Financial Management

This is only a summary. Please read the text and readings given for details. Removal of errors and omissions, if any, in this ppt is your responsibility.

Books and Resources

Principles of Corporate Finance by Brealey & Myers Global Edition 10e Also refer to Corporate Finance by Aswath Damodaran

Corporate Finance by Ross, Westerfield and Jaffe

Financial Management by I.M. Pandey

Books and Resources

A regular finance daily viz, ET, BS, FE, FT, WSJ

A professional journal like Journal of Applied Corporate Finance, Financial Analysts Journal or McKinsey Quarterly (online edition available)

Field of Finance
Corporate Finance Investment Banking Commercial Banking Financial Services Behavioural Finance

Development of Finance
Economists were long aware of the credit markets especially as a way of allocating resources over time. Developed into a field of its own over time and specific applications

Key Contributors.

Eugene Fama

Harry Markowitz

Merton Miller

Robert Merton

Fisher Black

William Sharpe

Key Contributors.

Maurice Allais

Daniel Kanheman

Amos Tversky

Al Roth

Loyld Shapley

Richard Thaler
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What is Financial Management

Financing decision choosing where to get funds

Investment decision choosing how to use funds

Goals of a Firm
Three major decisions What projects to undertake (real investment and capital budgeting) How do you finance these projects (debt, equity) How should the firm distribute the cash generated by these projects (Dividend policy) All these decisions are to enhance the value of the firm
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Goals of a Firm
Is shareholder value maximization an appropriate measure or goal What about other constituents or stakeholders are they being ignored Various opinions, ideas, and perspectives.

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Goals of a Firm
Generally

Shareholders are the only stakeholders who simultaneously maximize everyones claims in seeking to maximize their own..

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Ownerships Vs. Control

In a corporation ownership and control are separate leading to the classic Agency Problem Information asymmetry, especially in a world of uncertainty and risk

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Ownerships Vs. Control

Specifically, managers may not always act in the best interest of the shareholders/owners of the corporation Insufficient effort by managers Unnecessary investment or expansion

Entrenchment strategies
Lack of transparency Self-dealing Short-term vs. long-term focus Inflated and unusual compensation package
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Ownerships Vs. Control

Potential solutions, although imperfect are through both internal and external control and monitoring Internal Control Mechanism Monitoring of the Management (e.g., by BoD) Periodic reporting and transparency Effective and independent Board of Directors External Control Mechanism Market Competition External Auditors Rating Agencies and Analysts Regulatory bodies
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This Course
Financial Markets Valuation of Real Assets Valuation of Financial Assets (including risk-return tradeoff and Cost of Capital)

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Main Principles
Time Value of money Risk-Return tradeoff Gains to diversification

No arbitrage

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Financial Markets
Financial markets allows people to easily buy and sell financial securities, and commodities at low transaction costs and at market-based prices Financial markets facilitate raising capital, transferring risk and international trade Financial markets bring borrowers and lenders together and improve the market liquidity With globalization world financial markets are interlinked and affect each other
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Financial Markets
In India there is financial dualism formal and informal market Formal Organized and regulated (Banks, RBI, MoF, SEBI) Subject to interest rate bands and regulation Usually inflexible credit structure Relatively high transaction cost (not just monetary, includes intangible search costs)

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Financial Markets
Informal Unorganized and non-regulated Flexible and need-based Relatively low transaction cost Presumed to have high probability of default Interest rates are very high Examples: traditional money lender, pawn shop, store credit based on knowing each other, usually rural and caters to the credit-deprived With liberalization, planned growth and regulation, banking services have spread to the rural areas and increased the scope of the formal sector
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Financial Markets
The financial markets can be divided in several ways (relies on an underlying security) Capital markets (providing long-term financing) Money markets (short-term financing and investments) Forex (Foreign exchange) Derivatives Capital markets can be either primary or secondary Equity and Debt Other markets Futures, Insurance,
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Financial Markets
Primary market (generally for new issues) Equity offered to exiting shareholders is Rights Offering When equity is offered to select entities it is a Private Placement When anyone can subscribe to the issue it is Public Offer

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Financial Markets
Secondary Market Market for previously issued securities Generally, the issuing firm is not affected by the trading of the securities

A security can trade any number of times

Much larger than the primary market Transaction takes place in the listed exchanges

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Financial Instruments
Financial instruments are Evidence of an ownership interest in an entity an asset Marketable and traded in organized markets Can be held by individuals (or firms) in a portfolio for risk diversification Links borrowers and lenders

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Financial Instruments
Firms have a choice of raising capital for financing primarily using Debt or Equity Within each there is a variety of offerings and the choice of a specific instrument (vehicle) is firm specific and based on economic conditions Financial innovation has led to the growth of various hybrid instruments i.e. having some features of debt and some of equity. E.g. Convertible bonds, Preferred stock, Debentures
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Financial Instruments
Equity - ownership capital, right to control firm, risky, residual claimant Debt borrowing under terms of contract

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Financial Instruments
Difference between debt and equity lies in the nature of the claims to the firms cash flows
Debt has a claim to a contracted set of cash flows for both the interest and principal while Equity is the residual claimant (more risky) In the event of liquidation, debt has earlier claim to the cash flows vs. equity Tax treatment differential Debt is for a contracted period of time while equity has infinite life Equity has control over a firms management
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Financial Instruments
Debentures Similar to promissory notes Relationship with firm like a lender-borrower (debt) Can have various features convertible, non-convertible, partially convertible, or optionally convertible Can be secured or unsecured Can be floating or fixed interest rate

Examples Shriram Transport Finance Company, one of the largest asset financing NBFCs in India, plans to enter the debt capital market on October 7, 2013 with a public issue of Secured Redeemable Non-Convertible Debentures (NCDs) of face value of Rs.1,000 each. August 2012 saw back-to-back non-convertible debenture (NCD) issues from India Infoline Investment Services, Shriram City Union Finance, Mannapuram Finance and Muthoot Finance, with a fixed interest rate ranging between 11.5% and 12.25% Religare Finvest issued an NCD in Sep 2012
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Financial Instruments
Preference shares are a hybrid form of instruments They resemble equity share as well as debentures Resemblances to equity share Dividend payable from distributable profits No obligation on the firm to preference dividend Resemblances to a debenture Rate of dividend fixed Preference shareholders enjoy priority or preference over equity holders
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Financial Instruments
Key features of Preference shares Accumulation of dividends Callability Convertibility

Redeemability
Participation in excess profits

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Market Index
Stock market indices are akin to barometers A picture of how the market as a whole has fared Is a very directional indicator of the consumer perception or economic sentiment

Stock market indicators like Sensex and Nifty are nothing but weighted average index numbers
The Dow Jones Industrial Average (DJIA) comprises of a set of firms a few years ago, it dropped one of the firms which one, why?
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Market Index
Some index have multiple versions depending on the weighting, how dividends are accounted for Global index includes companies w/o regard to the country in which they are traded Some index are for specialized sectors or industry Recently, ethical index, sustainability index, environment index, CSR index and several such have cropped up

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Market Index
Various weighting schemes

Price weighted Nikkei 225, DJIA

Capitalization weighted Sensex, Nifty, S&P 500 Equally weighted indices A version of the Ryder S&P (tracks the S&P 500), Kansas Board of Trade

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IPO Book Building

For example Assume a company comes with a public issue of 3000 shares with a price band of Rs 50 60 and received five bids as shown below:
Bid quantity 500 1000 1500 2000 2500 Bid price 60 59 58 57 50
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IPO Book Building

The cumulative demand for the shares of the company at various prices are as shown below:
Cum. Qty.
Subscription

(%)

500 1500

16.67 50.00

3000
5000

100.00
166.67

7500

250.00
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IPO Book Building

The highest price at which the issuer is able to issue the desired number of shares is the price at which the book cuts off i.e. Rs 58 in the earlier example The issuer in consultation with the BRLMs, will finalize the issue price at or below the cut off price, i.e., at or below Rs. 58 All bids at or above this issue price and cut-off bids are valid bids and are considered for allocation in the respective categories
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Future Sessions
Time Value of Money

Capital Budgeting Techniques

Investment Decision and Estimating Cash Flow Valuation of Securities Risk & Return (CAPM) Cost of Capital

Options (depending on time available)

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Thank you!

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