Orientation & Introduction BBA, MBA (Finance), London Topic # 01 Financial Management Orientation & Introduction Zulfiqar Hasan BBA, MBA (Finance), London FIN 331 Associate Professor ZULFIQAR HASAN

Text Book James C. Van Horne, John M. Wachowicz Jr. “Fundamentals of Financial Management”, Latest Edition Lecture Handout on Web www.studyandjobs24.com >University Resources >Undergraduate> BBA Book Websites: http://wps.pearsoned.co.uk/ema_uk_he_wachowicz_fundfinman_13/106/27149/6950232.cw/index.html http://cwx.prenhall.com/bookbind/pubbooks/wachowicz ZULFIQAR HASAN

Course Websites: http://wps.pearsoned.co.uk/ema_uk_he_wachowicz_fundfinman_13/106/27149/6950232.cw/index.html ZULFIQAR HASAN

Additional Readings Fundamentals of Financial Management By Brigham & Houston; Edition ≥10th Principles of Managerial Finance by L J Gitman Essentials of Managerial Finance by Besley and Brigham Corporate Finance by Ross, Westerfield and Jaffe Fundamentals of Corporate Finance by Brealey, Myers and Marcus ZULFIQAR HASAN

Course Websites 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 www.teachmefinance.com www.studyfinance.com www.investorwords.com www.Islamicfinance.com ZULFIQAR HASAN

Continuous Assessment Evaluation Process Mid-Term 30 Final Exam 40 Continuous Assessment Class Test: Closed book/ Open book/Surprised Test/ Take Home exam/viva 20 Assignment /Case Study/Presentation Class Attendance and Performance 10 Total 100 ZULFIQAR HASAN

Topic 01 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. ZULFIQAR HASAN

Recalling: What is Finance? Deficit Sector Surplus Sector 01 They are the individual /organization/govt. who have shortage/deficit of money They are the individual /organization/government who have excess/surplus of money 02 They don't know from where they can collect this money They don't know in where they can invest/utilize this money 03 They don't know how to collect this money They don't know how to invest/utilize this money Finance is the process of transferring fund from surplus economic unit to deficit economic unit. ZULFIQAR HASAN

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. ZULFIQAR HASAN

Common Functions of Finance Sectors of Finance 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/Dividend Financial Markets and Institutions 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 ZULFIQAR HASAN

Review 01 Finance is the relationship between deficit sector and surplus sector of the society which represents the processes that transfer money among businesses, individuals, and governments. False /True 02 The main objective of Finance is to keep the financial gap between deficit sector and surplus sector of the society. False/True 03 How many major sectors of Finance? 04 What are the sources of Financing? 05 What are the main functions of Finance? ZULFIQAR HASAN

Financial management Definition Financial management can be defined as the process of acquiring and using funds to accomplish a financial objectives. Financial Management concerns the acquisition, financing, and management of assets with some overall goal in mind. (James C Van Horne) The another name of Financial Management is Managerial Finance or Business Finance. ZULFIQAR HASAN

Questions involved in Financial Management Financial Management Decisions Capital budgeting (Investment) Capital structure (Financing) Working capital management (Short-term Financing) What long-term investments should the firm take on? Where will we get the long-term financing to pay for the investment? How will we manage the everyday financial activities of the firm? ZULFIQAR HASAN

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. ZULFIQAR HASAN

Forms of Business Organization Sole proprietorship Partnership Corporation ZULFIQAR HASAN

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. ZULFIQAR HASAN

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 ZULFIQAR HASAN

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. ZULFIQAR HASAN

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 ZULFIQAR HASAN

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. ZULFIQAR HASAN

Partnership vs. Corporation Issues Partnership Corporation Starting Easy Hard Transferability of ownership Difficult Easy Taxation Single Double Owners and Mangers Same Separate Life Duration Limited Unlimited Liability Unlimited Limited Capital Size Medium Large Raising of Fund Uneasy Easy ZULFIQAR HASAN

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 ZULFIQAR HASAN

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 ZULFIQAR HASAN

Objectives of Financial Management Objectives of Financial Management may be broadly divided into two parts such as: Profit Maximization: Main aim of any kind of economic activity is earning profit. A business concern is also functioning mainly for the purpose of earning profit. Profit is the measuring techniques to understand the business efficiency of the concern. Profit maximization is also the traditional and narrow approach, which aims at, maximizes the profit of the concern firm. Profit maximization is also called as earnings per share maximization. It leads to maximize the business operation for profit maximization. Wealth Maximization: Wealth maximization is one of the modern approaches, which involves latest innovations and improvements in the field of the business concern. The term wealth means shareholder wealth or the wealth of the persons those who are involved in the business concern. Wealth maximization is also known as value maximization or net present worth maximization that means maximization of the market price of share. ZULFIQAR HASAN

Criticism against Profit Maximization It is vague: In this objective, profit is not defined precisely or correctly. It creates some unnecessary opinion regarding earning habits of the business concern. It ignores the time value of money: Profit maximization does not consider the time value of money or the net present value of the cash inflow. It leads certain differences between the actual cash inflow and net present cash flow during a particular period. It ignores risk: Profit maximization does not consider risk of the business concern. Risks may be internal or external which will affect the overall operation of the business concern. Profit maximization leads to exploiting workers and consumers. Profit maximization creates immoral practices such as corrupt practice, unfair trade practice, etc. Profit maximization objectives leads to inequalities among the sake holders such as customers, suppliers, public shareholders, etc. ZULFIQAR HASAN

Favorable Arguments for Wealth Maximization The primary financial goal is shareholder wealth maximization, which translates to Direct benefit to shareholders as stock price increases Societal benefits as businesses compete to create wealth Includes effects of all financial decisions Wealth maximization is superior to the profit maximization because the main aim of the business concern under this concept is to improve the value or wealth of the shareholders. Wealth maximization considers the comparison of the value to cost associated with the business concern. Total value detected from the total cost incurred for the business operation. It provides extract value of the business concern. Wealth maximization considers both time and risk of the business concern. Wealth maximization provides efficient allocation of resources. It ensures the economic interest of the society. ZULFIQAR HASAN

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). ZULFIQAR HASAN

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 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. ZULFIQAR HASAN

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 ZULFIQAR HASAN

Factors that Affect Stock Price Projected cash flows to shareholders Timing of the cash flow stream Riskiness of the cash flows ZULFIQAR HASAN

Financial Markets & Institutions ZULFIQAR HASAN

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) ZULFIQAR HASAN

What is 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 ZULFIQAR HASAN

Why study Financial Markets and Institutions? 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 ZULFIQAR HASAN

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 ZULFIQAR HASAN

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 ZULFIQAR HASAN

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 ZULFIQAR HASAN

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 ZULFIQAR HASAN

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: he “forward” FX transaction involves the exchange of currencies at a specified date in the future and at a specified exchange rate ZULFIQAR HASAN

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 ZULFIQAR HASAN

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. ZULFIQAR HASAN

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. ZULFIQAR HASAN