
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