Financial Management

Part 1

Dr. M. Thiripalraju
Director, Indian Institute of Capital
Markets

BirdsEyeView/SatelliteViewofCorporate
Finance(CF)
Valuation
International
corporatefinance
Regulatory
management
Taxation
management
Interfunction
management

Financingstrategy

Corporate
Finance

Servicinginvestors

Longtermasset
management
Workingcapital
management
Investment
management

WhatisFinance?
Peoplewhounderstandfinanceareoftwokinds:thosewhohave
vastfortunesoftheirownandthosewhohavenothingatall.
Totheactualmillionaire,amilliondollarsissomethingrealand
comprehensible.Totheappliedmathematicianandthelecturerin
economics(assumingbothtobepracticallystarving)amillion
dollarsisatleastasrealasathousand,theyhavingnever
possessedeithersum.Buttheworldisfullofpeoplewhofall
betweenthesetwocategories,knowingnothingofmillionsbut
wellaccustomedtothinkinthousands,anditisofthesethat
financecommitteesaremostlycomprised.
C.NorthcoteParkinson
ParkinsonsLawandOtherStudiesinAdministration

WhyStudyFinance?
Therearealteastfivegoodreasonstostudyfinance:
Tomanageyourpersonalresources.
Todealwiththeworldofbusiness.
Topursueinterestingandrewardingcareer
opportunities.
Tomakeinformedpublicchoicesasacitizen.
Toexpandyourmind.

FinancialDecisionsofHouseholds
Householdsfacefourbasictypesoffinancialdecisions:
Consumptionandsavingdecisions:Howmuchoftheir
currentwealthshouldtheyspendonconsumptionandhow
muchoftheircurrentincomeshouldtheysaveforthefuture?
Investmentdecisions:Howshouldtheyinvestthemoneythey
havesaved?
Financingdecisions:whenandhowshouldthehouseholduse
otherpeoplesmoneytoimplementtheirconsumptionand
investmentplans?
Riskmanagementdecisions:Howandonwhattermsshould
thehouseholdseektoreducethefinancialuncertaintiesit
faces,orwhenshoulditincreaseitsrisks?

QuickCheck
Whatarethefourbasictypesoffinancialdecisions
householdshavetomake?Giveanexampleofeach.

FinancialDecisionsofFirms
Capital
Physicalcapital
Financialcapital
Strategicplanning
Capitalbudgetingprocess
Capitalstructure
Workingcapitalmanagement

QuickCheck
Whatarethebasictypesoffinancialdecisionsfirmsmust
make?Giveanexampleofeach.

FormsofBusinessOrganisation
Soleproprietorship
Partnership/LLP
Corporation/Company
Limitedliability
Trust
Associationofpersons(AOPs)

SeparationofOwnershipandManagement

QuickCheck
Whatarethemainreasonsforhavingaseparationof
managementandownershipoffirms?Howdoesthe
corporateformoforganisationfacilitatethisseparation?

TheGoalofManagement

QuickCheck
Whyistheshareholderwealthmaximizationruleabetter
oneforcorporatemanagerstofollowthantheprofit
maximizationrule?

QuickCheck
Howdoestheexistenceofawellfunctioningstockmarket
facilitatetheseparationofownershipandmanagementof
firms?

MarketDiscipline:Takeovers

QuickCheck
Howdoesthethreatofatakeoverserveasamechanismto
dealwiththeconflictofinterestbetweenownersand
managersofacorporation?

TheRoleoftheFinanceSpecialistina
Corporation
BoardofDirectors

ChiefExecutiveOfficer

VPOperations

Treasurer

ChiefFinancialOfficer

VPFinancialPlanning

VPMarketing

Controller

FinancialFunctionsinaCorporation
Planning
ProvisionofCapital
AdministrationofFunds/TreasuryManagement
AccountingandControl
ProtectionofAssets/ManagementofAssets
TaxAdministration
InvestorRelations
EvaluationandConsulting
ManagementInformationSystems

FirstPrinciplesofCorporateFinance
Invest in projects that yield a return greater than the
minimumacceptablehurdlerate.
The hurdle rate should be higher for riskier projects and
should reflect the financing mix used either owners
funds(equity)orborrowedmoney(debt).
Returns on projects should be measured on the basis of
cash flows generated and the timing of these cash flows;
they should also take into account both positive and
negativesideeffectsoftheseprojects

FirstPrinciplesofCorporateFinance(Contd.)
Choose a financing mix that maximizes the value of the
firmandmatchestheassetsbeingfinanced

Iftherearenotenoughinvestmentsthatearnthehurdle
rate,returnthecashtotheownersofthefirm.
Theformofreturnsdividendsandstockbuybackwill
dependonthestockholderscharacteristics.

Objective:MaximizethevalueoftheFirm.

CorporateFinanceandtheFirm:
AFinancialViewoftheFirm
ASimpleViewofaFirm
Liabilities
Debt

Equity

Borrowed
Money

Assets
Existinginvestments
generatecashflows
today

OwnersFund Expectedvaluethat
willbecreatedby
futureinvestments

Investments
already
made

Investments
already
made

FirstPrinciplesofCorporateFinance

FirstPrinciplesofCorporateFinance

InvestmentPrinciple:

TheFinancingPrinciple:

TheDividendPrinciple:

FirstPrinciplesofCorporateFinance

Invest in projects that yield a return greater than the

minimumacceptablehurdlerate.
Thehurdlerateshouldbehigherforriskierprojectsand
reflectthe financingmix usedownersfunds(equity)
orborrowedmoney(debt)
Returns on projects should be measured based on cash
flowsgeneratedandthetimingofthesecashflows;they
should also consider both positive and negative side
effectsoftheseprojects.

FirstPrinciplesofCorporateFinance

Choose a financing mix that minimizes the hurdle rate

andmatchestheassetsbeingfinanced.

Iftherearenotenoughinvestmentsthatearnthehurdle
rate,returnthecashtostockholders.
Theformofreturnsdividendsandstockbuybacks
willdependuponthestockholderscharacteristics.
Objective:MaximizetheValueoftheFirm

TheInvestmentPrinciple

TheFinancingPrinciple

TheDividendPrinciple

TheDividendPrinciple
TheFinancingPrinciple
TheFinancingMixQuestion:
BorrowedMoney

Whatproportionsofdebtand
equityshouldthefirmuse?

Debt

OwnersFund

TheFinancingTypeQuestion:
Whattypesofdebtandequity
financingshouldthefirmuse?

TheObjectiveoftheFirm

CorporateFinancialDecisions,FirmValue,
andEquityValue

TheToolsofCorporateFinance

TheObjectiveinCorporateFinance

StockholderWealthMaximizationasthe
objectiveinDecisionMaking

Whydoweneedauniqueobjective?

TheCharacteristicsoftheRightObjective

WhyCorporateFinanceFocusesonStock
PriceMaximization

Whenisstockpricemaximizationtheonly
objectiveafirmneeds?

TheClassicalObjectiveFunction:
StockPriceMaximizationinAnIdealWorld
STOCKHOLDERS
Maximize
stockholder
wealth

BONDHOLDERS

Hire&fire
managers
Board
AnnualMeeting
LendMoney
NoSocialCosts
MANAGERS
Protect
Costscanbe
bondholder
tracedtofirm
Interests
Reveal
information
honestlyand
ontime

Marketsare
efficientand
assesseffecton
value

FINANCIALMARKETS

SOCIETY

StockpricemaximizationandAgencyCosts

StockPriceMaximizationandAgencyCosts
WhyStockPriceMaximizationWorks
Stockholdershiremanagerstoruntheirfirmsforthem.
Becausestockholdershaveabsolutepowertohireandfiremanagers.
Managerssetasidetheirinterestsandmaximizestockprice..
Becausemarketsareefficient
Stockholderwealthismaximized
Becauselendersarefullyprotectedfromstockholderactions.
Firmvalueismaximized
Becausetherearenocostscreatedforsociety.
Societalwealthismaximized

StockholdersandManagers

StockholdersandManagers

AnnualMeeting

TheBoardofDirectors

ConsequenceofStockholderPowerlessness

StockholdersandBondholders

TheFirmandFinancialMarkets

TheInformationProblem

AreMarketsInefficient?

ASynthesis:FinancialMarketandStockPrice
Maximization

TheFirmandSociety

StockPriceMaximizationwithAgencyCosts

StockPriceMaximizationwithAgencyCosts:
AgencyProblemsandStockPriceMaximization
STOCKHOLDERS
Managersputtheirinterest
abovestockholders

Havelittlecontrol
overmanagers

BONDHOLDERS

LendMoney

MANAGERS

Bondholder
canbeexploited
Delaybad
newsor
provide
misleading
information

Significant
SocialCosts
SomeCostscannot
betracedtofirm

Marketsmakes
mistakesandcan
overreact

FINANCIALMARKETS

SOCIETY

AlternativetoStockPriceMaximization

ADifferentSystemforDiscipliningManagement
(CorporateGovernance)

ChoosinganAlternativeObjective
MaximizationofMarketShare
ProfitMaximizationObjectives
Size/RevenueObjectives
SocialWelfareObjectives

StockPriceMaximizationwithLowerAgencyCost

StockholdersandManagers
MakingManagersThinkMoreLikeStockholders
MoreEffectiveBoardofDirectors
IncreasingStockholderPower
TheThreatofaTakeover

StockholdersandBondholders
BondCovenants
SecurityInnovations
EquityStakes

FirmsandFinancialMarkets
ImprovingtheQualityofInformation
MakingMarketsMoreEfficient

FirmsandSociety
AnArgumentforStockholderWealthMaximization

FirmsandSociety
ConstrainedStockPriceMaximization
STOCKHOLDERS
Stockbased
compensation
Hostiletakeovers
Activistinvestors

BONDHOLDERS

LendMoney

Managersthinklike
stockholders

MANAGERS

Protect
themselveswith
covenantsand
newbonds

Moreexternal
information
Activeanalysts

Reduced
SocialCosts

SOCIETY

Lawsandrestrictions
Investors/Customerbacklash

Marketsmakesmistakes
andcanoverreact

FINANCIALMARKETS

APostscriptTheLimitsofCorporate
Finance

TheFinancialSystem
Everyindividualendeavourstoemployhiscapitalsothat
itsproducemaybeofgreatestvalue.Hegenerallyneither
intendstopromotethepublicinterest,norknowshow
muchheispromotingit.Heintendsonlyhisown
security,onlyhisowngain.Andheisinthisledbyan
invisiblehandtopromoteanendwhichwasnopartofhis
intention.Bypursuinghisowninteresthefrequently
promotesthatofsocietymoreeffectivuallythanwhenhe
reallyintendstopromoteit.
AdamSmith
TheWealthofNations(1776)

WhatisFinancialSystem?

TheFlowofFunds

Markets

SurplusUnits

DeficitUnits

Intermediaries

QuickCheck
Adepositorputs$5000intoabankaccountandyoutakea
$5000studentloanfromthebank.Tracethisflowoffunds
inearlierfigure.

TheFunctionalPerspective
Itrestsontwobasicpremises:
Financialfunctionsaremorestablethanfinancial
institutionsthatis,functionschangelessovertimeand
varylessacrossborders.
Institutionalformfollowsfunctionthatis,innovation
andcompetitionamonginstitutionsultimatelyresultin
greaterefficiencyintheperformanceoffinancialsystem
functions.

TheFunctionalPerspective
Function1:Transferringresourcesacrosstimeandspace
Afinancialsystemprovideswaystotransfereconomic
resourcesthroughtime,acrossgeographicregions,and
amongindustries.

QuickCheck
Giveanexampleofatransferofresourcesovertimethat
takesplacethroughthefinancialsystem.Isthereamore
efficientwayforthistransferofresourcestobehandled?

TheFunctionalPerspective
Function2:Managingrisk
Afinancialsystemprovideswaystomanagerisk.

QuickCheck
Giveanexampleofatransferofriskthattakesplace
throughthefinancialsystem.

TheFunctionalPerspective
Function3:ClearingandSettlingPayments
Afinancialsystemprovideswaysofclearingandsettling
paymentstofacilitatetheexchangeofgoods,services,
andassets.

TheFunctionalPerspective
Function4:Poolingresourcesandsubdividingshares
Afinancialsystemprovidesasmechanismforthepooling
offundstounderstandlargescaleindivisibleenterprise
orforthesubdividingofsharesinlargeenterpriseswith
manyowners.

QuickCheck
Giveanexampleofaninvestmentwhichwouldnotbe
undertakenifitwerenotpossibletopoolthesavingsof
manydifferenthouseholds.

TheFunctionalPerspective
Function5:Providinginformation
Afinancialsystemprovidespriceinformationthathelps
coordinatedecentraliseddecisionmakinginvarious
sectorsoftheeconomy.

QuickCheck
Giveanexampleofafinancialtransactionthatprovides
importantinformationtopartiesnotinvolvedinthe
transaction.

TheFunctionalPerspective
Function6:DealingwithIncentiveProblems
Afinancialsystemprovideswaystodealwiththe
incentiveproblemswhenonepartytoafinancial
transactionhasinformationthattheotherpartydoes
not,orwhenonepartyisanagentthatmakesdecisions
foranother.
Moralhazard
Adverseselection
Lifeannuities
Principalagentproblem
collateralization

QuickCheck
Giveanexampleofhowtheproblemofmoralhazard
mightpreventyoufromgettingfinancingforsomething
youwanttodo.Canyouthinkofawayofovercomingthe
problem?

QuickCheck
Suppose a bank offered to make bank loans to potential
borrowers without checking their credit history. What would be
true of the types of borrowers they would attract compared to
banks that did checks of credit history? Would such a bank
charge the same interest rate on loans as banks that check credit
history?

QuickCheck
Ifyougetfinancialplanningadvicefromyourinsurance
agent,howdoesthisgiverisetoaprincipalagentproblem?
Canyouthinkofawayofovercomingtheproblem?

Financial Innovation and the Invisible Hand

FinancialSystemandCorporateFinance

GlobalFinancialSystemCorporateFinance
Domesticmarket

SupraNational
Institutions

Foreignmarket
Euro
Euro
currency bond

Shorttermmarket

equity

Bond Derivatives

Longtermmarket

OTC
Primary
market

Exchange
Secondary Traded
market
market

Issuers

Investors Instruments

Retail

High Institutional
networth
indv.

Primary
market

Secondary
market

Regulation Methods

Fixed BBM
price

Auction Hybrid

LongTermMarket(contd.)
Creditmarket
Primary
market

Capitalmarket

Secondary
market

Equity
Primary
market

Debt
Secondary
market

Issuers

Corporates

Investors
Firms

Instruments Methods
Partnership

Individuals

Exchange

Investors

Intermediaries

Issuers

Derivatives

Exchanges,
service
Instruments
providers,
RTA,
Rating
agencies
etc.

Banks/
NBFC

Syndication

EquityMarket:AnOverview

Primary

Public
Issues

Private
RightsPreferentialOffer
Placement Issue Issue
forSale

BookbuiltFixedPrice
I

Secondary

II

FunctionsofPrimaryMarket

Helpscapitalformationandeconomicdevelopment
Aidsentrepreneurstoraisecapitalinanefficientway
Providescapitalatlowcost
Itiscostefficientandtransparent
Itisaprecursortosecondarymarket

Institutions
Regulator

SEBI

SROs

Intermediaries

Facilitators

Depository

MerchantRegistrarCustodianBankerUnderwriterBroker
Banker&TA
Subbroker

Investors

Retail
Investor

HighNetworth Institutional
Investor(Trust) Investor

InstitutionalInvestors

FIIs

MFs

NRIs/OCBs

InsuranceCos.

Banks/FIs

Corporates

CapitalMarketInstruments

Equity/Ordinary/
CommonStock

Preference
Shares

Principal

Redeemable

NonRedeemable

Debt/Bond Financial
Derivatives
Warrants

Interest

Cumulative

Noncumulative

Debt/Bond
Gilt/Govt.

BondMarket

UnionGovernment

PrivateCorporate/
PublicCorporate
SectorBond

Municipal Agency
Bond Bonds
Market

StateGovernment

CouponPlain StripsFloating
BondsVanila
Rate

Zero
Coupon

Indexed
Bonds

PrivateCorporate/PublicCorporateSectorBonds
1.
2.
3.
4.
5.
6.
7.
8.
9.

Nonconvertible
Convertible
Cumulativeinterest
Noncumulativeinterest
Zerocouponbonds
Deepdiscountbonds
Floatingratebonds
Securedpremiumnotes
Securedbonds

10.
11.
12.
13.

14.
15.
16.
17.

Unsecuredbond
Long/Medium/Shortterm
bonds
Indexlinkedbonds
Bondswith
attached/detached
warrants
ECBs/Eurobonds
YANKEE
DRAGON
SAMURAI

RegulationandMarketIntegrity
Players

Products/
Companies

Position/Market
Exposure

Initial
Margin

Settlement

Trading

Markto
Market

Margins

Clearingand
Settlement

Settlemen
tPrice

VaR

PriceBands/
TradingHalts

Special
Margin

PrimaryMarket
Largepublicissues
Issuesbyanynewindustries
Premium:Isithighorlow
Lacklusterresponseofretailinvestortothelargeissues
Dominanceofinstitutionalinvestors
Impositionofmarginintheprimarymarket
Roleofforeigninstitutionalinvestorsinprimaryand
secondarymarket

PrimaryMarket(contd.)
Downpaymentbyretailinvestorsvs.institutional
investors
Pricediscoveryissues
Newprocesses
Newproducts
Vanishingpromoters/companies
Misrepresentation,misstatements
ExtendedtodraftOD
PenalactionintermsofSEBIAct

PrimaryMarket(contd.)
Artificialsubscription
Disclosures
Proportionateallotment
Delayingallotment,nonrefund
Shorteningofallotmentperiod
Penalinterestfordelay
Nondespatch/fakesharecertificates
Demat

PrimaryMarket(contd.)
Misuseofissueproceeds
Monitoringagency
Disclosures
Benamiapplications
PANno
Corneringofshares

PrimaryMarket(contd.)
Reservation
Minimumnoofinvestors
Artificialsubscriptions
Margining
Prohibitiononwithdrawal
Greymarketoperations
LockinofpreIPOshares
Collusionamongplayers
Codeofconduct
Prohibitiononassociates

PrimaryMarketIssuers
Delayingallotment,nonrefund
Shorteningofallotmentperiod
Penalinterestfordelay
Nondespatch/fakesharecertificates
Demat
Misuseofissueproceeds
Monitoringagency
Auditcommittee
Disclosures

PrimaryMarketInvestors
Benamiapplications
PANno
Demat
Validation
Corneringofshares
Reservation
Minimumnoofinvestors
Artificialsubscriptions
Margining
Prohibitiononwithdrawal

PrimaryMarketGeneral
Greymarketoperations
FreezingofISIN
LockinofpreIPOshares
Collusionamongplayers
Codeofconduct
Prohibitiononassociates

PrimaryMarketGeneral(Contd.)

Opportunitiesofmakingmoneyinquicktime.

Possibilities of integrating tainted money into the

system.

Impact on markets has a spectacular and wide spread

visibility

PrimaryMarketGeneral(Contd.)

Policy interventions required to stem adverse

possibilities.

EffectiveSupervision.

Coordinationbetweenmultipleenforcementagencies.

Crossbordercooperation.

QuickCheck
Whatarethedefiningfeaturesofdebt,equity,and
derivativesecurities?

FinancialMarketRates
Interestrates
Mortgagerate(Residential)
Commercialloanrate

FinancialMarketRates
Theinterestrateonanytypeofloanorfixedincome
instrumentdependsonanumberoffactors,threemost
importantare:
Unitofaccount
Maturity
Defaultrisk

FinancialMarketRates
Effectofunitofaccount
Effectofmaturity
Effectofdefaultrisk
Yield

FinancialMarketRates
Ratesofreturnonriskyassets
Capitalgainorcapitalloss
Marketindexesandmarketindexing
Indexingscostadvantage
Ratesofreturninhistoricalperspective
Inflationandrealinterestrates
Nominalprices
Realprices
Nominalinterestrate
Realrateofreturn
Indexlinkedbonds

QuickCheck
Supposetheriskfreenominalinterestrateonaoneyear
U.S.Treasuryis6%peryearandtheexpectedrateof
inflationis3%peryear.Whatistheexpectedrealrateof
returnontheTbill?WhyistheTbillriskyinrealterms?

QuickCheck
SupposethattherealrateofinterestonaTIPSis3.5%per
yearandtheexpectedrateofinflationintheU.S.is4%per
year.Whatistheexpectednominalrateofreturnonthese
bonds?

FinancialMarketRates
Interestrateequalisation
Interestratearbitrage

QuickCheck
Supposeyouhave$10,000inabankaccountearningan
interestrateof3%peryear.Atthesametimeyouhavean
unpaidbalanceonyourcreditcardof$5000onwhichyou
arepayinganinterestrateof17%peryear.Whatisthe
arbitrageopportunityyouface?

FinancialMarketRates
Thefundamentaldeterminantsofratesofreturn
Theproductivityofcapitalgoods
Thedegreeofuncertaintyregardingtheproductivity
ofcapitalgoods
Timepreferencesofpeople
Riskaversion

FinancialIntermediaries
Banks
Commercialbanks
Otherdepositorysavingsinstitutions
Insurancecompanies
Pensionandretirementfunds
Definedcontributionpensionplan
Definedbenefitpensionplan
Mutualfunds
Investmentbanks

FinancialIntermediaries
Venturecapitalfirms
Assetmanagementfirms
Informationservices

FinancialInfrastructureandRegulation
Rulesfortrading
Accountingsystems

GovernmentandQuasiGovernmental
Organizations
Centralbanks
Specialpurposeintermediaries
Regionalandworldorganisations

1.Howcanfirmsraisefundsfornew
investment?

InternalCapital&ExternalCapital
Public&PrivateSourcesofCapital

FinancingtheFirm(Contd.)
Financial
Intermediary
Commercialbank

Description

InvestmentBank

Raisesmoneyforcorporationsbyissuingsecurities

Insurance
Company

Investsmoneysetasidetopayfutureclamsinsecurities,
realestate,andotherassets

PensionFund

Investsmoneysetasidetopayfuturepensionsin
securities,realestateandotherassets.

Charitable
Foundation

Investstheendowmentofnonprofitorganisationsuchasa
university

MutualFund

Poolssavingsfromindividualinvestorstopurchase
securities

VentureCapital
Firm

Poolsmoneyfromindividualinvestorsandotherfinancial
intermediariestofundrelativelysmall,newbusinesses,
generallywithprivateequityfinancing.

Takesdepositsfromindividualsandcorporationsand
lendsthesefundstoborrowers

SourcesofCapital
CapitalMarkets

Equity

Debt

Commercial
paper

Bank
loans
Bonds

Common

Leases

Warrants

Preferred

InternalCapital&ExternalCapital

InternalCapital

Sources:theearningsfirmsgenerate&externalfunds
fromthecapitalmarkets
Percentageoftotalinvestmentfunds:40%80%,not
sufficienttomeetthetotalcapitalneeds

ExternalCapital
Debtvs.Equity
Debtisthemostfrequentlyusedsourceofoutside
capital.
1.Debtclaimsareseniortoequityclaims.
2.Interestpaymentsondebtclaimsaretaxdeductible,but
dividendsonequityclaimsarenot.

Public&PrivateSourcesofCapital

Comparison:Privatevs.Public
Private
canbecustomizedfor
individualinvestors
nocostlyregistration
withtheSEC
noneedtoreveal
confidentialinformation

Public
standardized

mustberegisteredwith
theSEC
insideinformation
illegal

Comparison:Privatevs.Public(Contd.)

easiertorenegotiate
limitedinvestorbase

lessliquid

moredifficult
countlessanonymous
investors
greatfluidity,canbe
tradedonpublic
secondarymarkets

InternationalMarkets

Euromarkets
acollectionoflargeinternationalbanksthathelpfirms
issuebondsandmakeloansoutsidethecountryin
whichthefirmislocated
DirectIssuance
sellingdirectlyintheforeignmarkets

Underwriting

Theunderwritingprocess
(1)Origination
(2)Distribution
(3)RiskBearing
(4)Certification

Origination

thetypeofsecuritytoissue
thetimingoftheissue
thepricingoftheissue
registrationstatementandsyndicatefo
investmentbankers

Distribution

sellingoftheissue
todecidetheamountoftheissueeachbankhasagreed
tosell

RiskBearing

tobuythesecuritiesthefirmissellingandto
resellthemtoitsclients
tofacetheriskofsellingthesecuritiesatbargain
pricesiftheissuedoespoorly

Certification

tocertifythequalityofanissue
Ifanunderwritersubstantiallymispricesan
issue,itsfuturebusinessislikelytobedamaged.

TypesofUnderwritingArrangements
FirmCommitmentvs.BestEffortsOffering
Negotiatedvs.CompetitiveOffering
ShelfOffering
RightOffering

InvestmentBank

TheCorporateBusiness
underwritingsecurities
providingmergerandacquisitionadvice
findingfinancingforthetakeover
planningtakeovertactics

InvestmentBank(Contd.)
TheSalesandTradingBusiness
sellingsecuritiestothebanksinstitutionalinvestors
publicmarketmaking
tradingontheinvestmentbankingfirmsownaccount

Comparisonbetweenfinancialsystemsin
Germany,Japan,U.K.andU.S.

Germany Japan
Banking
sector

universal
banking

separate
banking

Publicvs.
Private
capital
markets

private
primarily

private
primarily

U.K.

clearing
banks&
merchant
banks
Banks
greatvoting monitoring small
influenceon power
thedecisions becauseof
firms
offirms
banks
management reluctanceto
assumethe
risk
public
primarily

U.S.
commercial
banks&
investment
banks
small
because
common
stock
ownership
bybanksis
prohibited
public
primarily

Trendtosimilarity
Separationofcommercialandinvestmentbanking
becomesgraduallyabolished,universalbankingtakesthe
leadingposition.
BothGermanyandJapanenhancethefinancingfunction
ofpubliccapitalmarkets.

TrendsinRaisingCapital
Globalization
Bytakingadvantageofthedifferencesintaxesand
regulationsacrosscountries,corporationscan
sometimeslowertheircostoffunds.

TrendsinRaisingCapital(Contd.)
Deregulation
Withglobalization,capitalwilltendtogotocountries
wherereturnsarelargeandrestrictionsoninflowsand
outflowsaresmall,whichforcesthegovernmentto
deregulate.

TrendsinRaisingCapital(Contd.)
InnovativeInstruments
allowfirmstoavoidtheconstraintsandcostsimposed
bygovernments
tailorsecuritiestoappealtonewsetsofinvestors
allowfirmstodiminishtheeffectsoffluctuatinginterest
andexchangerates

TrendsinRaisingCapital(Contd.)
Technology
tosimultaneouslyissuebillionsofdollarsofsecurities
inascoreofcountriesacrosstheglobe
totradetrillionsofdollarsinthesecondarymarkets
topricenewinstruments

TrendsinRaisingCapital(Contd.)
Securitization
Theprocessofbundling,combiningfinancial
instrumentsthatarenotsecurities,registeringthe
bundlesassecurities,andsellingthemdirectlytothe
public,e.g.collateralizedmortgageobligations&
accountsreceivable

OtherNoticeableConceptionsandInformation
Importantfinancialintermediaries
Commercialbank,Investmentbank,Insurancecompany,
Pensionfund,Charitablefoundation,Mutualfund,Venture
capitalfirm
Majorformsofdebtandequityfinancing
Debt
Bankloans,Bonds,Commercialpaper,Leases
Equity
Common,Preferred,Warrants

OtherNoticeableConceptionsandInformation
(Contd.)
Threemostimportantpiecesoflegislation
TheSecuritiesActsof1933
TheSecuritiesExchangeActof1934
TheGlassSteagallAct(TheBankingActof1933)
ClassifyingOffering
IPOInitialPublicOffering,issuingequitytothe
publicforthefirsttime.
SEOSeasonedOffering,afirmisalreadytraded
andissimplysellingmorecommonstock.

TheTimeValueofMoney

TheIntuitiveBasisforTimeValueofMoney

CashFlowsandTimeLines

CashFlowsandTimeLines

TimeValueofMoney:Compoundingand
Discounting

ThePowerofCompoundingStocks,Bonds,and
Bills

Discounting

ThePresentValueEffectofHigherDiscountRates
TheFrequencyofDiscountingandCompounding

EstimatingEffectiveInterestRatesonMortgage
Loans

APRLegislation

TimeValueofMoney:AnnuitiesandPerpetuities
Annuities
CompoundinganAnnuity

IndividualRetirementAccounts(IRA)
DiscountinganAnnuity

EstimatingthePresentValueofAnnuities

MakingSenseofSportsContracts

HowDoTheyDoThat?LotteryPrices

PresentValueofMultipleAnnuities

CashDiscountversusaLowerInterestRate
AnAutomobileLoan
OptionforComputingTimeValueofMoney

GrowingAnnuities

TheBasicAccountingStatements
TheBalanceSheet

Assets

Liabilities

Longlivedrealassets

FixedAssets

Current
Liabilities

Shorttermliabilities
ofthefirm

Shortlivedassets

CurrentAssets

Debt

Debtobligationsof
firm

Investmentsin
Securitiesandassetsof
otherfirms

Financial
Investments

Other
Liabilities

Otherlongterm
obligations

Assetsthatarenot
physical,likepatents
andtrademarks

Intangible
Assets

Equity

Equityinvestmentin
firm

InformationalNeeds
IncomeStatement

Grossrevenuesfromsaleofproductsorservices

Revenues

Expensesassociatedwithgeneratingrevenues

OperatingExpenses

Operatingincomefortheperiod

OperatingIncome

Expensesassociatedwithborrowingandother
financing

FinancialExpenses

Taxesdueontaxableincome

Taxes

Earningstocommonandpreferredequityforcurrent
period

NetIncomeBefore
Extraordinaryitems

Profitsandlossesnotassociatedwithoperations

(+)

ExtraordinaryLosses
(Profits)

InformationalNeeds
IncomeStatement(Contd)
Profitsorlossesnotassociatedwithchangesin
accountingrules

IncomeorLossesfrom
ChangingAccounting
Rules

Dividendspaidtopreferredstockholders

PreferredDividends
NetIncometoCommon
Stockholders

InformationalNeeds
StatementofCashFlows
Netcashflowfromoperationsaftertaxesand
interestexpenses

CashFlowsfrom
operations

Includesdivestitureandacquisitionofreal
assets(capitalexpenditures)anddisposaland
purchaseoffinancialassets.Alsoincludes
acquisitionsofotherfirms.

CashFlowsfrom
Investing

Netcashflowfromtheissueandrepurchase
ofequity,fromtheissueandrepaymentof
debt,andafterdividendspayments

CashFlowsfrom
Financing

NetChangeinCash
Balance

InformationalNeeds
AFinancialBalanceSheet

Assets

Liabilities

Existinginvestments
Generatecashflowstoday
Includeslonglived(fixed)
andshortlived(working
capital)assets

Assets
inPlace

Expectedvaluethatwillbe
createdbyfuture
investments

Growth
Assets

Debt

Fixedclaimsoncash
flows
Littleornorolein
management
FixedMaturity
Taxdeductible

Equity Residualclaimsoncash
flows
Significantrolein
management
Perpetuallife

InformationalNeeds
KeyFinancialQuestions
Assets
Whataretheassetsin
place?
Howvaluablearethese
assets?
Howriskyarethese
assets?
Whatarethegrowth
assets?
Howvaluablearethe
assets?

Assets
in
Place

Growth
Assets

Debt

Liabilities
Whatisthevalueof
thedebt?
Howriskyisthedebt?

Equity Whatisthevalueof
theequity?
Howriskyisthe
equity?

Thank You