Introduction

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Introduction &

Course Overview

Financial Management

Abhinav Rajverma
Contact: +91-81281-95751
Evaluation
Component(s) Weightage
Quizzes 20%
Assignments 20%
MT Examination 30%
ET Examination 30%

Group Assignment: 5-6 participants per group

Finance is not a spectator sports. Do finance to learn finance

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Why Finance?

Personal Finance
 Investments & Risk Management

Middle & Top-management (excluding finance)


 Functional knowledge is a must
 Valuation (project)

Career in Finance. What next?


 FRM (Risk Management)
 CFA (IB, PM, etc.)

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Questions that are answered using Finance
Where to invest? How much to invest?
Long-term vs short-term investments?

How to raise money? How much to raise funds?


Long-term vs short-term financing?

How to manage financial activities in a firm?


Risk & return of financial assets
Portfolio management

How much to retain profits?


Dividend vs share repurchases
How to diversify risk?
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Course Coverage

 Planning the Finance (Investment)

 Raising the Finance (Financing)

 Investing the Finance (Distribution/Retention)

 Monitoring the Finance (WCM)

 Risk Management

Rule # 1: Money today is worth more than money tomorrow.

Rule # 2: Risk-free money is worth more than risky money.

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Fundamental Challenges of Finance
All Business Activities <= Two Functions
1. Valuation of Assets (real/financial, tangible/intangible)
2. Management of Assets (acquiring/selling)
Business Decisions: Valuation and Management
 Management starts with valuation
 Once value is established, management is easy
Objective + Valuation => Decision
Financial Markets and Price Discovery Process
* Applies to both personal and corporate financial decisions

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The Framework of Financial Analysis
Income & Balance Sheet

Corporate Personal
1. Cash raised from investors 1. Cash raised from financial institutions
2. Cash invested in real assets 2. Cash invested in real assets
3. Cash generated by operations 3. Cash generated by labour supply
4. Cash reinvested 4. Cash consumed and reinvested
5. Cash returned to investors 5. Cash invested in financial assets

𝑀𝑎𝑡h𝑒𝑚𝑎𝑡𝑖𝑐𝑠 +₹ ₹ ₹ =𝐹𝑖𝑛𝑎𝑛𝑐𝑒

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Fundamental Principles

1. No Free Lunch
2. Ceteris paribus, individuals
 Prefer more money to less (non-satiation)
 Prefer money now to later (impatience)
 Prefer to avoid risk (risk aversion)
3. All agents act to further their own self-interest
4. Financial Markets: Supply & Demand
5. Financial Markets: Highly adaptive & competitive
6. Risk-sharing & frictions: Central to financial innovation

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Asset Class
An asset class represents a group of financial
instruments having similar financial characteristics
and behavior at marketplace.

Stocks
Ownership, Volatile (risk)
Fixed Income
Interest rate, Maturity
Cash
Currency notes, Forex
Real Estate
Houses, Infrastructure
Commodities
Gold, Copper, Paddy, Crude oil
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Financial Markets
A financial market (FM) may be defined as a
mechanism (or place) that facilitates the exchange of
financial instruments including shares, bonds,
derivatives, currencies, government securities etc.

Importance:
Efficient allocation of scarce resources
Access to capital - Intermediary between the
savers and investors
Price determination of securities
Provides liquidity
Signals health of the economy
Employment
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Financial Markets
Financial
Markets

Money Capital
Markets Markets

T-Bills CDs CPs Repo Primary Secondary


Markets Markets

Public Rights Bonus Debt Equit


Issue Bonds
Issue Issue Issue y

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Financial Instruments

Markets Financial Instruments


Money Markets Call Money, T-bills, Certificate of Deposit,
Commercial Papers, Repos
Capital Markets Bonds (NCD, G-secs), Shares (Equity &
preference shares), Mutual Funds, FD
Derivatives Forwards, Futures, Options, Swaps,
Markets Insurance contracts
Forex Markets USD-INR, EUR-INR, GBP-INR, JPY-INR

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Elements of challenge in Finance

Time
• CFs now are different from CFs later
• Time is unidirectional
• How to model temporal differences
Risk
• Market is not perfect
• Risk creates significant challenge
• How to model the unknown (risk)

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Simple and Compound Interest
Example: As of March 1, 2020, the nominal interest rate,
compounded monthly, on your INR 5 lakh cash credit was 12
percent. Per the Government’s compound interest waiver
scheme, calculate the compensation amount for a six-month
moratorium period between March and August 2020.

Solution:
Compensation = Compound Interest – Simple Interest
SI = 5,00,000 * 0.12 * 0.5 = Rs. 30,000
CI = 5,00,000 * - 5,00,000 = Rs. 30,760

Compensation = Rs. 760

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Nominal vs. Effective
Nominal Interest Rate ()
Effective Interest Rate ()

Example: Calculate equivalent nominal rate with quarterly


compounding for 10% nominal rate with semi-annual
compounding.
Solution:
Semi-annually Compounding
• Frequency () = 2
• Nominal Rate (a) = 10% (given)
Quarterly Compounding
• Frequency () = 4
• Nominal Rate (b) = ?

Note: When an effective annual rate remains unchanged and why?


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Financial Management

What should be the goal of a corporation?


Maximize profit?
Minimize costs?
Maximize market share?
Maximize value of stocks?

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Organization
Stakeholders
Shareholders (Owner) <= Equity
Lenders <= Debt
Creditors (op) <= Goods & services
Employees
Buyers, Suppliers etc.

Example: Profit Maximization


Project A Project B
Investments Rs. 10,00,000 Rs. 2,00,000
Profits Rs. 2,00,000 Rs. 1,00,000
ROI 20% 50%
*EPS, ST profits manipulation, TVM, Risk, Payout Policy

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Wealth Maximization

Financial Objectives

Non-Financial Objectives
Employee Welfare
Customer Satisfaction etc.
Does this mean we should do anything and everything to
maximize owner wealth?

Agency Issues

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Functions of a Finance Manager
 Investment Planning
 Capital Budgeting
 Capital Structure Decision
 Sources to raise funds
 Fundraising
 Cash Management
 Working Capital Management
 Profit Distribution vs. Reinvestment
 Merger & Acquisition
Allocation of scarce resource across assets over
time to earn a return
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Financial Management
Working Capital
Management

Investment
Decisions
ng
Budgeti

Payout Poli
Financial
Fin Management
Capital

De anci ut
cis ng yo

cy
ion Pa ns
s is io
Dec

Capital Structure

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Case: Ten Ways to Create Shareholders Value

1. No earnings management
2. Strategic decisions: Maximize expected value
3. Acquisition: Maximize expected value
4. Asset creation: Maximize expected value
5. Distribute profits: No credible investment
6. Reward top management: Superior LT returns
7. Reward operations managers: Superior value
8. Reward middle managers: Superior performance on KPIs
9. ESOP: Senior executives
10.Value-relevant information: No information asymmetry

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Takeaways
Financial Management
Important policy decisions
Goals of financial management
Functions performed by a finance manager
Fundraising: Equity, Debt
Profit sharing: Dividends, Repurchases
Risk management: Project, Market, Hedging
Agency problems?
Owner-manager
Majority vs minority

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Thank You
for
Your Time

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