Financial Markets and Different instruments

1. 1-1
Dr. Mazharul Islam
FINA 252
Basics of Financial
Management
INTRODUCTORY
CLASS

2. 1-2
Lesson Plan
 Introduction – (Me and You)-15 minutes
 Subject Overview – 25 minutes
 Important Instructions- 10 Minutes
 Discussion on Topic 1: The role of Financial
Management.
Dr. Mazharul Islam

3. 1-3
Introduction
Me
– Personal
– Education
– Professional
Now You
– Background (Name, Home location)
– Life goals
– What do you want from this subject
Dr. Mazharul Islam

4. 1-4
My Background- Work
 Associate Professor, KAU – (2013-current)
 Senior Lecturer, Swinburne University of Technology,
Australia (2010-2012, currently on leave)
 Post Doctoral Research Fellow: RMIT University,
Australia (2008-2010)
 Lecturer: Faculty of Business Administration, Universiti
Tun Abdul Razak, (2004-2007)
 Research Assistant: National University of Malaysia
and International Islamic University of Malaysia.
 Graduate Research Assistant: National University of
Malaysia, Malaysia, (1997-2003)
Dr. Mazharul Islam

5. 1-5
Introduction
Now Your turn
– Background (Name, Home location)
– Life goals
– What do you want from this subject?
Dr. Mazharul Islam

6. 1-6
Subject Overview - Objectives
 To familiarize the student with the concept of finance and
the role financial managers.
 Recognize the ten different principles of financial
management.
 To understand the concept of corporate world, time value of
money, financial statements and cash flow, tradeoff
between risk and return, difference between simple interest
and compound interest, financial ratios and their
limitations.
 How to calculate both present value and future value, the
value of bonds, and the major financial ratios.
Dr. Mazharul Islam

7. 1-7
Subject Overview-Learning Methods
Lectures (interactive).
Tutorials (class exercise).
– Problem solving Group (home
work)
Dr. Mazharul Islam

8. 1-8
Subject Overview - Assessment
 Individual assignments
– Class Participation Activities (10%)
– 2 Quizzes (15%)
– Mid-term exam (15%)
– Final exam (40%)
 Group assignments
– Homework (20%)
Total = 100%
Dr. Mazharul Islam

9. 1-9
Subject Overview – Course Materials
Recommended textbook
Ross/ Westerfield/ Jordan (2010),
Fundamentals of Corporate Finance, 9th
Edition, McGraw-Hill/ Irwin, NY, USA (any
edition can be used).
Other References; (Journals, Reports,
Websites, E. Library…etc.)
 Lecture slides
Dr. Mazharul Islam

10. 1-10
The Firm and the
Financial Manager
Dr. Mazharul Islam

11. 1-11
Chapter Objectives
 What is Financial Management?
 10 principles of financial management.
 What are the Decisions that Financial
Manager must be Concern?
 The Goal of the Firm.
 Organization of the Financial
Management Function.
 Understand the agency problems.
Dr. Mazharul Islam

12. 1-12
What is Financial
Management?
Financial Management means
planning, organizing, directing
and controlling the financial
activities of the organization.
( ‫يعني‬ ‫المالية‬ ‫اإلدارة‬
‫التخطيط‬
‫وال‬
‫تنظيم‬
‫ال‬ ‫و‬
‫توجيه‬
‫و‬
‫السيطرة‬
‫المالية‬ ‫األنشطة‬ ‫على‬
‫)للمنظمة‬
It refers the efficient and effective management of
money (funds) in such a manner as to achieve the
goals of the organization. Dr. Mazharul Islam

13. 1-13
“It is necessary to understand
these principles in order to
understand finance.”
Ten Principles of
Financial Management
Dr. Mazharul Islam

14. 1-14
 We won’t take on additional risk unless we
expect to be compensated with additional
return.
 Investment choices have different
amounts of risk and expected returns.
 The more risk an investment has, the
higher its expected return will be.
Principle 1: The Risk-
Return Trade-off
Dr. Mazharul Islam

15. 1-15
 A dollar received today is worth more than
a dollar received in the future.
 Because we can earn interest on money
received today, it is better to receive
money earlier rather than later.
Principle 2: The Time
Value of Money
Dr. Mazharul Islam

16. 1-16
Cash Flow, not accounting profit,
is used as our measurement
tool.
Cash flows, not profits, are
actually can be reinvested.
Principle 3: Cash—
Not Profits—Is King
Dr. Mazharul Islam

17. 1-17
The incremental cash flow is the
difference between the projected
cash flows if the project is
selected, versus what they will
be, if the project is not selected.
Principle 4: Incremental
Cash Flows
Dr. Mazharul Islam

18. 1-18
 It is hard to find exceptionally profitable
projects
 If an industry is generating large profits,
new entrants are usually attracted. The
additional competition and added capacity
can result in profits being driven down to
the required rate of return.
 Product Differentiation, Service and
Quality can separate products from
competition
Principle 5: The Curse
of Competitive Markets
Dr. Mazharul Islam

19. 1-19
The markets are quick and the
prices are right.
The values of all assets and
securities at any instant in time
fully reflect all available
information.
Principle 6: Efficient
Capital Markets
Dr. Mazharul Islam

20. 1-20
 Managers won’t work for the owners
unless it is in their best interest
 A agency problem resulting from conflicts
of interest between the manager/agent and
the stockholder/owners.
 Managers may make decisions that are not in
line with the goal of maximization of
shareholder wealth.
Principle 7: The
Agency Problem
Dr. Mazharul Islam

21. 1-21
The cash flows we consider
are the after-tax incremental
cash flows to the firm as a
whole.
Principle 8: Taxes Bias
Business Decisions
Dr. Mazharul Islam

22. 1-22
Some risk can be diversified
away, and some cannot
The process of diversification
can reduce risk, and as a result,
measuring a project’s or an
asset’s risk is very difficult.
Principle 9: All Risk is
Not Equal
Dr. Mazharul Islam

23. 1-23
Each person has his or her own
set of values, which forms the
basis for personal judgments
about what is the right thing
Principle 10: Ethical Behavior is Doing
the Right Thing, and Ethical Dilemmas
Are Everywhere in Finance
Dr. Mazharul Islam

24. 1-24
Investment Decisions (Capital Budgeting)
(Investment decisions revolve around how to best
allocate money to maximize their value.)
Financing Decisions (Capital Structure)
(Financing decisions revolve around how to pay
for investments and expenses)
Asset Management Decisions
(Working Capital Management Decisions)
Decisions of Financial
Manager

25. 1-25
Investment Decisions
 how, when, where and how much
money will be spent on
investment opportunities.
 A firm has many options to invest
their funds but firm has to select
the most appropriate assets for
investment which will bring
maximum benefit for the firm.
Dr. Mazharul Islam

26. 1-26
Investment Decisions
 What specific assets should be
acquired?
 What assets (if any) should be
reduced or eliminated?
Dr. Mazharul Islam

27. 1-27
Financing Decisions
 A company can raise finance from various
sources such as by issue of shares,
debentures or by taking loan and advances.
These sources of finance can be divided into
two categories: owners fund (no risk involve)
and borrowers fund (risk involve).
 Find the least expensive sources of fund.
Determine how the assets will be financed.
Dr. Mazharul Islam

28. 1-28
Financing Decisions
What is the best type of financing?
Mix type financing.
What is the best financing mix?
Mixer debt and equity.
What is the best dividend policy?
Paying a consistent percentage of net earnings.
How will the funds be physically
acquired?
Dr. Mazharul Islam

29. 1-29
Asset Management
Decisions
How do we manage existing assets
efficiently?
Financial Manager has varying degrees
of operating responsibility over assets.
Greater emphasis on current asset
management than fixed asset
management.
Dr. Mazharul Islam

30. 1-30 1-30
Interrelationship of the decisions
made by a Financial Manager

31. 1-31
What are the Goals of the
Firm? (General Goals)
Dr. Mazharul Islam
 Survival
 Avoid financial distress and bankruptcy
 Beat the competition
 Maximize sales or market share
 Minimize costs
 Maximize profits
 Maintain steady earnings growth.

32. 1-32
Shortcomings of these
General Goals
 These goals are either associated with
increasing profitability or reducing risk.
 Could increase current profits while harming firm (e.g., defer
maintenance, issue common stock to buy Treasury-bills,
etc.).
 Does not specify timing or duration of expected returns.
 Calls for a zero payout dividend policy.
 They are not consistent with the long-term interests of
shareholders.
Problems
Dr. Mazharul Islam
So it is necessary to find a goal that can encompass
both profitability and risk.

33. 1-33
The Real Goal of
the Firm
Maximization of
Shareholder Wealth!
Shareholders’ wealth can be
measured as the current
value per share of existing
shares.
Dr. Mazharul Islam

34. 1-34
Strengths of Shareholder
Wealth Maximization
Takes account of: current and future
profits and EPS; the timing,
duration, and risk of profits; dividend
policy; and all other relevant factors.
Thus, share price serves as a
barometer for business performance.
Dr. Mazharul Islam

35. 1-35
The Modern Organization
There exists a SEPARATION
between owners and managers.
Modern Organization
Shareholders Management
Dr. Mazharul Islam

36. 1-36
Role of Management
 An agent is an individual
authorized by another person,
called the principal, to act in
the latter’s behalf.
Management acts as an agent
for the owners (shareholders)
of the firm.
Dr. Mazharul Islam

37. 1-37
Agency Theory
Agency Theory is a branch of
economics relating to the
behavior of principals and their
agents.
Jensen and Meckling developed
a theory of the firm based on
agency theory.
Dr. Mazharul Islam

38. 1-38
Agency Theory
Incentives include stock options,
perquisites, and bonuses.
Principals must provide incentives
so that management acts in the
principals’ best interests and then
monitor results.
Dr. Mazharul Islam

39. 1-39
Social Responsibility
Wealth maximization does not stop the
firm from being socially responsible.
Assume we view the firm as producing
both private and social goods.
Then shareholder wealth maximization
remains the appropriate goal in
governing the firm.
Dr. Mazharul Islam

40. 1-40
Organization of the Financial
Management Function
Board of Directors
President
(Chief Executive Officer)
Vice President
Operations
Vice President
Marketing
Vice President
Finance
Dr. Mazharul Islam

41. 1-41
Treasurer
Capital Budgeting
Cash Management
Credit Management
Dividend Disbursement
Fin Analysis/Planning
Pension Management
Insurance/Risk Mngmt
Tax Analysis/Planning
Organization of the Financial
Management Function
Vice President of Finance
Controller
Cost Accounting
Cost Management
Data Processing
General Ledger
Government Reporting
Internal Control
Preparing Fin Stmts
Preparing Budgets
Preparing Forecasts
Dr. Mazharul Islam