Introduction to Finance

and Banking

Course Code: 2302

A H M Noman Bin Alam

Cell# 01678-117393
E-mail- kosiralam@yahoo.com
 Syllabus for Mid-Term
Course Contents
For Mid Term
1. An overview of financial management and its environment (Ch 1)
What is Finance, financial and capital budgeting decision, and financial assets vs. real assets,
areas of finance, financial staffs’ responsibilities, corporate goals and Agency concept.

2. Financial Statements, Cash flows and taxes (Ch 2)

Financial statements and reports, balance sheet, income statement, statement of retained
earnings, cash flow and it’s statement, operating assets and capital, NOPAT, free cash flow,
corporate loss carry back carry forward.
Recommended Problems: ST-2, 2-(13 to 18)
Assignment: Problem 2-23

3. Analysis of Financial Statements (Ch 3)

Ratios: (liquidity, asset mgt, debt mgt, profitability, market value)-Definitions, implications,
uses and limitations.
Recommended Problems: ST-3, 3-(12 to 17, 19)
4. Time value of Money (Ch 7)
Time line, future value, present value, future and present value of ordinary annuity and
annuity due, perpetuities, uneven cash flow stream, other than annual compounding,
amortized loan.
Recommended Problems: ST-2, ST-3, 7-(1, 3, 5, 6, 7, 8, 11, 13—18, 20, 26—29)
 Basic Text:
Fundamentals of Financial Management,
Brigham,Eugene F., Houston, Joel F.,
10th Edition, Harcourt Asia PTE LTD 2006. (Required)

Reference books:
1. PRINCIPLES OF FINANCIAL MANAGEMENT, Gitman, Lawrence
J. Pearson Education Asia, 9th ed.
2. FUNDAMENTALS OF CORPORATE FINANCE, Rose Westerfield
fordan, Sixth edition
3. BANKING LAW AND PRACTICE, S.N. Maheshwari
 Finance
Latin “Finis” Finance
i.e., supplying or collection of money

Money and Finance are interrelated

In narrow sense_ Finance means procurement & make appropriate use of
money
In details_ Finance means planning about fund, provision, collection,
reserve, use and control.

So it can be defined as the science and art of

managing money
Its concerned with the process, institutions, markets and instruments
involved in the transfer of money among individuals, businesses and
governments.
 Why finance needs?
Finance is the life blood of all economic activities.
• Importance for individuals
Achieving personal goal as buying automobile,
house.
• Importance for Organization
No finance, no success
• Importance for Distribution of Economic
activities
“To have money to make money”
FOP_Land, Labor, Capital and entrepreneur
 Function of Finance
To ensure sufficient fund raising and proper utilization of fund every individual,
institution or government needs to perform many financial functions which are:
o Financial planning, here needs to consider purpose, amount, time,
importance and other relevant aspects.
o Identification of Sources, may be individual, F&F, Institution, other
external sources.
o Raising fund, needs to consider some principles, conditions, time frame.
o Investment of fund, analyze cost-benefit of many projects and invest fund
raised to that project which yields highest profitability.
o Protection of fund, needs to trade-off between risk and return to ensure
protection of fund.
o Distribution of profit, decision of retained earnings and dividend.
 What is Financial management?

• Financial management concerns the acquisition, financing, and

management of assets with a view to goal of the organization
• The ability to allocate financial resources in the areas which
generates the greatest returns
• Financial management deals with management of money matters.
• By Financial management we mean efficient use of economic
resources namely capital fund.
• Financial management is concerned with the managerial decisions
that result in the acquisition and financing of short term and long
tern credit for the firm.
In short, financial management deals with procurement of
funds and their effective utilization in business to achieve
business objective.
 Classification
. Finance

Private Public
Finance Finance

Non-
Personal Business
Business
Finance Finance
Finance
Corporate
Finance
State owned
business
Finance
Financing
autonomous
organization
 Organizational forms
Three major organizational forms:
 Proprietorship. (A business owned by an individual.)
 Partnership. (Proprietorships with more than one individual.)
 Corporation. (A legal entity where ownership is separated from management.)

Organizational Forms Advantages Disadvantages

Easily established. Unlimited Liability.

Proprietorship Tight control. Limited access to outside financing.
Not doubly taxed.
Easily established. Unlimited liability.
Partnership Tight control. Limited access to outside financing.
Not doubly taxed. Interpersonal problems.
Specialization of labor possible.

Limited liability. Owner has no control.

Corporation Unlimited life. Double taxation.
Good access to outside financing More difficult to establish
our Main area of concentration will be on the corporations because corporations
play an important role in our economy and stock price of a company serves as
a proxy for stockholders wealth
 Career opportunities in Finance

Finance consists of following inter-related

fields
 Money and capital markets _ deals with securities markets and
financial institutions
 Investments_ focus on decision made by individual and institutional
investors
 Financial Management_ involves decision within the firm

Career opportunities in each of the interrelated fields are wide

and varied but financial managers need to have a knowledge of all
three areas if they like to do well in their jobs.
 Money and capital
market
Consists of Banks, insurance companies,
mutual funds, investment banking firms.
Success depends on
 The knowledge valuation techniques, factors make interest rate up and
down, regulations and financial instruments.
 The knowledge of general administration as MGT. involves accounting,
sales, personnel, IT as well as financial management.
 Communication skill both verbal and written
 Investments
Functions are –
 Sales
 Analysis of individual securities
 Determination of optimal mix of securities for a given portfolio.

Finance graduates who go into investments may work for-

• Brokerage houses_ in sales or security analysis
• Banks, Mutual funds, insurance Co._ Mgt of investment portfolios
• Financial consulting firms_ advising individual investors
• Investment banks_ help businessmen for raising new capital
• Financial planners_ helps individuals in developing long-term financial
goals and port folios.
 Financial management
FM is important for in all types of businesses including-
• Banks, insurances as well as industrial and retail firms
• Government operations from school to hospital to highway depts.

Job opportunities in FM is most and broadest ranging from-

• Making decision for plant expansion to choosing types of securities to be issued to
finance expansion.
• Deciding credit terms under which customers may buy.
• Deciding level of inventories firm should carry.
• Deciding the volume of cash to be kept in hand and at banks.
• Deciding whether to acquire other firms or not.
• Deciding between retained earning and dividend.
 Financial Management Decisions
Investment Decision
Most important assets acquisition decisions are
• What is the optimal firm size?
• What specific assets should be acquired?
• What assets should be acquired or eliminated?
Financing Decision
Determine how assets will be financed
• What is the best type of financing?
• What is the best financing mix?
• How will the funds be physically acquired?
Divided decision
• What impact will have on share holder on dividend payment?
• What will be the dividend pay out ratio?
• What will be the optimum payout ratio?
• Whether cash divided or stock divided be paid?
Assets Management Decision
• How do we manage existing assets efficiently?
Financial manager has varying degrees of operating responsibilities on assets.
Greater emphasis on current assets management than fixed assets
GP Organogram CEO

Special Initiatives*
Senior Assistant to
CEO
TBA CHQ
Petter Russ

Public Relations
Syed Yamin Bakht Financial Services
Delwar Hossain Azad

Human Resources Cost Efficiency

Emad Ul Ameen Stein Naevdal

Climate Strategy
Corporate Affairs N K A Mobin
Khalid Hasan

Finance Networks Information Sales Marketing Customer

Md. Arif Al Md. Shafiqul Technology Laszlo Barta Rubaba Dowla Service
Islam Islam Frode Stoldal Arnfinn Groven

Director
Financial
Management
Raihan Shamsi Company Internal Audit
Secretary
Raihan Shamsi Farhad Ahmad
* Will evolve over time with projects/initiatives added and terminated
 Finance
Division
Chief Financial Officer (CFO)
Finance

Financial Planning Director

Financial Management

Treasury
Accounting

Investment Control Asset Management

SOA Compliance Revenue Accounting

Reporting
Supply Chain
Management

Tax & Regulatory

Capital Market

Financial Control
Business Support (
Commercial)
 The Financial Staff’s
Responsibilities
Financial staff’s task is to acquire and help operate
resources to
maximize the value of the firm. Here are some specific
activities:
1. Forecasting and planning: Interact and coordinate other
departments to shape firms future
2. Major investment and financing decision: To
increase turnover, investment is needed, so FS determine the optimum
sales growth and also decide how to finance those assets whether debt,
equity or both. If debt, short term or long term.
3. Coordinate and control: As all activities in the
organization has a financial implication, its financial staff’s responsibility to
interact with other departments to ensure efficient operation at best
possible level. e.g., Sales needs investment and investment needs
financing.
4. Dealing with financial Market: Money market and
Capital market for raising fund, selling stocks etc.
5. Risk Management: Risk is every where in the organization.
However risk can be reduced with insurance company or derivative
markets. Its FS’s responsibility to identify and manage the risk effectively
and efficiently.
 What is the Goal of the firm

Maximization of
Shareholder Wealth!

Value creation occurs when we maximize

the share price for current shareholders
Shortcomings of Alternative
Perspectives

Profit maximization
 Maximizing a firm’s earnings after taxes
Rationale of profit maximizing goal:
• Profit is the yardstick to measure efficiency
• Proper utilization of resources
• Social welfare
Criticism of profit maximization
 The concept is vague as profit is not defined clearly
 It ignores timing of profit and time value of money
 It ignores risk dimension of financial decision
 Shortcomings of alternative
perspectives

Earning per share maximization

 Maximizing earnings after dividend by
shares outstanding
Criticism of EPS maximization:
 Does not specify timing or duration of expected
returns.
 Ignores changes in the risk level of the firm.
 Calls for a zero payout dividend policy.
 Strengths of Shareholder wealth
maximization
Rationale of wealth maximization:
 Clear concept of wealth,
Takes accounts of
 Current and Future profits and EPS;
 The timing, duration, and risk of profit and EPS;
 Dividend policy and all other factors.
 Focus on market price of share
Thus, share price serves as a barometer for business
performance.
 Shareholder wealth
maximization
Shareholders wealth maximization means shareholders
utility maximization

If the firm acts to maximize stockholders’ wealth, then

individual shareholders can use this wealth to maximize
their own utility.

Stockholder’s current wealth = Number of shares owned * Current stock

price per share

In order to Maximize the By maximizing the

Maximize utility shareholder’s wealth current stock price
 What companies say about their
corporate goal
• The Coca-cola: ‘Our mission is to maximize share owner
value over time’
• Cadbury Schweppes: ‘Governing objective is growing
shareowners value’
• Credit Suisse Group: “ Achieve high customer
satisfaction, maximize shareholder value and be an
employer of choice”
• Dow Chemical Company: “Maximize long-term
shareholder value”
• ExxonMobil: “ Long-term, sustainable shareholder value”
 Constraints on Stockholders
wealth maximization
In order to maximize the stock price, financial managers
should
properly take into consider the following constrains in the
business environment.

Agency problem
Hostile takeover
Social responsibility
Business ethics
 Is maximizing stock price same as
maximizing profit?

Without doubt no,

There is a high correlation between EPS, Cash flow, and
stock price, and all will rise if sales rise.
But stock prices depend not just on today’s Earnings and
cash flow rather it depends on Future cash flow stream and
riskiness of firm’s assets.
Same action of a firm may stock prices and current
profit and vice versa
If a firm makes huge capital expenditure today, it may reduce
current profit but it will stock price, if the market
believes it will future earnings.
 Factors affecting stock
price
Stock prices depends on-
Managerial actions like-
• Investment decisions
• Financial decisions
• Dividend policy decisions

External factors like

• Legal constraints
• General level of economic activity
• Tax law
• Conditions of stock market

Managers can increase their stock prices by Expected

firm ’s cash flow, riskiness of firm’s assets
 The Modern Corporation

.
Board of directors

Shareholder
Debt holder
Management

Debts
Assets
Equity

Separation of ownership and

control
 Role of Management
Management acts as an agent for
the owners (Shareholders) of a firm.

An agent is an individual authorized

by another person, called principal,
to act in the latter’s behalf.
 Agency Problem
• Agency problems arise when there is a conflict between
the interests of the agents( e.g., the managers) and
those of the principal (e.g., Shareholders)
In a large corporation,
managers interests lie on the followings:
 Increase their job security as hostile is less likely
 Increase their own power, status, salaries
 Create more opportunities for their lower and middle level manager

Shareholders interest lies on

 Maximization of their wealth.
 Agency problem
• Agency relationship
-Principal hires an agent to represent their interest
-Stockholders (principals) hire managers (agents) to run the
company.
• Agency problem
-Conflict of interest between principals and agents
• Agency cost
-The cost that management needs to bear due to the agency
problem.
 Agency Theory
• Jensen and Meckling developed a theory of
the firm based on agency relationship
between agents and Principal of a firm.

• Agency Theory is a branch of economics

relating to the behavior of principals and their
agents.
 Agency Theory
Principals must provide incentives so
that management acts in the
principal’s best interest and then
monitor result.
• Incentives include stick options, perquisites and bonus.
• There is a markets for managerial talent, this may
provide market discipline for managers, they can be
replaced.
• If managers fail to maximize share price, they can be
replaced to hostile takeover.
Mechanisms to motivate managers to act
for stockholders best interest.
o Managerial compensation
( Higher salaries, bonus, LFA, perquisites, stock options etc)
 To attract and retain capable managers
 To align managers interest with stockholders interest
o Direct intervention by stockholder
Institutional investor can influence on firm’s operation by
 Acting as a lobbies
 Establishing proposal by voting on Annual Stockholders
meeting.
o The threat of firing
If the profitability of the firm decrease.
GP CEO- Arik Ass
Compaq Computer Corporation- CEO-Eckhard Pfeiffer
o Threat of takeover/ Hostile take over
If stock is undervalued due to poor performance of management.
In hostile takeover, Manager of acquired firm loss job or loss authority or
status
If you want to keep you job, don’t let your stock sell at a bargain
price
 Do the firms have any responsibility to
society at large?

Certainly. The firms have an ethical responsibility

To provide a safe working environment to its employees
To avoid polluting air and water
To produce high quality safe product and services at low operating cost
To protect national heritages
To increase standard of living
To increase efficiency
To develop new technology
To produce new product and new job

All are also essential for stock maximization. So stock maximization and social
well fare are not conflicting.
 Ethics in business
Firms should maintain ethical standard in all
types of business dealings.
There is a positive correlation between long-
run success and ethics.
Conflicts may rise between these two.
Managers should resolve all conflicts. Any
deviation may keep the firm to bankruptcy.
That is, there is no room for unethical
behavior in business.
 Financial Assets
Financial asset represents a financial claim on an asset that usually
documented by some form of legal formation.

Examples of various types of FAs-

1.Equity claim-direct_ represents ownership interest
Common stocks
Warrants_ right to buy common stock (convertible to one share) at a stated price in long term
options_ right to buy common stock(convertible to 100 shares) at a stated price in short term
2. Equity claim-indirect_ can be acquired through placing fund s in investment companies.
Investment company shares(Mutual fund)
Pension funds
Whole life insurance
3. Creditor Claim
Saving accounts
Money market funds
Commercial papers
Treasury , Municipal and corporate bills, notes, bonds
4. Preferred stock(Straight and convertible to common stock)
5. Commodity futures.
 Real Assets
A real asset represents an actual tangible asset that may be seen,
touched, felt, held, or collected.
Examples of various types RAs-
1. Real estate
Office buildings
Apartments
shopping centre

2.Precious metals
Gold
Silver

3. Precious gems
Diamonds
Rubies

4.Collectibles
Arts
coins stamps
rear books

5.Others
Cattle common, metals
 Social responsibility

• Should the firm behave ethically? Yes!

• Do the firms have any responsibility to the society at large?
Yes! Shareholders are also members of society.
• Does wealth maximization preclude the firm from being
socially responsible? No!
• Is maximizing stock price good for society, employees and
customers? Yes! Employment growth, Least priced quality
products and Corporate social works ensured with satisfying
wealth maximization goal of stock holders.

Firm answer the questions by producing both private and social

goods.