QB -Solved

Financial Management
MBM-633
Ans 1:

Investors: -This is the category of individual or financial institution who

participates in providing funds to firms, government agencies and individuals
who are in need of fund. The financial institutions that provide funds are
referred as institutional investors. These investors directly provide loan or
purchases the securities (equity, bond etc) issued by firms.
Financial Markets: - Financial markets represent forums that facilitate the flow
of funds among investors, firms, and government units and agencies. Each
financial market is served by financial institutions that act as intermediaries.
Financial Assets
Financial assets are also called securities; these are financial papers or
instruments such as shares and bonds or debentures.
Equity: - A firm sells shares to acquire equity funds, which represents legal
ownership rights of their holder (shareholder). The shareholders can be of two
types, ordinary and preference. Preference shareholders receive dividend at a
fixed rate and they have priority over others.
Debt: - It is source of securing capital through creditors or lenders. They make
money available to the firm as loan or debt on interest for a fixed period. Firms
issue bond or debenture which is certificate acknowledging the amount of
money lent by the bondholder. It has a fixed maturity period and interest.
Cash: - It is the currency issued by the central bank of a country. It is the most
liquid form of financial asset.
Financial Intermediaries
These are the institution which enables the flow of fund from someone having
the fund to someone in need of fund. Although who has surplus of fund can
directly lend it without the financial intermediaries for a higher return but it
might result in very high risk as compared to investing through intermediaries.
Moreover, financial intermediaries provide benefit of diversification also. Some
of the financial intermediaries are banks, term lending institutions, agriculture
finance institutions, insurance, mutual funds and NBFCs etc. In India these
financial intermediaries are mostly regulated by regulatory agencies like SEBI,
RBI and IRDA etc.
Financial Markets
Capital Market: - It is a market which facilitates the buying and selling of
securities such as shares and debentures. It can be classified into primary
market i.e. where company issues new securities to raise funds and secondary
market where market deals with already issued and listed securities. The
secondary market is also known as stock market. Secondary market also
includes derivatives and OTC market.

The primary disciplines are which go hand in hand with the finance are
accounting, macroeconomics and the microeconomics. the other disciplines are
macroeconomics. It tells you about the trade position in the market, tells you
about the supply and demand position in the market , that is in the
microeconomics but to the government policies, government budgets then as
international environment, everything is the part of the macroeconomics and
every firm these days is subject to the all these external factors, government
policies, government budgets, international environments, foreign exchange, all
of these things and largely they are the part of macroeconomics.
Microeconomics, demand and supply functions are the most important
functions, money, market, capital markets.
Ans 2. Indian Capital Markets are regulated and monitored by the Ministry of Finance, The Securities and Exchange
Board of India and The Reserve Bank of India.

The Ministry of Finance regulates through the Department of Economic Affairs - Capital Markets Division. The
division is responsible for formulating the policies related to the orderly growth and development of the securities
markets (i.e. share, debt and derivatives) as well as protecting the interest of the investors. In particular, it is
responsible for

• institutional reforms in the securities markets,

• building regulatory and market institutions,

• strengthening investor protection mechanism, and

• providing efficient legislative framework for securities markets.

The Division administers legislations and rules made under the

• Depositories Act, 1996,

• Securities Contracts (Regulation) Act, 1956 and

• Securities and Exchange Board of India Act, 1992.

Ans 3: Class Assignment 1

Ans 4:

Finance at Micro level refers to an application of finance at firm level. It represents securing of funds by a firm for its
application to generate returns.

Financial assets are also called securities; they are financial papers like shares, bonds, debenture etc which is issued
to investors in the primary market to raise capital. It is the process of financing. The firm takes its investment
decision to create real assets. Real assets are tangible assets like plant, machinery, factory etc and intangible like
technological collaboration, know-how, patents etc. Through investments, a firm gets the return on investment. A
part of profit/return is transferred to shareholders in form of dividend etc and a part of it is retained with the firm
for expansion, which called retained earnings.

At micro level, there are three different views of the firm

• The Investment Vehicle Model of Firm

• The Accounting Model of Firm
• Set of Contracts Model of Firm
The investment Vehicle Model of a Firm

Investors: - It represents either equity holders or debt holders. Financial Markets and Intermediaries: - It represents
entities that act as link between investors’ money and firm. The firm’s financial decisions are effectively carried out
by these markets by providing an easy way for investors to buy securities that represent claims to the firm’s cash
flows. The firm’s decision to raise capital through borrowing (e.g. by issuing bonds) or selling equity (e.g. by selling
common stock) relies almost completely on the existence of these financial markets.

Firm: - Represents firm itself, with its own uniqueness in term of product, manager, capital structure etc.

The World: - It represents entities such as markets, government, opportunities, and other variables which effects
firm’s decisions. Exchanges of money and real assets between the world and the firm represent the investment
decisions made by managers, the entrusted individuals who, theoretically, work in the best interest of the owners
(investors) So, investors provide financing to the firm in exchange for financial securities. The fund so obtained, is
invested in assets to generate income which is distributed to the investors.

The Accounting Model of a Firm

The accounting model of firm is based on balance sheet and separates decisions on the basis of functions. The
balance sheet represents the health of firm in terms of returns and risk. The balance sheet is a financial statement
which represents a firm’s position at a particular point of time. The left side of balance sheet represents investment
decisions like cash, securities, accounts receivable, inventory etc. The right-hand side of the balance sheet is made
up of two categories: The first category, debts, includes such items as accounts payable, current debt, current
liabilities, long-term debt, and bonds. The second category, owner’s equity, includes all that is left over when
liabilities are subtracted from debt. The right-hand side of the balance sheet represents the financing decisions made
by the managers of the firm. The Accounting Model is accurate but can sometimes be misleading. Advantages of
defining a firm with the Accounting Model include categorizing a company by functions rather than entities. A
disadvantage includes the fact that the definition is always historic.

Set of Contracts model of a Firm

It views links between stakeholders and the firm as a set of obligations. The most important stakeholders are those
most directly affected by the firm such as stockholders, debt holders, smaller creditors, employees, customers, and
managers to name a few. These stakeholders are primary because they hold explicit contracts with the corporation.
The contracts between the firm and primary stakeholders are typically in writing and represent legally binding
relationships with specific right and obligations specifically spelled out. Secondary stakeholders are those who hold
implicit contracts with the corporation like community or society.

Ans 5:

Financial Intermediaries

These are the institution which enables the flow of fund from someone having the fund to someone in need of fund.
Although who has surplus of fund can directly lend it without the financial intermediaries for a higher return but it
might result in very high risk as compared to investing through intermediaries. Moreover, financial intermediaries
provide benefit of diversification also. Some of the financial intermediaries are banks, term lending institutions,
agriculture finance institutions, insurance, mutual funds and NBFCs etc. In India these financial intermediaries are
mostly regulated by regulatory agencies like SEBI, RBI and IRDA etc.

Ans 6:

The various disciplines of finance are:

a) Investment Analysis & Portfolio Management: - Investment analysis deals with analysis of past investment
decision. It is very useful for successful portfolio management.

b) Capital Markets and Financial Institutions: - Source for raising funds, includes study of primary and secondary
markets and market participants like intermediaries.

c) International Finance: - International finance is the branch of financial economics broadly concerned with
monetary and macroeconomic interrelations between two or more countries. It examines the dynamics of the global
financial system, international monetary systems, balance of payments, exchange rates, foreign direct investment,
and how these topics relate to international trade.

d) Financial Services: - It involves study of banks, credit card companies, insurance companies, consumer finance
companies, stock brokerages, investment funds and some government sponsored enterprises.

e) Corporate Finance: - Corporate finance is the discipline of finance involving various money related decisions and
tools and methods which a firm uses for investment-financing decisions.

f) Personal Finance: - Principles of finance applicable to individuals for consumer loans, mutual funds, shares,
insurance, tax etc.

g) Real-Estate Finance: - Allocation and generation through investment in real estate business.

h) Public Finance: - Related to government and its enterprises, may disinvestment decisions, fiscal policies etc.
Finance was evolved through economics and even now, it has no unique body of knowledge. It draws heavily from
other disciplines.
UNIT-II
1. a. How can one become millionaire using the power of compounding?

b. Your brother has offered to give you $5,000 after one year or $10,000 after 9 years. if the interest rate is 6% which
offer is the preferred one?

2. a. What do you understand by effective rate of interest?

b. A bank offers 8% nominal rate of interest with quarterly compounding what is the effective rate of interest?

3. a. Why learning Time value of Money concepts is important?

b. If we deposit Rs. 1,000 today calculate the time taken for the deposit to double if the interest rate is 10% ,
compounded annually , using

a. Future value method b. Rule 72 c. Rule 69

4. a. What do understand by ‘amortization‘?

b. Against a house, mortgage loan is obtained for Rs. 10,00,000 for 15 years and at annual interest of 12%. What is
the annual payment?

5.a. What is yield to maturity for a bond?

b. A five-year, $1000 bond with an 8% coupon rate and semi-annual coupons is trading for a price of $1035. What is
the bond’s yield to maturity?

6.a. What do you understand by dividend discount model?

b. Hal wants to buy 500 shares of Xenon Corporation’s common stock. Xenon’s next dividend payable one year from
today, is expected to be $3.50 per share. The dividend is expected to grow at a 2 percent rate for the foreseeable
future.

i) If the investor-required rate of return is 16 percent, what will be the price per share of Xenon’s common stock
today?

ii) Hal expects to hold the stock for only two years. What is the estimated selling price of the stock two years from
today?

7. a. What is an annuity ? How does is differ from a perpetuity ?

b. How can you calculate the present value of an annuity using perpetuities ?

8. A company will pay a dividend of $1.50 this year. Dividends are expected to grow by 6% per year. If equity cost of
capital is 10% what is the price per share.