BBC406 Fundamentals of

Finance
Week 1

Week 1
Part 2

Learning Objectives
At the end of this chapter, you should be able to:
Identify the basic forms of business in Malaysia
and explain the respective strengths and
weaknesses
Identify, describe and explain the various financial
statements that businesses produce
Prepare simple financial statements of a firm
Show an appreciation of the makeup of financial
markets in Malaysia
Distinguish between primary and secondary
markets

Forms of Business
Sole Proprietorship
Partnership
Company (Firm)

Sole Proprietorship
Owned by a single person
Owner has title to the business assets, and all of the
business liabilities as well.
No limitation as to the amount of gains and losses
that the owner shall be entitled or liable to.
Owner is entitled to all of the business profits, and yet
must absorb any and all losses that may arise.

Sole Proprietorship (cont.)

Advantages:
No legal requirements other than the need to register
the business with the Registrar of Business
Cheapest form of business
Business incurs no corporation or income tax tax
liability borne by the individual owner
Life of business depends on the life of the owner
(ceases upon death of the owner) or at the choice of
the owner

Sole Proprietorship (cont.)

Disadvantages:
Funds in business limited to amount that the sole
proprietor has personally
Sole proprietor has unlimited liability for business
debts and liabilities.
No distinction and separation is made between
business and personal assets
Creditors may claim the sole proprietors personal
assets when the business assets cannot pay the
creditors.

Partnership

Coming together (association) of two or

more individuals for a common purpose to
operate a business together for profit.

Two subcategories of partnership:

i.

General partnerships

ii. Limited liability partnerships

General Partnerships
All partners agree to provide an agreed portion of funding and work
contribution into the joint business.
To share in the resulting profits and losses, on a pre-agreed profit
sharing ratio
Each partner shall be liable, jointly and severally, for the losses
incurred by the business.

Limited Liability Partnership

Liability of certain partners shall be limited (restricted) to
the amount of capital put in by the said partner into the
partnership.
However, there must exist at least one partner who is
not a limited liability partner.
Losses (and liabilities) incurred by the business that
cannot be met by the capital contributed by the partners
shall be borne by this non-limited liability partner(s).
Limited liability partners may not be allowed to
participate in the management and daily running of the
business.

Advantages of Partnerships
Inexpensive and easy to form.
Management control resides with the general partners.

Disadvantages of Partnerships
General partners have unlimited liability on all
debts incurred by the partnership (but contrast for
limited liability partnerships).
Partnership is terminated when one partner dies
or withdraws from the partnership arrangement.
It may be difficult to raise additional funding.
Equity contribution is limited to the partners
ability and desire to contribute funds to the
partnership.
Income from a partnership is taxed as personal
income of the partners.

Company (Firm)
Given its legal status by the Companies Act, 1965
Subject to the laws as set out in the Act, for which a company must be
incorporated with the Registrar of Companies, under Companies
Commission of Malaysia
Must have a Memorandum and Articles of Association (M&A)
Separation of ownership and control

Advantages of Having a
Company (Firm)
Ownership can be transferred by way of transfer of shares from one
shareholder to another.
Companies can have unlimited life.
Shareholders liability limited to the amount invested in the company.
Easier for a company to raise additional funding from external
providers of finance (e.g. bank)

Disadvantages of Having a
Company (Firm)
Annual accounts would have to be prepared
responsibility of the directors of the company
Accounts of the company would have to be audited by
external auditors.
Filing of financial statements and annual returns must be
made with the Registrar of Companies every year.
Annual and extraordinary general meetings must be
conducted.
At least two directors must be appointed
Is subject to corporation tax

Financial Statements of a
Company
Income Statementpresents the revenues and
expenses, and resulting net income or loss of a
firm for a specified financial period
Statement of Financial Positionreports the
assets, liabilities and shareholders equity of a
firm as at a specific date
Statement of Cash Flowssummarizes the
information concerning the cash inflows
(receipts) and outflows (payments) for a
specified financial period

Income Statement

Statement of Financial Position

Statement of Cash Flows

Financial Markets
Perform the important economic function of
channelling funds from the providers (households,
other firms and government) that have surplus funds
to those who have a shortage of funds (and hence,
require funds).
Financial markets bring these two groups together:
a) Providers
b) Users of finance

Financial Markets (cont.)

The roles of financial markets include:
Facilitation of savings by individuals by allowing them
to consume less today (savings) to be able to
consume more in the future
Platform to raise financing by the users (firms) of
finance
Channel whereby demand for and supply of funds can
interact and arrive at a suitable market price for funds
Provision of financial services that allow participants to
work out and balance their risk tolerance and expected
returns

Debt vs. Equity Securities

Debt securitiescontractual obligations by the firm to
repay borrowings, in the form of interest and principle
Equity securitiescomprise of ordinary and preferred
shares; represents non-contractual claims by the
holders of this type of security on the firms residual
cash flows after having settled with the debt holders

Primary vs. Secondary

Markets
Primary marketsfunds are raised from providers of finance by
firms that require such funds
Firms issue shares and debt instruments (bonds or loan stock) to
providers of finance.
Secondary marketsinvestors (providers of finance) buy and sell
shares, bonds, loan stocks and so on

Money Markets
Markets for debt securities that will be repaid in the short
term (< one year)
Relates to a group of loosely connected markets, e.g.
dealer markets
Main player in the role as dealer is the banks; particularly
active in this market, both as lenders and borrowers
Large firms lend when they have surplus cash (invest in
Certificate of Deposits, Commercial Paper, Treasury
Securities, Bankers Acceptances, etc.) and borrow when
they are short of money

Capital Markets
Markets for long-term debt (i.e. debt securities that will be repaid after
more than one year) and equity

Capital Markets (cont.)

Long-term debt
Bonds, debentures or loan stocks
Term loan
Leasing
Industrial hire purchase
Contractual (legal) obligation to repay borrowings
Interests and principle

Equity
Shares are equity in a firm
Represents ownership
Residual interest in a firmshareholders can only
claim on their share of earnings and assets of a firm
after the distribution of earnings or assets has been
made to other claimants (debt holders)
Shareholders have dividend rights, voting rights,
liquidation and pre-emptive rights.

Primary Market
Used when firms (and government) first issue
securities for funds
Firms engage into two types of primary market
activitiespublic offerings and private placements
Public offeringsissue of debt/equity securities to
the public at large
Publish prospectuses and advertise in national
newspapers, calling for subscriptions for the
securities by the public

Primary Market (cont.)

Issues underwritten by merchant banks, stockbroking companies or
investment banks
Firms concerned would have to be listed with Bursa Malaysia
Private placementsfirms may issue debt or equity to certain
parties (and not to the public at large) after having undertaken private
discussions and negotiations
Providers of finance under this category include pension funds,
insurance firms, banks and selected individual investors.

Secondary Markets
Holder of a security sells the security concerned to another investor
Provide the means for transferring ownership of a security
(debt/equity)

Derivative Markets
Financial instrument that is derived from other financial securities
or some other underlying asset
Examples of derivatives are forwards, futures, options and
swaps.

Derivative Markets (cont.)

Forward contractagreement to buy or sell an
underlying asset at some time in the future, at a
price agreed upon today
Tailor-made to suit the participants or investors
requirement
Futuresagreement by the investors or
participants to deliver or take delivery (buy or sell)
an underlying asset some time in the future at a
price agreed upon today
Futures are standardized contracts and are
typically traded through an exchange.

Forward vs Futures
Forward contracts can be customized to fit a
customer's requirements, while futures
contracts have standardized features in terms
of their contract size and maturity.
The lack of standard features means that
forward contracts seldom trade on exchanges,
whereas futures contracts are generally
exchange-listed.
Since forward contracts generally tend to be
large in size, the forward market is dominated
by financial institutions, government bodies
and large corporations.

Derivative Markets (cont.)

Option gives the holder the right but not the obligation, to buy or
sell a fixed quantity of asset, at a pre-specified price, on or before
a fixed future expiry date.
A call option gives the holder the right to buy an asset whereas;
A put option gives the holder the right to sell an asset.

Derivative Markets (cont.)

Swapagreement to exchange a series of payments
sometime in the future
Fixed-for-floating interest rate swap one party pays fixed
interest and receive floating interest, whereas the other party
would be the one to pay floating interest and receive fixed
interest
Currency swap
Commodity swap
Credit default swap
Subordinated risk swaps