Financial Management for

Built Environment Sector

Explanatory notes to supplement
readings from prescribed or other standard texts
 Overview of Financial Markets

► Overview of financial markets & institutions, Sources of capital -

Equity/ Preference / Debenture/ Term loans; Cost of Capital –
opportunity cost, Cost of debt, Equity, preference capital,
Weighted Average Cost of Capital, Project cost of capital; Capital
Market efficiency; Introduction to Risk and Return: Risk and
Return Concepts; Risk in a Portfolio Context, Portfolio risk and
Return, Systematic and unsystematic risk; Portfolio risk for n
assets, CAPM, Beta,

► References:
► As per course doc
Avenues for Authenticity in Financial Markets
Where to go for funds ….
► Returning to our company Authenticity, Authenticity needs to set up a large project for
which it is in need for financial assistance. Finance can be raised (remember that it is
external sources we are looking at, since Authenticity is deficient in funds, but is surplus
in ideas ! ) from markets (including financial institutions and banks, each having
different features and characteristics).
► Financial markets in a way resemble the often discussed ‘vegetable market’ or ‘fish
market’ where there is a curious (almost simultaneous) interplay of many buyers (of
financial assets) and many sellers (of financial assets i.e. companies like Authenticity).
Avenues for Authenticity in Financial Markets
Where to go for funds ….
► Remember that Financial Assets (are assets) with claims on (potential) cashflows in
future.
► Financial institutions are also markets in a way, but which could resemble or be
conceived as banks. Being in the same market for financial assets, they face the same
market dynamics but usually with lesser number of buyers and sellers (of financial
assets). Sometimes the agents enter into negotiated transactions. In this case, the
buyers are the concerned financial institutions (and banks) and the sellers are
companies looking to sell financial assets (i.e. exchanging them for future cashflows).
► Authenticity could thus approach any of these sources (or markets) for financial
assistance.
Avenues for Authenticity in Financial Markets
Where to go for funds ….
► Financial institutions provide different types of financial assistance through financial
instruments.
► As stated earlier, Financial Assets are claims on cashflow hence they are generally
bound by certain understanding and limitations contained in contracts of different
types.
► These define the inter-se roles and responsibilities of the players that enter into
contracts.
Avenues for Authenticity in Financial Markets
Where to go for funds ….
► Some typical indicative differences between markets and financial institutions are as
under :
Attribute Markets
Returns Market determined, depending on
demand and supply of funds.
Number of Large number of participants both for
participants demand and supply of funds.
Entry Barriers As stipulated by exchange for accessing
markets.
Size of transactions Usually small, though large
transactions may also take place.
Specialization Many niches may exist in the market,
but the market is usually uniform.
Platform Modern markets facilitate exchange of
cashflows through electronic
exchanges.
Financial Institutions
Market determined as well, but with some
limits to cover for services.
Not too many participants in the demand or
supply of funds.
As stipulated by institutions / regulators for
raising finance.
Usually, few transactions but each of them
having large size.
Usually these are specialised in nature and
different entities may have different
specialisations depending on type of
financing (retail / bulk), OR size of financing
(large / small) etc
Financial institutions usually consider
negotiated transactions for both supply and
demand of funds
Avenues for Authenticity in Financial Markets
Where to go for funds ….
► Some typical indicative differences between markets and financial institutions are as
under :
Attribute Markets
Returns Market determined, depending on
demand and supply of funds.
Number of Large number of participants both for
participants demand and supply of funds.
Entry Barriers As stipulated by exchange for accessing
markets.
Size of transactions Usually small, though large
transactions may also take place.
Specialization Many niches may exist in the market,
but the market is usually uniform.
Platform Modern markets facilitate exchange of
cashflows through electronic
exchanges.
Financial Institutions
Market determined as well, but with some
limits to cover for services.
Not too many participants in the demand or
supply of funds.
As stipulated by institutions / regulators for
raising finance.
Usually, few transactions but each of them
having large size.
Usually these are specialised in nature and
different entities may have different
specialisations depending on type of
financing (retail / bulk), OR size of financing
(large / small) etc
Financial institutions usually consider
negotiated transactions for both supply and
demand of funds
Avenues for Authenticity in Financial Markets
Financial Markets ….

► Financial markets can be classified on many dimensions eg time / timing of cashflows

(i.e. when the cashflows will materialize - either periodic or terminal). Instruments
which are expected to mature within one year are transacted in the segment called
Money Market. Those which have life longer than one year are transacted in the Capital
Markets.
► As equity shares have potentially infinite lives, they are traded in capital markets, while
borrowings of short term maturity (government borrowings, bank call money etc) are
traded in money market.
Avenues for Authenticity in Financial Markets
Where to go for funds ….
► Some typical indicative differences between money markets and capital markets are as
under :

Attribute Money Markets Capital Markets

Maturity Less than one year. More than one year.

Size of transactions Usually large transactions, but small
transactions may also happen.
Type of instrument Usually borrowings OR fixed maturity
instruments.
Platform Usually an electronic marketplace –
operating through telephonic networks
or computer networks.
Usually small transactions though large
transactions also occur.
Equity shares, bonds, debentures
Modern markets facilitate exchange of
cashflows through electronic exchanges.
Avenues for Authenticity in Financial Markets
Financial Markets ….

► Markets can also be classified on the basis of ‘age of the financial asset’.
► Thus, ‘fresh’ financial assets are traded in Primary markets while ‘not-so-fresh’ financial
assets are traded in the Secondary markets.
► Relating to the automobile market – primary market could be vehicles being sold from
the showrooms, while secondary markets are markets for used automobiles.
► Similarly, primary markets for RE BE space are those markets where the properties
directly sold by developers would fall in Primary markets and others would fall in the
secondary market or resale markets.
Avenues for Authenticity in Financial Markets
Financial Markets ….

► Secondary market transactions of assets cannot happen unless the primary market
already occurred.
► Another important point is that since markets facilitate exchange of assets for cash (OR
financial assets for cash, OR buying and selling of financial assets for cash), only the
seller of the instrument gets the cash. No one else receives the cash.
► Hence, Authenticity needs to tap the primary market because it wishes to receive cash.

► If Authenticity already has issued financial assets (securities or shares) in the past, their
transactions in the secondary markets will not benefit Authenticity directly. The cash
benefits will go to the current holder of the securities.
Avenues for Authenticity in Financial Markets
Financial Instruments ….

► In order to raise finance, Authenticity has to consider offering some financial

instruments (or Financial Assets) which provide claim on future cashflows to potential
financers.
► Remember our earlier discussion on real assets and financial assets.

► These instruments carry names such as equity shares, bonds, debentures, term loans
(i.e. the loan agreement, which is also an financial asset, etc.)
► Except for equity shares which have (infinitely) long life, all other instruments which
have an element of borrowing have a date by when the entire amount raised earlier has
to be returned (also called redeemed).
Types of instruments
Financial Instruments …. Debt, Preference Capital and Equity

► Authenticity could raise money either in the form of debt, OR in the form of equity,
depending on the financial analysis conducted by it. Or even by way of preference
capital.

► Debt and Equity, two basic forms constitute virtually two ends of the financing
spectrum. Debt and equity have different characteristics, and hence they attract
different types of economic agents or entities.

► Authenticity could also design instruments which have characteristics of both debt and
equity eg Preference Shares.
Types of instruments
Financial Instruments …. Debt, Preference Capital and Equity
► Some differences between equity and debt are as under. Preference capital sits
somewhere in-between.
Attribute Equity Debt

Returns There is no obligation for refund of
investment OR periodic returns
Ownership Equity offers ownership of company
Rights Equity investors get only residual rights
over cashflows after debt investors
claims have been met
Timing of rights After meeting claims of debt holders
There is (usually) a formal legal agreement
which lists dates for return of capital and
periodic returns, if any.
Debt offers no right to ownership of
company
In case of financial difficulty, debt investors
get a right over company cash flows and
assets
Before meeting other investors rights

Risk As return is not obligated, and entire Debt holders have a sort of safety on the
capital could be lost, this is considered interest and principal
risky
Types of instruments
Financial Instruments …. Debt, Preference Capital and Equity
► Some differences between equity and debt are as under. Preference capital sits
somewhere in-between.
Attribute Equity
Returns expectation Equity investors demand high returns
looking to the risk involved
Types of return (an uncertain) dividend stream
representing periodic payouts to
shareholders, and (an uncertain)
capital appreciation
Remaining life Equity shares have infinite life. There is
no fixed life of shares.
Debt
Debt investors are satisfied with relatively
lower return
Periodic interest payments (also called
Coupon Payments in case of bonds /
debentures – used interchangeably here)
plus return of principal on maturity
Debt is usually of a finite life. The entire
borrowed amount has to be returned
during the said life, together with periodic
returns.
Types of instruments
Financial Instruments …. Another option – loan
► Loan is one instrument which is also a large component of the financial markets. Loans
come from banks and financial institutions. Loans are of different sizes. Loans by nature
may not be standardized for bulk investors eg Authenticity and a bank.

► There are retail loans or home loans which could be as low as a few hundred thousand
rupees and as high as a few million rupees, particularly in India. On the other hand,
loans for corporate borrowers could be really large, and the smallest loan could be
many times the largest retail loan.

► Loans are of course standardized for retail borrowers eg home loan for retail customers.
Types of instruments
Financial Instruments …. Another option – loan
► Big lenders could be specialized in their operations and could be potentially classified by
way of sector focus, scale and size operations i.e. capacity to lend, expertise in the
certain segments of the sector eg capacity to screen potential borrowers etc.
► In somewhat less developed markets, loans are usually one-to-one and are very specific
to the borrower. These are the 121 loans and could contain very specific conditions and
clauses. By their nature, they are usually held till maturity.
Types of instruments
Financial Instruments …. Another option – loan
► In matured markets on the other hand, there is a possibility of trading of loan accounts
in some market or financial exchange. There may also be certain specialized institutions
which have great expertise in creating loans, and they subsequently trade it off and
realise their returns. The loans could also be bundled into new securities and these new
securities could be sold to new investors, thereby raising money. This is called
securitization.
Types of instruments
Financial Instruments …. Another option – loan
► Citibank, HDFC etc are big players in the securitization market where they bundle lot of
homogenous loans into one bundle and pass it on to other investors. Such securities are
called mortgage backed securities (MBS) or having similar names.
► Recall that the global financial crisis erupted due to phenomenal growth of MBS and
there were significant defaults on the underlying mortgage loans.
► Authenticity, could also therefore approach a bank or a financial institution for a loan. It
would offer (or create) a new financial asset (eg a term loan).
Types of instruments
Financial Instruments …. Another option – loan
► Thus, there exist different types of entities which can extend finance to Authenticity.
Authenticity is free to approach any of them for its financial needs.
► The only condition will be that Authenticity needs to satisfy the conditions for the fund
raising.
► Fund raising will require creation of (specific type of) financial assets containing
appropriate features.
Types of instruments
Financial Instruments …. Another option – loan
► So we see that the market offers different mechanisms and financial instruments and
different types of financing, in order to meet the varying needs of companies such as
Authenticity.
► In modern times, markets and financial institutions are also segregated or classified
along different lines to facilitate an efficient resource allocation where each participant
transacts with a comparable or a known participant having some view on the market.
The parties involved in the transaction are called counterparties.