Introduction to Financial

Management
[Lecture 01]
By
Dr. Trilochan Tripathy
What are Your expectations?
Course Outline
 Outline of this lecture
• Browse through the Course handout
• Finance: A Quick Look
• Business Finance and Financial Manager
• Forms of Business Organization
• Goal of Financial Management
• Agency Problem and Control of the Corporation
• Financial Markets and the Corporation
 Introduction
• Management is a borrowed science
• Management is heavily dependent on:
• Accounting, Economics, Statistics, Mathematics, Physics,
Taxation, Law, Operations Research, Production and
Marketing etc.
• Art and science of Managing money: Finance
• Plaining, raising, controlling and administering
funds for business activity: Business finance
 Areas of Finance & Financial System
• Finance:
– Financial Management/CF/BF
– Financial Economics
• Financial Markets
– Money (TBill, CDs, BA, DCP, MMMF) and capital (stocks, Bonds
and Currencies)
• Financial instruments: Financial and Non Financial
• Bonds, stocks debentures, currency, Deposits, post
office savings, MFs, cash equivalents, and GOLD, Real
estate, commodity
Areas of Finance & Financial System
• Financial Institutions: Companies that specialize
in financial matters
– Regulatory institution s:RBI, SEBI, CBDT, CBCE-
responsible for maintaining the transparency and
the national interest in the operations of the
institutions under their supervision
– Intermediaries: Banking institutions and NBFCs (
asset financing and Investment financing
institutions)
» Specialized: UTI, NABARD, SIDBI, HUDDCO, STCI,
IDBI, LIC, GIC, NHB, Brokerage Firms
Finance and Financial System contd.
– Security analysis (investment Science)
– Portfolio Management
– Financial Risk management
– Empirical Finance
– Behavioral Finance
– International finance
– Personal Finance
– Public Finance
– Entrepreneurial Finance
– Investment banking
– Business Ethics and Corporate Governance
– Financial Econometrics
– Financial and Commodity Derivatives
– ………………Evolving…….
 Forms of Business Organization
Three major Forms:
–Sole proprietorship (single ownership)
» Features: Easy to start, least regulated &conflict, personal
income tax, unlimited liability, difficult to sell, limited
equity capital
–Partnership (same as partnership but greater scope)
–Corporation: A legal person distinct from owner and
resident of a state
» Features: limited liability, longer life, separation of
management from ownership, easy transfer of ownership
and raising capital, double taxation- income and dividend
–Domestic &International (JSC, PLC & LLC)
Corporate Organogram
 Financial Management Decisions
• Capital budgeting
– What long-term investments or projects should the business take on?
• Cash flow, ROI, Risk and investment criteria ( labour, technology, legal, input,
machinery..)
• Capital structure
– How should we pay for our assets?
– Should we use debt or equity?
• Cost, risk, cash flow position, floating cost, economic condition, Fixed
operating cost.
• Dividend Decision
– How to distribute surplus fund?
• Earning, stability of earning, cash flow position, growth opportunity
• Working Capital Management
– How do we manage the day-to-day finances of the firm?
• Nature of business, scale of operation, business cycle, production cycle, level
of competition.
 Aim of Financial Management
– Maximize profit?
• Will profit maximization also results in stock rice
maximisation?
– Minimize costs?
– Maximize market share?
– Maximize the current value per share of the
company’s existing stock
– Maximize the market value of the existing
owners’ equity
Aim of Financial Management contd.
• Will maximization of earnings per share maximize
the stock holder welfare?
– Should projected earning matters?
– Should timing of earning matters?
– Should Riskiness of projected earning matters?
– Should capital structure matters?
– Should dividend policy matters?
[ common stock, prefered stock and bond]
 The Agency Problem
• Agency relationship
– Principal hires an agent to represent its
interests
– Stockholders (principals) hire managers
(agents) to run the company
• Agency problem
– Conflict of interest between principal and
agent (Agency problems arise when an agent
does not act in the best interest of the
principal)
• Management goals and agency costs
 What Affects the Stock Price?
• The stock price is the sum of present and
future dividends.
• Future dividends are affected by three major
factors:
– The amount of the dividends
– When the dividends are received
– The risk associated with the dividends
 Can you try this?
Suppose you want to buy a house 10 years from
now, you estimated that an initial down
payment of Rs. 1,00,00,000. To accumulate the
aforesaid amount, you wish to make equal
annual end of year deposits into an account
paying annual interest of 6% . How much you
should deposit in the account , which will result
in aforesaid amount at the end of 10 years
period? $758,679.58
 Why money has a time value?
• Fundamental value, Intrinsic value, Present
value, Future value, discounted value, annuity,
annuity due, perpetuity, mixed streams of
future values, compounding, h-d-w-m-sa-y
..continuous
• risk free rate of interest, nominal and real
effective RI,
 Do you know the followings?
CAPM
Risk premium, market risk premium, security market
line, Capital market line, risk and return, diversifiable
risk, non diversifiable risk, market risk, idiosyncratic
risk, correlation, covariance
Single Index Model
FFTFM, CFM, FFFFM
Security and portfolio, portfolio diversification,
portfolio optimization
 Have you come across with the
following terms?
- Coupon rate, face value, indenture, yield and
yield cure, term structure of interest rates, yield
to maturity, callable bond, non callable bond…
- Zero growth model, constant growth model,
variable growth model, FCF- BV- PE methods of
valuations
 How investment decisions are made?
• Initial investment, operating cash flows,
terminal cash flows
• Capital structure decision
– Cost of equity, cost of debt, WACC
• International capital budgeting
• Working capital management- CCC
Is negative cash flow is always bad?
• Cash hoarding, cash management, factors
affecting CM….
• CM in a international business context
 Are you exposed to a few concepts?
• Market, Exchanges, OTC ….
• Money, Currency, Stock, Bond, Commodity , real
estate, mortgages, ABS, loans, credit products,
structured products ….
• Cash, derivative- forward, futures, options,
Swaps,
• Dealers, market makers, brokers
• Individual investors, retail investors
• Arbitrageurs, speculators
 Have you ever hard about
the Story of
Alpha
Beta
Delta
Gamma
Theta
Rho
Vega ……?
What is Kappa?
 Perhaps many of you know about
trading strategies
• Technical and fundamental
• Short sale ..
• Options , call , put, call put parity
• Bull and bear, butterfly, protective, reverse
protective, strangle, straddle…….
• Real options
 Quick Wrap Up
• What are the diverse areas of finance?
• What are the three types of financial
management decisions, and what questions
are they designed to answer?
• What are the three major forms of business
organization?
• What is the goal of financial management?
What are agency problems, and why do they
exist within a corporation?
• Brief discussion on the course coverage