Introduction to Business Finance, The Financial System, Determinants of Interest Rate, Financial Markets

1. Chapter 1
INTRODUCTION
Saeed Akbar

2. The Concept of Business Finance
 Definition: The raising and managing of funds by business organizations is
called Business Finance.
 Business finance is concerned with making decisions about which
investments the business should make and how best to finance those
investments.
Two major decisions in Business Finance:
 1. Investment Decision
Businesses typically invest in real assets such as land, buildings, plant and
inventories (or stock), though they may also invest in financial assets,
including buying shares or bonds of other businesses

2. Financing Decision
Usually, money is obtained from the owners of the business (the shareholders)
and from long-term lenders, with some short-term finance being provided by
banks

3. The Financial System and Environment

4. An Overview of Financial Markets
 A financial market is a market in which financial assets (securities) can be purchased or
sold.
 Financial market facilitate financing and investing by household, firm, and government
agencies.
 Types of Financial Markets
 1. Primary Market: A primary market is the market where securities such as shares and
bonds are being created and traded for the first time without using any intermediary such
as an exchange in the process. (eg. Initial Public Offering)
 2. Secondary Market: A secondary market is a place where investors purchase
previously issued securities such as stocks, bonds, futures and options from other
investors, rather from issuing companies themselves.
 3. Money Market: It is a market where short-term securities are sold and purchased.
Short-term securities are having a maturity of up to one year.
 4. Capital Market: It is a market where long-term securities are traded having maturity of
more than one year.
 5. Over-the-Counter Market: An over-the-counter (OTC) market is a decentralized
market in which market participants trade stocks, commodities, currencies or other
instruments directly between two parties and without a central exchange or broker. Over-
the-counter markets do not have physical locations; instead, trading is conducted
electronically.

5. Examples of Short and Long-term Securities
 Short-term Securities: Market Treasury Bills, Commercial Paper, Negotiable
Certificate of Deposits (CD’s) etc.
 Long-term securities: Pakistan Investment Bonds, Stocks (shares) etc.

6. Interest Rates and its Determinants
Real Rate of Interest
Inflation Premium
+Real Risk-Free Rate of Interest
Default Risk Premium
Liquidity Risk Premium
Maturity Risk Premium
Risk Premiums
Real Rate of Interest
Inflation Premium
Default Risk Premium
Liquidity Risk Premium
Maturity Risk Premium
= Nominal Rate of Interest Rate
𝑅𝑒𝑎𝑙 𝑅𝑎𝑡𝑒 𝑜𝑓 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 = 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑅𝑎𝑡𝑒 𝑜𝑓 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 − 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑃𝑟𝑒𝑚𝑖𝑢𝑚

7. Overview of Financial Statements
 Balance Sheet: A balance sheet is a financial statement that reports a
company's assets, liabilities and shareholders' equity. It shows the financial
position of a company. Balance sheet is like a snapshot as it reports the
financial position at a particular point in time.
 Income Statement or Profit and Loss Statement: An income statement is
a financial statement that shows you the company's income and expenditures.
It also shows whether a company is making profit or loss for a given period.
• Statement of Cash Flows: A cash flow statement is a financial statement that
summarizes the amount of cash and cash equivalents entering and leaving a
company. The cash flow statement measures how well a company manages its
cash position, meaning how well the company generates cash to pay its debt
obligations and fund its operating expenses.

9. (EBIT)
(Gross Profit)