1. Orientation & Introduction BBA, MBA (Finance), London
Topic # 01
Financial
Management
Orientation & Introduction
Zulfiqar Hasan
BBA, MBA (Finance), London
FIN 331
Associate Professor
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2. Text Book
James C. Van Horne, John M. Wachowicz Jr. “Fundamentals of Financial Management”, Latest Edition
Lecture Handout on Web
>University Resources >Undergraduate> BBA
Book Websites:
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3. Course Websites:
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4. 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
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5. 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
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6. 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
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7. 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.
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8. 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.
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9. 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.
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10. 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
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11. 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?
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12. 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.
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13. 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?
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14. 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.
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15. Forms of Business Organization
Sole proprietorship
Partnership
Corporation
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16. 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.
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17. 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
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18. 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.
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19. 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
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20. 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.
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21. 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
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22. 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
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23. 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
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24. 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.
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25. 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.
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26. 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.
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27. 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).
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28. 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.
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29. 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
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30. Factors that Affect Stock Price
Projected cash flows to shareholders
Timing of the cash flow stream
Riskiness of the cash flows
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31. Financial Markets
&
Institutions
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32. 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)
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33. 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
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34. 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
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35. 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
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36. 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
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37. 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
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38. 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
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39. 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
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40. 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
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41. 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.
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42. 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.
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