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Banking Essentials - Part I

This pathway will walk us through the basics of banks, starting with some of the different types and their main functions, then starting to look at the regulation faced by the banks, both before and after the Global Financial Crisis.

Greenwashing

Greenwashing is the act of distributing false information about something being more environmentally friendly than it actually is.

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Tackling the Cost of Living Crisis

In this video, Max discusses the cost-of-living crisis currently enveloping the UK. He examines its impact on households as well as the overall economy.

CSR and Sustainability in Financial Services

In the first video of this two-part video series, Elisa introduces us to sustainability. She begins by looking at the difference between sustainability and corporate social responsibility, two terms that can be easily confused.

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Net Present Value (NPV) and Internal Rate of Return (IRR)

Net Present Value (NPV) and Internal Rate of Return (IRR)

Abdulla Javeri

30 years: Financial markets trader

Abdulla introduces the concept of Net Present Value, or the NPV, and the Internal Rate of Return also known as the IRR.

Abdulla introduces the concept of Net Present Value, or the NPV, and the Internal Rate of Return also known as the IRR.

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Net Present Value (NPV) and Internal Rate of Return (IRR)

5 mins 39 secs

Key learning objectives:

  • Define NPV and its shortcomings

  • Define an IRR

Overview:

Investments normally require upfront payments that lead to expected future benefits. Calculating net present value and internal rates of return are essential to determine projects that generate future cash flows. NPV finds the nominal value of a project while IRR finds the minimum required rate of return.

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Summary

What is NPV and what are its shortcomings?

The net present value (NPV) is the difference between the initial cost of the investment and the present value of those future returns discounted at a minimum required rate of return. If the investment has a 0 or positive NPV, it’s worth considering. If the NPV is 0, investors are earning their required rate of return. What NPV doesn’t quantify is what that means in terms of a divergence from a required rate of return. It effectively gives a yes or no answer, accept or reject. This is where the Internal Rate of Return (IRR) is useful.

One of the issues with NPV is that it doesn’t rank the desirability of investments; the results are not ordinal. A higher NPV does not necessarily mean one investment is superior to another. The higher number could be the result of the size of the cash flows associated with it. It might have the higher NPV but a lower IRR than a smaller investment.

What is IRR?

The Internal Rate of Return is another way of assessing the profitability of an investment. It is referred to as the break-even rate i.e. the discount rate that produces an NPV of 0. It reflects the difference between the actual rate of return of the cash flows against the required rate.

It is sometimes possible to derive more than one IRR depending on the pattern of the cash flows. It also assumes that when returns are received they can be re-invested at that same rate, which might not be possible. The advantage IRR has over NPV is that it ranks investments in terms of return. Presumably, given the same risk and limited funds investors would prefer to invest in the opportunity with the higher IRR.

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Abdulla Javeri

Abdulla Javeri

Abdulla’s career in the financial markets started in 1990 when he entered the trading floor of the London International Financial Futures Exchange, LIFFE, and qualified as a pit trader in equity and equity index options. In 1996, Abdulla became a trainer for regulatory qualifications and then for non-exam courses, primarily covering all major financial products.

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