| COVERVEW OF ANANCALABNASEWENT 5 ployment, In these cases, they may require detailed accounting\for the flows of peas or may allow only certain types of intemational ransctons, ‘The study tare of funds tween individuals and orgaiztons across national borers cette development of methods of handling the flows more efficiealy we ‘the scope of international finance. 1 suscture contains a number of fi nce companies, pension funds, and a vidal savers and accu. ines Sinvesmnert, Without these insutions, rsd not be ready avilable Tinance business Uansitions, (he PA hase of private homes and commercial facilites, andthe variety of other activi- ties that require substantial amiounts ‘of capital. ‘Institutional Finance deals. with formation and the orgaviations tht ‘Individual businesses face problems dealing with the Fann OF Rn earry on their actives and with e determination of ‘optimum methods of employing the funds. In tive marketplace, bust is 1s Man} esses must actively manage tai funds 2 techniques have been developed to a ‘Proper courses of action. These ool lp the manager determine. which Peeper re lowes cst of funds and which alist will prowiee the atest return on invested capital eal management field of greatest Eon wo tig corporat financial ofcers and wil be the major thst of the approach that we wil use in studying fiance. sera review ofthe five fields of finance i given in Figure 1-1 Publ Finance Sreritiesand lnvestment Analysis sed by individual and iestttional investors. easutes isk n securities transactions, Measre kel return Used in Feder, state, and local government. {Examines taxés and other revenues. Pursues nonprofit goa. Institutional Finance international Finance stucieseconomnie vansaetions amongnations Sod individuals international. ‘Concerned with flows among countries. Examines banks, insurance companies, and pension funds. Seadies saving and capital focmation. Financial Management ‘seeks profble business activites ov" Studies franca! problems Seeks sources of in individual fers. fowcost finds. FIGURE 1-1 Various feiss of franca6 7 TEFOUNDATION OBJECTIVES OF THE FIRM ‘A successful business enterprise often uses a goal Financial manager performs certain tasks or functions of the finance department. tng objectives. The Firm should ensre that the actions ofall ogra ing finance, are helping it ‘The starting point defining of workable goa! general terms, propery defined and understood: ‘objectives de moving the firm to a future des ‘organizations, ther objectives mary objectives are commonly encountered: max of wealth. = ‘The frst businessuien belie ing down. costs the ing do paing 2 simple a rational goal for a business and focuses the firm’s ef Profit a is widely professed, but 1. Ie Is Vague. The problem ‘whorhar may be quite different from profits ia the-long run. Pe to cpee apiece ower this year's operating expe ‘will pay for the short-run saving in future years, ceapable of operating again tly stated goal of the that as Tong a. they are ext yare achieving this goal. Prof ‘Straightforward statement of purpose. Ic is easly Un oriented financial structure. The that help to achieve the go “The goals ie turn help the firm achieve is overall operat ng ucts, includ- to achieve its stated or understood objectives. 1 for developing a gosl-ocented financial structure is the I for the firm as a whole. Although they may be stated in the Key to successfully sired positon. Since busines firms are profi seek are frequently expressed in terms of money. Two Pr Jmization of profits and maximize firm is to maximize profits. Many ing as mh as possible whilé hold: pas the benefit of. stood as & forts toward making money. fet he goncept hs 5 rae js the definition of the term profits. Profits in the if a fcm continues Gthoutpropet maintenance, it may be abl tures, This will increase profits. Bu the firm ‘when the machine fs noTonger \Socase of por neglect. Gly, maximizing pros does ‘of machinery wi somes negleting he loge pwn fat of on ss es beh vals hon 2. It Ignores Timing. Becquse money Fes ee ese next yeas a pea e ‘must consider the tim- meer three-year proj ccent rettim? The 17 percent project may se did not immediately reinvest its pro ‘year project. oe Some businesses If a firm is maximizing profits, does if select a ym or a five-year project with 217 per rin greater total profits ifthe fim and profits. : usinesses do not earry ot 3. It Overlooks Quality Aspects of Furre Activites eet Oey wae wetivites BoTely wilh of Fae rieving the higest posible pots ih of sales and are will hhave placed a high value on the £70“Be Wealth, with wealth defined 2s the Met present Ne veRveW CRMC to accep lone profits in ote to gain the stability provided by 3 26 vol- ing ere, Onhe businesses recognize tat diversifying thes aces ite Uiferent products or markets strengthens the firm, even thoxeB i My FS=T ghossterm declines in profits. OB ' portion of their pr chieve soci feayr Ics widely obseried | that nonprofit factors jon of corporate goals, even in firms professing to maximize profits Aesiization of Wet ‘The second frequently encountered objective ofa fem i.10. value of th x the long rin. This goa! may aso be stated as the Sf efi aeeen directly on profits, this gosl emphasizes the impact of prs oF the current aa Cae i Finn's scutes, notably is common stook. Natural ere fsa rari fan between the presen worth of a firm ad its value ovet the lo Pt Iethe Soe be Highly valuable in te foreseeable tue, it has @ high curent value. “The reverse would be true fora firm with poor prospects. Coat uation of-westh objective is inked to the longterm pei of the fra A simple ealeutation hat Finks curent value wits long-termyprofts is given in Figure 1-2. 3 “aan example, if a firm expects @ net income after fares of $150,000 per year for many yeas, the firm would have a present wor of SI million to a Per ee ite was considering purchasing the frm and who desires © 15 percent ae ie money invested (6150,000/.15 = St milfior) TE the fim expected 2 rosoe0 profi each year, we would expect the firm to havea ghee present value By applying the formula, we can see that the firm's present worth would increase 10 $1.5 million ($225,000/.15). wximize-the Formula Net tocome os = Fine where CSeax = carent market ofthe firm's common Stock expresied in dallas, Aanoudl net income alter taxes forecast for the frm over the fog term, EtRtnieg = expecta return thats required by Investor Pafate they wil purchase and hold the Bern's ‘common stock. Netincome = FICURE 1-2 Current valu of common stack of afr sepressed 25 & ‘neton of future earrings and required rotum enTHE FOUNDATION Tun value is affected by the firm's growth, the amount of risk acceptable to tors, the market pric siideling, afi Example: The Arden Company has 12 million shares of common stock out. standing. Its net income after taxes is $54 million, and this level should co’. tinue indefinitely. Investors who purchaie Arden stock require a 125 percent return on their investment. What is the total value of Arden’s common stock? the value on a per share basis? Answer: $432 million at $36 per share as follows: '54,000,000/.125 = $432,000,000 ‘market price per share = 432,000,000/12,000,000 = $36 Maximization of wealth implies other Factors in addition to profits. Long: Of the stock, and the cash dividends paid. As a general that is maximizing weatth must do the following: J. Avoid High Levels of Rist. Ia im is taking a long-term perspective on its business operations, it must avoid unnecessary or high levels of risk. Projects that promise exceptionally high’ profits with relatively high degrees of risk aie Rot accepted. Accepting these projects over the long run means that single _Muajor failure might jeopardize the firm's coninued operation, Pay Divi lends are payments from the firm to the stockholders, who 4 Sown the firm. Dividends must be consistent with both the firm’s and stockhold- cers’ needs. During the fim's eal, high-growth years, dividends may be small ‘or may take the form of stock to allow the conservation of cash. As the firm . feaches maturity and needs to etn Jess cath to finance expansion, i wll be able to pay out a larger shar of profits as dividends. By paying consistent, re sonable dividends, the fr helps attract investors seek cash income, which npn be nak vali te Sock ‘Seek Growin, As a firm iereass sales and develops new markets fr pede, i protects self against a barnes setback that might dive it from the atk place. A larg i the finn againal exon ‘Maintain Market Price of Stock, The value ofthe firm's common stock in the maiketplace isa mater of primary concem to a management pursuing a goal of ‘wealth maximization: lis the price ofthe common stock that is, in effet, being ‘maximized. A company’s management can take a number of positive steps to ‘maintain the market price of the stock at reasonable levels. By taking time to explain company actions, the managers can encourage Tividuals to invest in the firm, thus creating the fir wi or fel ke and othe aetioas can Kelp to draw attention to the firm and keep the present worth of its stoek a high levels; ——Money market and Capital market The key two financial markets are the money market and the capital market. Money Market: The money market is a market for short term funds having maturities of one year or less. This market is created by a financial relationship between suppliers and demanders of short term funds which have maturities of one year or less. Treasury bills, commercial papers, negotiable CDs are traded in this market. This market exists'becduse investors (i and financial institutions) have temporarily idle funds that they wish to place in short term interest earning instrument. At the same time, other Entities /organizations find themselves in need of seasonal/temporary financing," ‘The money market brings together these suppliers and demanders of short term . individuals, business entities, government fiquid funds. Capital Market: The capital market is the market for long term funds. The capital market is a financial relationship created by a number of. institutions and arrangements that allows suppliers and demanders of long term funds with maturities exceeding one year to make transactions. Examples of these types of Securities are ordinary shares, preference shares, bonds or debentures and Convertible securities. ‘The backbone of the capital market is formed by the various securities exchanges that provide a forum for equity and debt transactions. Stock Exchange Stock exchanges are organized physical market places established specially for the buying and selling of securities, such as shares and bonds, According to Securities Contract Act 1956, “Stock Exchange is an association, organization, or body of individuals whether incorporated or established for the Purpose of assisting, regulating and controlling business in selling and dealing in Securities.” Itis the only recognized market for buying and selling of shares and bonds Im this market shares, bonds or debentures of government, nongovernment andregistered public companies are traded. For being traded in a stock exchange, shares or bonds must be listed with stock exchange i.. only the securities of listed companies are traded here. A security can be listed if it fulfills the listing requirements of the Stock Exchange. Generally a stock exchange is established as a company of limited liabilities. But it can not operate any business for its own name. Only it provides co-operation to its members to operate business. The persons or institutions involved with trading of securities must be members of stock exchange. Characteristics of a Stock Exchange ° There are some distinctive characteristics of stock exchange in its definition. They are as follows: 1, Stock exchange is an organized market. Share, stock, debenture etc. of different companies are transacted here. 2. For trading of the securities, some laws and regulations must be followed. 3. Stock exchange is registered as limited company i.e. its liabilities are limited by share values. But it cannot trade securities for his own name, trading is made for the name its members. 4. There is a board of directors or executive committee for operating and regulating the stock exchange. 5. No one can transact directly in this market, Only the registered members of stock exchange can trade the listed securities here. 6. Stock exchange has a physical platform where the members come together regularly. 7. Transactions must be made in this market within the transaction time period.! | | Difference between Primary market and Secondary market The capital market comprises of (1) primary market/new issue market [Initial Public Offering (IPO) market] and (2) secondary market/stock market (stock/security exchange). The differences between primary market and secondary market are presented below: Primary market - Secondary market 1. Primary market relates to the issue of new securities by business firms to raise new funds i.e. securities are offered to the public for the first time. 2. This marker is the first stage where the securities are acquired from the issuing companies, 3. Primary market provides funds to the issuing companies either for starting a new business or for the expansion or diversion of the existing one, and therefore, its contribution to the company financing is direct, w 4. Transaction of each issue happens once in primary market, 5. Primary market is not rooted in any particular spot and has no geographical existence. 6. This market has not any administrative or organizational set up. 7. Offering of securities may be made in two ways: (i) Direct/ private placement: A share or bond issue may be placed directly with the individuals or company who will own the securities. (ii) Underwritten placement: An offering may be made through an investment banker, who acts as the middleman between the issuer and the public. L = — ‘Secondary markets relate to the trading of already outstanding securities among investors. 2. This market is the secondistage where the securities are purchased and ‘sold continuously among the investors without any involvement of the issuing companies, 3. Secondary markets provide only institutional facilities for the continuous Purchase and sale of securities. Thus their role to company financing is indirect. 4. Transaction of the security happens again and again in this market. 5. Secondary markets have physical existence and are located in a particular geographical area. 6. Secondary markets/ stock exchanges have an administrative or organizational setup. 7. The trading of outstanding securities is aided by dealers and brokers in this market. Dealers act as principals and buy securities for their own accounts. They sell securities from their own inventories. Brokers act as agents for others and receive a commission for assisting a transaction.