Financial Management & Objectives

1. Course Instructor: Md.Shahriar Parvez Lecturer MBA (Finance and Banking) BBA (Finance, Banking and Insurance) Financial Management & Objectives

2. “While humanity shares one planet, it is a planet on which there are two worlds, the world of the rich and the world of poor” SIR RAANAN WEITZ(1986) “The world has become a global financial village But the poorest 20% of the world’s people have benefited little from the increased globalization of economies” UNITED NATIONS, HUMAN DEVELOPMENT REPORT, 1995

3. Financial Management (economic viewpoint) • Microeconomics is concerned with the behaviour of individual firms and consumers or households. • Macroeconomics is concerned with the economy at large, and with the behaviour of large aggregates such as the national income, the money supply and the level of employment. • Macroeconomics policy can affect financial manager’s planning and decision-making in various ways for example via interest rate changes, which affect borrowing costs and required rates of return.

4. Economic policies and objectives • The policies pursued by a government may serve various objectives such as 1)Economic growth: Growth implies and increase in national income in real terms. 2)Control Price Inflation: This means achieving stable prices. Inflation is viewed as a problem as if a country has higher rate of inflation then its major trading partners, its exports will become relatively expensive. 3)Full Employment: Full employment does not mean that everyone who wants to a job has one all the time, but it does mean that unemployment levels are low and involuntary unemployment is short term.

5. Economic policies and objectives Balance of Payments: The wealth of a country relative to others a country’s creditworthiness as a borrower and the good will between countries in international relations might all depend on the achievement of an external trade balance over time. Deficits in external trade with imports exceeding exports might also be damaging for the prospects of economic growth.

6. Different Policy Tools • A) Monetary Policy: Monetary policy aims to influence monetary variable such as the rate of interest and the money supply in order to achieve targets set for employment, inflation, economic growth and the balance of payment. • B) Fiscal Policy: Fiscal policy involves using government spending and taxation in order to influence aggregate demand in the economy

7. Different Policy Tools • C) Prices and Incomes Policy: Some economists argue that inflation must be tackled directly through government controls over prices and incomes • D) Exchange Rate Policy: Economic objectives can be achieved through management of the exchange rate by the government. The strength or weakness of sterling’s value.

8. Different Policy Tools • External Trade Policy: A government might have a policy for promoting economic growth by stimulating exports. These policy tools are not mutually exclusive and a government might adopt a policy mix of monetary policy, fiscal policy, and exchange rate policy in an attempt to achieve its intermediate and ultimate economic objectives.

9. Types of financial markets • Physical assets market: Also called tangible or real asset market. • Financial assets market: Deal with financial derivatives • Money market: The financial markets in which funds are borrowed or loaned for short periods. • Capital market: The financial market for stocks and long-term debt. • Primary market: • Secondary market:

10. Types of financial markets • Spot market: The markets in which assets are bought or sold for “ on the spot” delivery. • Futures market: The markets in which participants agree today to buy or sell an asset at some future date • Public market: Markets in which standardized contracts are traded on organized exchanges. • Private market: Markets in which transactions are worked out directly between two parties.

11. How is capital transferred between savers and borrowers? • Direct transfers • Investment banking house • Financial intermediaries

12. Types of financial intermediaries • Commercial banks • Savings and loan associations • Mutual savings banks • Credit unions • Pension funds • Life insurance companies • Mutual funds

13. The Value of Money • Value of money is getting the best possible combination of services from the least resources, which means maximizing the benefits for the lowest possible cost. This is usually accepted as requiring the application of • Economy (spending money prudently) • Efficiency (getting out as much as possible for what goes in) • Effectiveness (getting done, by means of what was supposed to be done)

14. More Formally • Economy is attaining the appropriate quantity and quality of inputs at lowest cost to achieve a certain level of outputs • Efficiency is the relationship between inputs and outputs • Effectiveness is the extent to which declared objectives or goals are met.

15. The cost of money • The price, or cost, of debt capital is the interest rate. • The price, or cost, of equity capital is the required return. The required return investors expect is composed of compensation in the form of dividends and capital gains.

16. What four factors affect the cost of money? • Production opportunities: The returns available within an economy from investments in productive (cash-generating) assets. • Time preferences for consumption: the preferences of consumers for current consumption as opposed to saving for future consumption. • Risk: In a financial market context, the change that an investment will provide a low or negative return. • Expected inflation: The amount by which prices increase over time

17. “Nominal” vs. “Real” rates k = represents any nominal rate k* = represents the “real” risk-free rate of interest. Like a T-bill rate, if there was no inflation. Typically ranges from 1% to 4% per year. kRF = represents the rate of interest on Treasury securities.( k* + IP) also called Nominal risk free rate

18. Determinants of interest rates k = k* + IP + DRP + LP + MRP k = required return on a debt security (Quoted Interest Rate) k* = real risk-free rate of interest (The rate of interest that exist on default-free U.S Treasury securities if no inflation were expected) IP = Inflation Premium ( A premium equal to expected inflation that investors add to the real risk free of return)

19. Determinants of interest rates DRP = default risk premium (The difference between the interest rate on a U.S treasury bond and a corporate bond of equal maturity and marketability) LP = liquidity premium (A premium added to the equilibrium interest rate on a security if that security cannot be converted to cash on short notice and at close to fair market value) MRP = maturity risk premium (A premium that reflects interest rate risk)

20. Interest Rate (%) 15 Maturity risk premium 10 Inflation premium 5 Real risk-free rate Years to Maturity 0 1 10 20 The Term Structure of Interest Rate ** The relationship between bond yields and maturities** Yield Curve: A graph showing relationship between bond yields and maturities.

21. Yield Curve • Normal Yield Curve: An upward-sloping yield curve • Inverted Yield Curve: A downward-sloping yield curve • Humped Yield Curve: A yield curve where interest rate on medium term maturities are higher then rates on both short and long term maturities.

22. Risks associated with investing overseas • Exchange rate risk – If an investment is denominated in a currency other than U.S. dollars, the investment’s value will depend on what happens to exchange rates. • Country risk – Arises from investing or doing business in a particular country and depends on the country’s economic, political, and social environment.

23. Global Perspective • Top Five Countries (Least Amount of Country Risk) Rank Country Total Score (out of 100) • Switzerland 95.6 • Luxembourg 94.2 • Germany 94.1 • Netherlands 93.8 • United Kingdom 93.7

24. Global Perspective • Bottom Five Countries (Greatest Amount of Country Risk) Rank Country Total Score (out of 10) • North Korea 08.8 • Congo 08.4 • Sierra Leone 08.3 • Liberia 08.0 • Afghanistan 04.5

25. What is investment risk? • Two types of investment risk • Stand-alone risk • Portfolio risk • Investment risk is related to the probability of earning a low or negative actual return. • The greater the chance of lower than expected or negative returns, the riskier the investment.

26. Firm X Firm Y Rate of Return (%) -70 0 15 100 Expected Rate of Return Probability distributions • A listing of all possible outcomes, and the probability of each occurrence. • Can be shown graphically.

27. Should I try to avoid the risk, share the risk, accept therisk, or reduce the risk? Enterprise Risk Management A process usedby a company toproactively identifyand manage risk. Once a company identifies its risks, perhaps themost common risk management tactic is to reduce risks by implementing specific controls.

28. Reasons that corporations engage in risk management • Increase their use of debt. • Maintain their optimal capital budget. • Avoid financial distress costs. • Utilize their comparative advantages in hedging, compared to investors. • Reduce the risks and costs of borrowing. • Reduce the higher taxes that result from fluctuating earnings. • Initiate compensation programs to reward managers for achieving stable earnings.

29. Enterprise Risk Management