Introduction to Finance and Banking Updated - Copy

Introduction to Finance and BankingCourse Code: 2302A H M Noman Bin Alam Cell# 01678-117393 E-mail- [email protected]

Syllabus for Mid-TermCourse ContentsFor Mid Term 1. An overview of financial management and its environment (Ch 1) What is Finance, financial and capital budgeting decision, and financial assets vs. real assets, areas of finance, financial staffs responsibilities, corporate goals and Agency concept. 2. Financial Statements, Cash flows and taxes (Ch 2) Financial statements and reports, balance sheet, income statement, statement of retained earnings, cash flow and its statement, operating assets and capital, NOPAT, free cash flow, corporate loss carry back carry forward. Recommended Problems: ST-2, 2-(13 to 18) Assignment: Problem 2-23 3. Analysis of Financial Statements (Ch 3) Ratios: (liquidity, asset mgt, debt mgt, profitability, market value)-Definitions, implications, uses and limitations. Recommended Problems: ST-3, 3-(12 to 17, 19) 4. Time value of Money (Ch 7) Time line, future value, present value, future and present value of ordinary annuity and annuity due, perpetuities, uneven cash flow stream, other than annual compounding, amortized loan. Recommended Problems: ST-2, ST-3, 7-(1, 3, 5, 6, 7, 8, 11, 1318, 20, 2629)

Basic Text:Fundamentals of Financial Management, Brigham,Eugene F., Houston, Joel F., 10th Edition, Harcourt Asia PTE LTD 2006. (Required)

Reference books:1. 2. 3. PRINCIPLES OF FINANCIAL MANAGEMENT, Gitman, Lawrence J. Pearson Education Asia, 9th ed. FUNDAMENTALS OF CORPORATE FINANCE, Rose Westerfield fordan, Sixth edition BANKING LAW AND PRACTICE, S.N. Maheshwari

FinanceLatin Finis Financei.e., supplying or collection of money

Money and Finance are interrelatedIn narrow sense_ Finance means procurement & make appropriate use of money In details_ Finance means planning about fund, provision, collection, reserve, use and control.

So it can be defined as the science and art of managing moneyIts concerned with the process, institutions, markets and instruments involved in the transfer of money among individuals, businesses and governments.

Why finance needs?Finance is the life blood of all economic activities.

Importance for individualshouse. Achieving personal goal as buying automobile,

Importance for OrganizationNo finance, no success

Importance for Distribution of Economic activities To have money to make moneyFOP_Land, Labor, Capital and entrepreneur

Function of FinanceTo ensure sufficient fund raising and proper utilization of fund every individual, institution or government needs to perform many financial functions which are:

o Financial planning, here needs to consider purpose, amount, time,importance and other relevant aspects.

o Identification of Sources, may be individual, F&F, Institution, otherexternal sources.

o Raising fund, needs to consider some principles, conditions, time frame. o Investment of fund, analyze cost-benefit of many projects and invest fundraised to that project which yields highest profitability.

o Protection of fund, needs to trade-off between risk and return to ensureprotection of fund.

o Distribution of profit, decision of retained earnings and dividend.

What is Financial management?

Financial management concerns the acquisition, financing, and management of assets with a view to goal of the organization The ability to allocate financial resources in the areas which generates the greatest returns Financial management deals with management of money matters. By Financial management we mean efficient use of economic resources namely capital fund. Financial management is concerned with the managerial decisions that result in the acquisition and financing of short term and long tern credit for the firm. In short, financial management deals with procurement of funds and their effective utilization in business to achieve business objective.

Classification.Private Finance Personal Finance Business Finance Corporate Finance State owned business Finance Financing autonomous organization NonBusiness Finance

FinancePublic Finance

Organizational formsThree major organizational forms: Proprietorship. (A business owned by an individual.) Partnership. (Proprietorships with more than one individual.) Corporation. (A legal entity where ownership is separated from management.)

Organizational Forms

Advantages Easily established. Tight control. Not doubly taxed. Easily established. Tight control. Not doubly taxed. Specialization of labor possible. Limited liability. Unlimited life. Good access to outside financing

Disadvantages Unlimited Liability. Limited access to outside financing. Unlimited liability. Limited access to outside financing. Interpersonal problems.

Proprietorship

Partnership

Corporation

our Main area of concentration will be on the corporations because corporations play an important role in our economy and stock price of a company serves as a proxy for stockholders wealth

Owner has no control. Double taxation. More difficult to establish

Career opportunities in FinanceFinance consists of following inter-related fields Money and capital markets _financial institutions deals with securities markets and

Investments_investors

focus on decision made by individual and institutional involves decision within the firm

Financial Management_

Career opportunities in each of the interrelated fields are wide and varied but financial managers need to have a knowledge of all three areas if they like to do well in their jobs.

Money and capital marketConsists of Banks, insurance companies, mutual funds, investment banking firms. Success depends on The knowledge valuation techniques, factors make interest rate up and down, regulations and financial instruments. The knowledge of general administration as MGT. involves accounting, sales, personnel, IT as well as financial management. Communication skill both verbal and written

InvestmentsFunctions are Sales Analysis of individual securities Determination of optimal mix of securities for a given portfolio.

Finance graduates who go into investments may work for Brokerage houses_ in sales or security analysis Banks, Mutual funds, insurance Co._ Mgt of investment portfolios Financial consulting firms_ advising individual investors Investment banks_ help businessmen for raising new capital Financial planners_ helps individuals in developing long-term financial goals and port folios.

Financial managementFM is important for in all types of businesses including Banks, insurances as well as industrial and retail firms Government operations from school to hospital to highway depts.

Job opportunities in FM is most and broadest ranging from Making decision for plant expansion to choosing types of securities to be issued to finance expansion. Deciding credit terms under which customers may buy. Deciding level of inventories firm should carry. Deciding the volume of cash to be kept in hand and at banks. Deciding whether to acquire other firms or not. Deciding between retained earning and dividend.

Financial Management DecisionsInvestment DecisionMost important assets acquisition decisions are What is the optimal firm size? What specific assets should be acquired? What assets should be acquired or eliminated?

Financing DecisionDetermine how assets will be financed What is the best type of financing? What is the best financing mix? How will the funds be physically acquired?

Divided decision What impact will have on share holder on dividend payment? What will be the dividend pay out ratio? What will be the optimum payout ratio? Whether cash divided or stock divided be paid?

Assets Management Decision How do we manage existing assets efficiently? Financial manager has varying degrees of operating responsibilities on assets. Greater emphasis on current assets management than fixed assets

GP OrganogramSenior Assistant to CEO TBA

CEO

Special Initiatives*CHQ Petter Russ

Public Relations Syed Yamin Bakht

Financial Services Delwar Hossain Azad Cost Efficiency Stein Naevdal Climate Strategy N K A Mobin

Human Resources Emad Ul Ameen

Corporate Affairs Khalid Hasan

Finance Md. Arif Al Islam

Networks Md. Shafiqul Islam

Information Technology Frode Stoldal

Sales Laszlo Barta

Marketing Rubaba Dowla

Customer Service Arnfinn Groven

Director Financial Management Raihan Shamsi

Company Secretary Raihan Shamsi

Internal Audit Farhad Ahmad

* Will evolve over time with projects/initiatives added and terminated

Finance DivisionChief Financial Officer (CFO) Finance Financial Planning Director Financial Management

Treasury Accounting

Investment Control

Asset Management

SOA Compliance

Revenue Accounting Reporting

Supply Chain Management Tax & Regulatory Capital Market Financial Control Business Support Commercial) (

The Financial Staffs ResponsibilitiesFinancial staffs task is to acquire and help operate resources to maximize the value of the firm. Here are some specific activities:

1. 2. 3. 4. 5.

Forecasting and planning:departments to shape firms future

Interact and coordinate other To

Major investment and financing decision: Coordinate and control:

increase turnover, investment is needed, so FS determine the optimum sales growth and also decide how to finance those assets whether debt, equity or both. If debt, short term or long term.

As all activities in the organization has a financial implication, its financial staffs responsibility to interact with other departments to ensure efficient operation at best possible level. e.g., Sales needs investment and investment needs financing.

Dealing with financial Market: Money market andCapital market for raising fund, selling stocks etc.

Risk Management:

Risk is every where in the organization. However risk can be reduced with insurance company or derivative markets. Its FSs responsibility to identify and manage the risk effectively and efficiently.

What is the Goal of the firm

Maximization of Shareholder Wealth!Value creation occurs when we maximize the share price for current shareholders

Shortcomings of Alternative PerspectivesProfit maximization Maximizing a firms earnings after taxes Rationale of profit maximizing goal: Profit is the yardstick to measure efficiency Proper utilization of resources Social welfare Criticism of profit maximization The concept is vague as profit is not defined clearly It ignores timing of profit and time value of money It ignores risk dimension of financial decision

Shortcomings of alternative perspectives Earning per share maximization Maximizing earnings after dividend by shares outstanding Criticism of EPS maximization: Does not specify timing or duration of expected returns. Ignores changes in the risk level of the firm. Calls for a zero payout dividend policy.

Strengths of Shareholder wealth maximization Rationale of wealth maximization: Clear concept of wealth, Takes accounts of Current and Future profits and EPS; The timing, duration, and risk of profit and EPS; Dividend policy and all other factors. Focus on market price of share Thus, share price serves as a barometer for business performance.

Shareholder wealth maximizationShareholders wealth maximization means shareholders utility maximization If the firm acts to maximize stockholders wealth, then individual shareholders can use this wealth to maximize their own utility.Stockholders current wealth = Number of shares owned * Current stock price per share

In order to Maximize utility

Maximize the shareholders wealth

By maximizing the current stock price

What companies say about their corporate goal The Coca-cola: Our mission is to maximize share owner value over time Cadbury Schweppes: Governing objective is growing shareowners value Credit Suisse Group: Achieve high customer satisfaction, maximize shareholder value and be an employer of choice Dow Chemical Company: Maximize long-term shareholder value ExxonMobil: Long-term, sustainable shareholder value

Constraints on Stockholders wealth maximizationIn order to maximize the stock price, financial managers should properly take into consider the following constrains in the business environment.

Agency problem Hostile takeover Social responsibility Business ethics

Is maximizing stock price same as maximizing profit?Without doubt no, There is a high correlation between EPS, Cash flow, and stock price, and all will rise if sales rise. But stock prices depend not just on todays Earnings and cash flow rather it depends on Future cash flow stream and riskiness of firms assets. Same action of a firm may stock prices and current profit and vice versa If a firm makes huge capital expenditure today, it may reduce current profit but it will stock price, if the market believes it will future earnings.

Factors affecting stock priceStock prices depends onManagerial actions like Investment decisions Financial decisions Dividend policy decisions

External factors like Legal constraints General level of economic activity Tax law Conditions of stock market

Managers can increase their stock prices by Expected firm s cash flow, riskiness of firms assets

The Modern Corporation.Board of directors

Shareholder

Debt holder

Management

Assets

Debts Equity

Separation of ownership and control

Role of ManagementManagement acts as an agent for the owners (Shareholders) of a firm. An agent is an individual authorized by another person, called principal, to act in the latters behalf.

Agency Problem Agency problems arise when there is a conflict between the interests of the agents( e.g., the managers) and those of the principal (e.g., Shareholders)In a large corporation,

managers interests lie on the followings: Increase their job security as hostile is less likely Increase their own power, status, salaries Create more opportunities for their lower and middle level manager

Shareholders interest lies on Maximization of their wealth.

Agency problem Agency relationship -Principal hires an agent to represent their interest-Stockholders (principals) hire managers (agents) to run the company.

Agency problem -Conflict of interest between principals and agents Agency cost -The cost that management needs to bear due to the agency problem.

Agency Theory Jensen and Meckling developed a theory of the firm based on agency relationship between agents and Principal of a firm. Agency Theory is a branch of economics relating to the behavior of principals and their agents.

Agency TheoryPrincipals must provide incentives so that management acts in the principals best interest and then monitor result. Incentives include stick options, perquisites and bonus. There is a markets for managerial talent, this may provide market discipline for managers, they can be replaced. If managers fail to maximize share price, they can be replaced to hostile takeover.

Mechanisms to motivate managers to act for stockholders best interest.o Managerial compensation( Higher salaries, bonus, LFA, perquisites, stock options etc) To attract and retain capable managers To align managers interest with stockholders interest

o Direct intervention by stockholder

Institutional investor can influence on firms operation by Acting as a lobbies Establishing proposal by voting on Annual Stockholders meeting.

o The threat of firing

If the profitability of the firm decrease. GP CEO- Arik Ass Compaq Computer Corporation- CEO-Eckhard Pfeiffer

o Threat of takeover/ Hostile take over

If stock is undervalued due to poor performance of management. In hostile takeover, Manager of acquired firm loss job or loss authority or status

If you want to keep you job, dont let your stock sell at a bargain price

Do the firms have any responsibility to society at large?Certainly. The firms have an ethical responsibilityTo To To To To To To To provide a safe working environment to its employees avoid polluting air and water produce high quality safe product and services at low operating cost protect national heritages increase standard of living increase efficiency develop new technology produce new product and new job

All are also essential for stock maximization. So stock maximization and social well fare are not conflicting.

Ethics in businessFirms should maintain ethical standard in all types of business dealings. There is a positive correlation between longrun success and ethics. Conflicts may rise between these two. Managers should resolve all conflicts. Any deviation may keep the firm to bankruptcy. That is, there is no room for unethical behavior in business.

Financial AssetsFinancial asset represents a financial claim on an asset that usually documented by some form of legal formation. Examples of various types of FAs1.Equity claim-direct_ represents ownership interestCommon stocks Warrants_ right to buy common stock (convertible to one share) at a stated price in long term options_ right to buy common stock(convertible to 100 shares) at a stated price in short term

2. Equity claim-indirect_ can be acquired through placing fund s in investment companies.Investment company shares(Mutual fund) Pension funds Whole life insurance

3. Creditor ClaimSaving accounts Money market funds Commercial papers Treasury , Municipal and corporate bills, notes, bonds

4. Preferred stock(Straight and convertible to common stock) 5. Commodity futures.

Real AssetsA real asset represents an actual tangible asset that may be seen, touched, felt, held, or collected. Examples of various types RAs1. Real estateOffice buildings Apartments shopping centre

2.Precious metalsGold Silver

3. Precious gemsDiamonds Rubies

4.CollectiblesArts coins stamps rear books

5.OthersCattle common, metals

Social responsibility Should the firm behave ethically? Yes! Do the firms have any responsibility to the society at large? Yes! Shareholders are also members of society. Does wealth maximization preclude the firm from being socially responsible? No! Is maximizing stock price good for society, employees and customers? Yes! Employment growth, Least priced quality products and Corporate social works ensured with satisfying wealth maximization goal of stock holders.

Firm answer the questions by producing both private and social goods.