BBA (Finance), MBA (Banking), DU Topic # 01 Fundamentals of Financial Management Ayesha Saimoon BBA (Finance), MBA (Banking), DU Senior Lecturer Ayesha Saimoon www.studyandjobs24.com

L J Gitman, “Principles of Managerial Finance”, Latest Edition Required Text Book L J Gitman, “Principles of Managerial Finance”, Latest Edition Additional Readings James C. Van Horne, “Fundamentals of Financial Management” Brigham and Houston, “Fundamentals of Financial Management” Besley and Brigham, “Principles of Managerial Finance”

Required Computer Knowledge 1. MS-Excel Spread Sheet 2. MS-Word 3. PowerPoint Presentation Course Websites www.teachmefinance.com www.studyfinance.com www.investorwords.com www.Islamicfinance.com Ayesha Saimoon www.studyandjobs24.com

Xy or yx or Λ Required Instrument A good Financial Calculator or a Good Scientific Calculator. Your Calculate must have any of the following keys: Xy or yx or Λ Ayesha Saimoon www.studyandjobs24.com

Evaluation Process One Mid-Term 30 Final Exam 40 Class Test Closed book Open book Surprised Test Take Home exam 10 Assignment and Presentation/case study Class Attendance and Performance Total 100 Ayesha Saimoon www.studyandjobs24.com

Points To Be Noted For Closed book class test, student will get one week prior notice. For open book class test, student will get 7 days prior notice. For Assignment/presentation/case study, student will get maximum 2 months to submit it. For take home exam, student will get 7 days to submit the (hand written) answer scripts. Ayesha Saimoon www.studyandjobs24.com

CONTENTS Fundamentals of Financial Management: Definition of Financial Management, Financial management decisions, The balance sheet model of the firm, Pie model of Capital structure, Modern World Perspective: Globalization of Business, Information Technology, and Regulatory Attitude of Management. Importance of Financial Management, Goals of the Corporation: Agency costs and agency problems-the set of contracts perspective, Separation Theorem, Financial Environment: External Environment, Business Ethics, MNCs. Ayesha Saimoon www.studyandjobs24.com

Meanings of Finance Finance is the relationship between deficit sector and surplus sector of the society. The commercial activity of providing funds and capital The branch of economics that studies the management of money and other assets The management of money and credit and banking and investments Finance represents the processes that transfer money among businesses, individuals, and governments Actually “ the art and science of Managing Money” is called Finance. Ayesha Saimoon www.studyandjobs24.com

Common Functions of Finance Sources of Financing Individual Organization Domestic Government Foreign Agencies Financial Planning Identification of Sources Analyzing and Selecting of Sources Raising of Funds Investment of Funds/Utilization of Fund Protection of Funds Distributions of Profit Ayesha Saimoon www.studyandjobs24.com

Sectors of Finance Financial Markets and Institutions Investments Money and capital markets Investments Investment in Existing Business Investment in Expansion of Existing Business Investment in New Project Investment in R&D Financial management Ayesha Saimoon www.studyandjobs24.com

Financial Management Definition Financial Management is concerned with the acquisition, financing, and management of assets with some overall goal in mind. Financial management can be defined as the process of acquiring and using funds to accomplish a financial objectives. The another name of Financial Management is Managerial Finance. Anticipating Financial Needs Acquiring financial resources Allocating Funds in business Administrating the allocation of funds Analyzing the performance of funds Reporting to the management Financial Management Ayesha Saimoon www.studyandjobs24.com

Financial Management Decisions Capital Budgeting (Investment) Asset Management Decisions Capital Structure (Financing) Working Capital Management (Short-term financing) Dividend Decisions Provide some examples of capital budgeting decisions, such as what product or service will the firm sell, should we replace old equipment with newer, more advanced equipment, etc. Be sure and define debt and equity. Provide some examples of working capital management, such as who should we sell to on credit, how much inventory should we carry, when should we pay our suppliers, etc. Ayesha Saimoon www.studyandjobs24.com

Factors Influencing Financial Management Decisions Internal Factors Size of the firm Nature of Business The legal forms of business organizations Situation of business cycle Assets structure Regulatory and adequacy of income Economic life of business Terms of credit Management Philosophy External Factors Government Regulations Tax System Economic Condition of the country Political Condition of the country Condition of money market Condition of capital market Ayesha Saimoon www.studyandjobs24.com

Who is a Financial Manager? Financial Manger is a person who actively manages the financial affairs of any type of business, whether financial or nonfinancial, private or public, large or small, profit-seeking or not-for profit. To create value, the financial manager should: Try to make smart investment decisions. Try to make smart financing decisions. Ayesha Saimoon www.studyandjobs24.com

03 Forms of Business Organization Sole proprietorship: A business owned by one person and operated for his or her own profit. Partnership: A partnership has roughly the same advantages and disadvantages as a sole proprietorship. Business formed by two or more owners is called Partnership. Corporation: A business entity that legally functions separate and apart from its owners. A business firm which sells its shares in the financial market or already got the permission to sell its shares is called Corporation. Discuss the characteristics, advantages and disadvantages of each of the above business organization. Ayesha Saimoon www.studyandjobs24.com

Sole Proprietorship Advantages: Definition: A business owned by one person and operated for his or her own profit. Advantages: Business owned by one person. Least regulated form of organization. Owner keeps all the profits but assumes unlimited liability for the business’s debts. Life of the business is limited to the owner’s life span. Amount of equity raised is limited to owner’s personal wealth. Ayesha Saimoon www.studyandjobs24.com

Sole Proprietorship: Disadvantages Limited to life of owner and difficult to continue when proprietor dies. Equity capital limited to owner’s personal wealth Owner has Unlimited liability Difficult to sell ownership interest Difficult to give employees long-run career opportunities Ayesha Saimoon www.studyandjobs24.com

Partnership A partnership has roughly the same advantages and disadvantages as a sole proprietorship. Business formed by two or more owners is called Partnership. All partners share in profits and losses of the business and have unlimited liability for debts. Easy and inexpensive form of organization. Business ceases if one partner sells out or dies. Amount of equity raised is limited to the combined personal wealth of the partners. Income is taxed as personal income to partners. Ayesha Saimoon www.studyandjobs24.com

Corporation: Advantages A business entity that legally functions separate and apart from its owners. A business firm which sells its shares in the financial market or already got the permission to sell its shares is called Corporation. Limited liability Unlimited life Separation of ownership and management Transfer of ownership is easy Easier to raise capital Ayesha Saimoon www.studyandjobs24.com

Corporation: Disadvantages Subject to greater government regulation More expensive to organize than other business forms Facing Agency problems Double taxation (income taxed at the corporate rate and then dividends taxed at personal rate) Lacks secrecy, because stock holders must receive financial reports. Ayesha Saimoon www.studyandjobs24.com

Practice 01: Liability Comparison Merideth Harper has invested $25,000 in Southwest Development Company. The firm has recently declared bankruptcy and has $60,000 in unpaid debts. Explain the nature of payments, if any, by Ms. Harper in each of the following situations. Southwest Development Company is a sole proprietorship owned by Ms. Harper. Southwest Development Company is a 50–50 partnership of Ms. Harper and Christopher Black. Southwest Development Company is a corporation. Ms. Harper has unlimited liability. Ms. Harper has limited liability, which guarantees that she cannot lose more than she invested. Ayesha Saimoon www.studyandjobs24.com

Discuss how separation of ownership and management can be both an advantage and a disadvantage: Advantages You can benefit from ownership in several different businesses (diversification) You can take advantage of the expertise of others (comparative advantage) Easier to transfer ownership Disadvantage Agency problems if management goals and owner goals are not aligned Ayesha Saimoon www.studyandjobs24.com

Financial Goals of the Firm Survival Avoid financial distress and bankruptcy Beat the competition Maximize sales or market share Minimize costs Maintain steady earnings growth Maximize profits To Maximize the Wealth Ayesha Saimoon www.studyandjobs24.com

Profit Maximization is not the right answer Firms commonly measure profits in terms of EPS. Profit maximizing is not a reasonable goal because it fails for a number of reasons: It Ignores the timing of returns It ignores the cash flows available to stockholders It ignores the risk Ayesha Saimoon www.studyandjobs24.com

Benefits of Maximizing Shareholder Wealth The primary financial goal is shareholder wealth maximization, which translates to maximizing stock price. Direct benefit to shareholders as stock price increases Societal benefits as businesses compete to create wealth Includes effects of all financial decisions Ayesha Saimoon www.studyandjobs24.com

Is stock price maximization the same as profit maximization? No, despite a generally high correlation amongst stock price, EPS, and cash flow. Current stock price relies upon current earnings, as well as future earnings and cash flow. Some actions may cause an increase in earnings, yet cause the stock price to decrease (and vice versa). Ayesha Saimoon www.studyandjobs24.com

Agency Problems The agency problem suggest a possibility of conflict of interests between these two parties. Agency problem is the likelihood that managers may place personal goals ahead of corporate goals. The agency theory was Developed by Jensen and Meckling, 1976. Types of agency problems are: Managers vs Owners Senior management vs Owners Creditors vs Owners Owners vs Other Parties The agency relationship is the relationship between shareholders (owners) and management of a firm. Agency costs refer to the direct and indirect costs arising from this conflict of interest. Monitoring costs (audit fees, higher employee compensation) The cost of Implementing control devices. Ayesha Saimoon www.studyandjobs24.com

Factors/Tools used to Limit the Conflicts Monitoring of management; Managerial compensation plans Incentives plans Stock Options Performance Plans Performance Shares Cash Bonuses Direct intervention by shareholders The threat of firing The threat of takeover Ayesha Saimoon www.studyandjobs24.com

Practice 02: Identifying agency problems, costs, and resolutions Explain why each of the following situations is an agency problem and what costs to the firm might result from it. Suggest how the problem might be dealt with short of firing the individual(s) involved. a. The front desk receptionist routinely takes an extra 20 minutes of lunch to run personal errands. b. Division managers are padding cost estimates in order to show short-term efficiency gains when the costs come in lower than the estimates. c. The firm’s chief executive officer has secret talks with a competitor about the possibility of a merger in which (s)he would become the CEO of the combined firms. d. A branch manager lays off experienced full-time employees and staffs customer service positions with part-time or temporary workers to lower employment costs and raise this year’s branch profit. The manager’s bonus is based on profitability. Ayesha Saimoon www.studyandjobs24.com

Practice 02: Answers In this case the employee is being compensated for unproductive time. The company has to pay someone to take her place during her absence. Installation of a time clock that must be punched by the receptionist every time she leaves work and returns would result in either: (1) her returning on time or (2) reducing the cost to the firm by reducing her pay for the lost work. The costs to the firm are in the form of opportunity costs. Money budgeted to cover the inflated costs of this project proposal is not available to fund other projects which may help to increase shareholder wealth. Make the management reward system based on how close the manager's estimates come to the actual cost rather than having them come in below cost. The manager may negotiate a deal with the merging competitor which is extremely beneficial to the executive and then sell the firm for less than its fair market value. A good way to reduce the loss of shareholder wealth would be to open the firm up for purchase bids from other firms once the manager makes it known that the firm is willing to merge. If the price offered by the competitor is too low, other firms will up the price closer to its fair market value. Generally part time or temporary workers are not as productive as full-time employees. These workers have not been on the job as long to increase their work efficiency. Also, the better employees generally need to be highly compensated for their skills. This manager is getting rid of the highest cost employees to increase profits. One approach to reducing the problem would be to give the manager performance shares if they meet certain stated goals. Implementing a stock incentive plan tying management compensation to share price would also encourage the manager to retain quality employees. Ayesha Saimoon www.studyandjobs24.com

What is Financial Market A financial market is a market in which financial assets such as stocks and bonds can be purchased or sold. ( Jeff Madura) Financial markets are mechanisms by which borrowers and lenders get together. It is a system comprised of individuals and institutions, instruments, and procedures that bring together borrowers and savers, no matter the location. (Besely & Brigham) Ayesha Saimoon www.studyandjobs24.com

Financial Market It is a forum in which suppliers of funds and demanders of funds can transact business directly. Financial Market is a market where financial goods and services are bought and sold. Financial markets are institutions and procedures that facilitate transactions in all types of financial claims—facilitate the transfer of savings from economic units with a surplus to economic units with a deficit. Exist to facilitate the efficient flow of savings from the surplus sectors to deficit sectors Ayesha Saimoon www.studyandjobs24.com

Why study Financial Markets and Institutions? Functions of Financial Markets They are the cornerstones of the overall financial system in which financial managers operate Individuals use both for investing Corporations and governments use both for financing Provide for financial intermediation--financial savings (Surplus Units) to investment (Deficit Units) Provide payments system Provide means to manage risk Ayesha Saimoon www.studyandjobs24.com

Broad Classifications of Financial Markets Money Market Capital Markets Primary Market Secondary Markets Organized Market Over-the-Counter Market Foreign Exchange Market Spot Market Forward Ayesha Saimoon www.studyandjobs24.com

Money Market vs. Capital Markets Money Market: Markets that trade debt securities with maturities of one year or less. Examples: CD’s, Bangladesh Bank Treasury bills, Commercial Papers, Repurchase agreements etc. Short-term, < 1 year High quality issuers Debt only Primary market focus Liquid market--low returns Capital Market: Markets that trade debt and equity instruments with maturities of more than one year Debt Instruments: Bonds, Mortgages etc. Equity Instruments: Stocks Long-term, >1Yr Range of issuer quality Debt and equity Secondary market focus Financing investment--higher returns Ayesha Saimoon www.studyandjobs24.com

Primary Market vs. Secondary Markets Primary Market: markets in which users of funds raise funds by issuing financial instruments Users of funds : corporations, governments Financial instruments: stocks and bonds New issue of securities Exchange of funds for financial claim Funds for borrower; an IOU for lender Secondary Market: markets where financial instruments are traded among investors: Secondary Markets Examples: NYSE, NASDAQ, DSE, CSE) Trading previously issued securities No new funds for issuer Provides liquidity for seller Ayesha Saimoon www.studyandjobs24.com

Organized vs. OTC Markets Visible marketplace Members trade Securities listed Example: New York Stock Exchange, DSE, CSE. OTC Market Wired network of dealers No central, physical location Examples: NASDAQ Ayesha Saimoon www.studyandjobs24.com

Foreign Exchange Markets Definition: Markets deal in trading one currency for another is called “FX” market. (e.g. dollar for yen) Spot Market: The “spot” FX transaction involves the immediate exchange of currencies at the current exchange rate Forward Market: The “forward” FX transaction involves the exchange of currencies at a specified date in the future and at a specified exchange rate Ayesha Saimoon www.studyandjobs24.com

Securities Traded in Financial Markets Money market securities Money market securities are debt securities that have a maturity of one year or less. Capital market securities Securities with a maturity of more than one year are called Capital market Securities. Derivative securities Financial contracts whose value is derived from the values of underlying assets Ayesha Saimoon www.studyandjobs24.com

You Purchase a 9-month Bangladesh Bank T-Bill at Taka 100,000. Concept Check!: Classify the following financial Transaction as to whether they fit in (a) the money market or the Capital Market, (b) the primary market or the Secondary market and (c) the spot market or the forward/futures market. You visit Eastern Bank Ltd and borrow a three-year loan to purchase a Flat at Dhanmondi Area. You Purchase a 9-month Bangladesh Bank T-Bill at Taka 100,000. Hearing the upward trend of Beximco Pharma’s Share price, you have just purchased 100 shares of this company from Dhaka Stock Exchange. You purchase $1000 from HSBC Bank at 10:00 am today. Concerned about recent trends in the price of $, from Sonali Bank you purchase 1000 Dollars at today’s $/Tk exchange rate for delivery in six months, when you plan to fly United States of America. Ayesha Saimoon www.studyandjobs24.com

Preparation The followings are given as sample questions only!!!! Define Financial management. Discuss the three financial management decision relating them to the Balance Sheet Model. What are the common types of business organizations? Differentiate between a Partnership and a Corporation. Discuss the goals of the a business firm. Why profit maximization should not be the goal of a Corporation? What is agency problem? Discuss the ways to reduce the agency problems in any firm. Define Financial market. Discuss the characteristics of different financial markets in details. Ayesha Saimoon www.studyandjobs24.com