Imagination is more important than Knowledge.

Knowledge is limited, Imagination encircles the world.

…..Albert Einstein

Thought of the day

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Financial Management
Course Code: SL FI 501

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Introduction to Financial Management
• If you decide to start your own business
• What will you require?

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 Introduction to Financial Management
For the purpose of starting any new business, an entrepreneur goes through the
following stages
Stage 1 Stage 2 Stage 3 Stage 4

Decide which assets Determining what is total Apart from buying assets The next stage is to
(premises, machinery, investment (since assets the entrepreneur would decide what all sources,
equipment etc) to buy. cost money)required for also need to determine does the entrepreneur
buying assets. how much cash he would need to tap to finance
need to run the daily the total investment
operations (payment for (assets and working
raw material, salaries, capital). The sources
wages etc.). In other could be Share Capital
words this is also defined (Including Entrepreneur’s
as Working Capital own funds) or Borrowing
requirement. from Banks or
Investment from Financial
Institutions etc.
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Meaning of Financial Management
• Financial management is
that managerial activity
which is concerned with
planning and controlling of
the firm’s financial resources.

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Functional view of Organization

R & Production
D Finance

Purchase Firm Personnel

Marketing IT
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Stakeholders` view of Organization
Government

Shareholders Lenders

Regulators
Firm Suppliers

Society Employees

Customers

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FINANCIAL DECISIONS FOR THE FIRM
Financial decision‐making involves procurement of funds and their
optimal utilization through:
• Investment
• Financing
• Dividend and
• Working capital decisions

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INVESTMENT DECISIONS
• Aim at selecting the most productive avenues that maximize the
Return on Investment(ROI).
Examples include:
• Expansion
• Modernization and replacement
• R&D expenditure.
Also referred to as Capital Budgeting decisions
> Critical for long‐term survival and growth
> Huge outlay and Irreversible

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FINANCING DECISIONS
• These are also referred to as Capital Structure decisions.
The main issues involved are:
• Where from to procure the requisite funds?
• What should be the optimal mix of various sources of capital?
• How much should be the proportion of short‐term and long‐term
funds?

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DIVIDEND DECISIONS
• Are mainly concerned with deciding the mix of profits to be
distributed as dividends and those to be ploughed back for future
financing needs of business.
• Depend on trade off between future financing needs of the firm and
current consumption requirements of the shareholders.
• Generally, firms in sectors with a high‐growth rate follow a policy of
high retention and low payout.

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WORKING CAPITAL DECISIONS
• Are concerned with the management of current assets.
The two key decision points in working capital management are:
• Level of investment in current assets
• Financing of current assets.

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KEY ISSUES IN FINANCIAL DECISION-MAKING

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INTEGRATED VIEW OF FINANCE DECISION-
MAKING
• The four key decision areas in finance are the part of an integrated
decision making framework in finance.
• They are directly linked and reinforce each other.
• All the decisions have a common objective function Shareholders’
Wealth Maximization.

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Scope of Financial Management

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Objectives of Financial Management:
Which one should be the objective??

• Profit Maximization
or
• Shareholders Wealth Maximization

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Objectives of Financial Management:

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Objectives of Financial Management
• The goal of wealth maximization is the widely accepted goal of the
business.
• It reconciles the varied, often conflicting, interest of the stakeholders.
• It is free from the limitations that other objectives are faced with.

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Interface of Financial Management with
Other Functional Areas

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Evolution of Financial Management
• The evolution of financial management is divided into three phases.
Financial Management evolved as a separate field of study at the beginning
of the century. The three stages of its evolution are:
• The Traditional Phase: During this phase, financial management was
considered necessary only during occasional events such as takeovers,
mergers, expansion, liquidation, etc.
• The Transitional Phase: The general problems related to funds analysis,
planning and control were given more attention in this phase.
• The Modern Phase: It is important to carry out financial analysis for a
company. During this phase, many theories have been developed regarding
efficient markets, capital budgeting, option pricing, valuation models and
also in several other important fields in financial management.

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AGENCY PROBLEM
• While there are compelling reasons for separation of ownership
and management, a separated structure leads to a possible
conflict of interest between managers and shareholders.
• The lack of perfect alignment between the interests of managers
and shareholders results in the agency problem.
• To mitigate the agency problem, effective monitoring has to be
done and appropriate incentives have to be offered.

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Organisation of Finance Function

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Success requires no explanation,
Failure permits no alibi

Thought of the day

Review of Lecture
• Which One out of the four Financial Decisions is Short Term Decision?
• Financing Decision….Is it Correct Answer or NOT???
Review of Lecture
• What is Dividend?

• What is meant by Shareholder`s Wealth Maximisation?

Financial Markets

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What is Financial Market?
• A financial market is a market for creation and exchange of financial
assets.
• If you buy or sell financial assets, you will participate in financial
markets in some way or another.

• Have you ever participated in financial market???

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Functions of Financial Markets
• Facilitate price discovery
• Provide liquidity
• Reduce the cost of transacting

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Classification of Financial Markets

Nature of Maturity of Seasoning of Timing of Organizational

Claim Claim Claim Delivery Structure

Exchange
Debt Money Primary Cash/Spot
Traded
Market Market Market market
Market

Forward Over-the-
Equity Capital Secondary
or Future counter
Market Market Market
Market Market

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Overview of Financial Markets

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Money Market Meaning
• A money market is a segment of the financial market in which financial
instruments with high liquidity and very short maturities are traded.

• The money market is used by participants as a means for borrowing and lending
in the short term, from several days to just under a year.

• It is a market for overnight short-term funds and instruments having a maturity

period of one or less than one year.

• It is not a place (like the Stock market), but an activity conducted by

telephone/auctioning.
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 The Players
• Reserve Bank of India

• Commercial Banks, Co-operative Banks and Primary Dealers are allowed to

borrow and lend.

• Specified All-India Financial Institutions, Mutual Funds, and certain

specified entities are allowed to access to Call/Notice money market only
as lenders .

• Firms, companies, corporate bodies, trusts and institutions can purchase

the treasury bills, commercial papers and certificate of deposits.

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The Products of Money Market
 Treasury Bills
 Commercial Paper (CP)
 Certificate of Deposit (CD)
 Call Money Market

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Treasury Bills
• Treasury bills or T-bills, which are money market instruments, are
short term debt instruments issued by the Government of India.
• Presently issued in three tenors, namely, 91 days, 182 days and 364
days.
• Treasury bills are zero coupon securities and pay no interest.
• They are issued at a discount and redeemed at the face value at
maturity.
• For example, a 91 day Treasury bill of Rs.100/( face value) may be
issued at say Rs. 98.20, that is, at a discount of say, Rs.1.80 and would
be redeemed at the face value of Rs.100/ implying annual interest
cost of 7.25% [(1.8 x /98.2) x (360/91)]
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Features of T bills
• They are negotiable securities .
• They are highly liquid instruments.
• There is absence of default risk.
• They have assured yield , low transaction cost and eligible for
inclusion in SLR(Statutory Liquidity Ratio) to be maintained by banks.

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 Commercial Paper
• Commercial paper can be defined as a short term, unsecured promissory
notes which are issued at discount to face value by well known companies
that are financially strong and enjoy a high credit rating.
• The basic purpose of CP is to meet working capital requirements of
companies.
• They are unsecured instruments as they are not backed by any assets of
the company which is issuing the commercial paper.
• It helps the highly rated company in the sense they can get cheaper funds
from commercial paper rather than borrowing from the banks.
• CP can be issued for maturities between a minimum of 7 days and a
maximum up to one year from the date of issue.

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Certificate of Deposit
• CDs are unsecured, negotiable short term instruments in bearer form issued by
commercial banks and DFIs.
• CDs are short-term borrowings having a maturity of not less than 7days up to a
maximum of one year. For FIs not less than 1 year up to a maximum of 3 years
• They are like bank term deposits accounts.
• Unlike traditional term time deposits these are freely negotiable instruments and
are often referred to as Negotiable Certificate of Deposits.
• They can be issued to individuals, corporations, companies, trust, funds, etc.
• CDs are issued by banks during periods of tight liquidity and relatively high
interest rates..
• Banks resort to this method when deposit growth is slow but credit demand is
high.

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Call money market
 Call money market is a market for uncollateralized lending and
borrowing of funds.
 This market is predominantly overnight and is open for participation
only to scheduled commercial banks and the primary dealers.

Banks borrow in this market for the following purpose :

• To fill the gaps or temporary mismatches in funds.
• To meet the CRR & SLR mandatory requirements as stipulated by the
Central bank.
• To meet sudden demand for funds arising out of large outflows.

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Participants in Call Money Market
• Scheduled Commercial banks
• Foreign banks
• State, district and urban cooperative banks
• Mutual funds
• Insurance Companies
• Brokers and primary dealers

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Discount And Finance House of India
• DFHI was set up in March 1988 by Reserve Bank of India jointly with
public sector banks and all India Financial Institutions to develop the
money market and to provide liquidity to money market instruments.
• To even out the liquidity imbalances in the banking system i.e. to
balance the demand with the supply for short term finance in the
money market.
• To promote secondary market in short term money market
instruments.
• Commercials bill discounting

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Government Securities
• A Government security is a tradable instrument issued by the Central
Government or the State Governments. It acknowledges the Government’s
debt obligation. Such securities are short term (usually called treasury bills,
with original maturities of less than one year) or long term (usually called
Government bonds or dated securities with original maturity of one year or
more).
• In India, the Central Government issues both, treasury bills and bonds or
dated securities while the State Governments issue only bonds or dated
securities, which are called the State Development Loans (SDLs).
• Government securities carry practically no risk of default and, hence, are
called risk free gilt-edged instruments.

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How and in what form can Government
Securities be held?
• Government securities may be held by investors either as physical
stock or in dematerialized form.
• From May 20, 2002, it is mandatory for all the RBI regulated entities
to hold and transact in Government securities only in dematerialized
form.

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How does the trading in Government
securities take place?
• There is an active secondary market in Government securities. The
securities can be bought / sold in the secondary market through
(i) Over the Counter (OTC) or
(ii) through the Negotiated Dealing System (NDS) means bidding or
(iii) stock exchange

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Why should one invest in Government securities?
• Besides providing a return in the form of coupons (interest), Government
securities offer the maximum safety as they carry the Sovereign’s
commitment for payment of interest and repayment of principal.
• They can be held in book entry, i.e., dematerialized/ scripless form, thus,
obviating the need for safekeeping.
• Government securities are available in a wide range of maturities from 91
days to as long as 30 years to suit the duration of a bank's liabilities.
• Government securities can be sold easily in the secondary market to meet
cash requirements.
• Government securities can also be used as collateral to borrow funds in the
repo market.

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 Capital Market

Primary Market Secondary Market

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Derivatives Market
• The derivatives market is the financial market for derivatives, financial
instruments like futures contracts or options, which are derived from
other forms of assets.

The market can be divided into

• Exchange-traded derivatives and
• Over-the-counter derivatives.

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Derivatives
• Forwards
• Futures
• Options

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International Capital Market
• ADRs
• GDRs

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