BBA, MBA (Finance & Banking), DU Topic # 01 An Overview of Finance Ayesha Saimoon BBA, MBA (Finance & Banking), DU Ayesha Saimoon

Principles of Finance/L1MBA Contents Definitions Of Finance, Basic Principles Of Finance, Functions Of Finance, Sectors Of Finance, Responsibility Of Financial Manager, Financial Management Issue Of The New Millennium, Forms Of Business Organizations, Financial Goals Of The Corporations, Profit Maximization Vs. Wealth Maximization And The Agency Problems. Kazi Zulfiqar Hasan, Senior Lecturer in Finance

Principles of Finance/L1MBA What is Finance? Finance is the relationship between deficit sector and surplus sector of the society. The commercial activity of providing funds and capital The branch of economics that studies the management of money and other assets The management of money and credit and banking and investments Finance represents the processes that transfer money among businesses, individuals, and governments Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Finance is the management of money. Finance is the process of raising fund and utilizing the fund to earn highest profit. Ayesha Saimoon

Principles of Finance: Principles of Finance/L1MBA Principles of Finance: Principles of Risk and Return Principles of the Time Value of Money Principles of Cash Flow Principles of Profitability and Liquidity Hedging Principles Principles of Diversity Principles of Business Cycle Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Functions of Finance (Responsibilities of Financial Manager) Principles of Finance/L1MBA Functions of Finance (Responsibilities of Financial Manager) Financial Planning Identification of Sources Analyzing and Selecting of Sources Raising of Funds Investment of Funds/Utilization of Fund Protection of Funds Distributions of Profit Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Agency conflict/ agency problem: Agent: When somebody represent any individual or firm is called agent. Agency problem: Agency problem is a conflict of interest between the shareholders and the managers or stockholders and creditors. Overcoming the agency problem: Several mechanism are used to motivate managers to act in the shareholders best interests. These includes- Ayesha Saimoon

Managerial compensation incentives) The threat of firing Shareholders intervention The threat of takeover. Ayesha Saimoon

Sectors of Finance (Career Fields in Finance) Principles of Finance/L1MBA Sectors of Finance (Career Fields in Finance) Financial Markets & Institutions Money and capital markets: Investments Investment in Existing Business Expansion of Existing Business Investment in New Project Research and Development Financial management Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Principles of Finance/L1MBA Role of Finance in a Typical Business Organization (Career Opportunities in Finance) Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Finance in The 20th Century Principles of Finance/L1MBA Finance in The 20th Century Some issues are observed and discussed in the 20th century’s ---- Inflation and its effects on business decisions Deregulation of financial institutions and the resulting trend toward large, broadly diversified financial services companies------------------- Mergers and Acquisitions The dramatic increase in both the use of computers for analysis and the electronic transfer of information The increased importance of global markets and business operations Innovations in the financial products offered to investors The effect of changing technology The globalization of business Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Principles of Finance/L1MBA Forms of Business Organizatios Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Alternative Forms of Business Organization Principles of Finance/L1MBA Alternative Forms of Business Organization Sole proprietorship Partnership Corporation Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Principles of Finance/L1MBA Sole Proprietorship Sole Proprietorships: A business owned by a single individual Disadvantages Limited to life of owner Equity capital limited to owner’s personal wealth Unlimited liability Difficult to sell ownership interest Advantages Easiest to start Least regulated Single owner keeps all the profits Taxed once as personal income Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Principles of Finance/L1MBA Partnership A partnership has roughly the same advantages and disadvantages as a sole proprietorship with two or more owners. Disadvantages Unlimited liability Partnership dissolves when one partner dies or wishes to sell Difficult to transfer ownership, but less difficult than sole proprietorship – add partners Advantages Two or more owners More capital available Relatively easy to start Income taxed once as personal income Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Principles of Finance/L1MBA Corporation Generally, any business organization which shares are traded in the share market is called Corporation. A business entity that legally functions separate and apart from its owners. Advantages Limited liability Unlimited life Separation of ownership and management Transfer of ownership is easy Easier to raise capital Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Corporation: Disadvantages Principles of Finance/L1MBA Corporation: Disadvantages Separation of ownership and management (Agency Problem) Double taxation (income taxed at the corporate rate and then dividends taxed at personal rate) – proposal to have dividends deductible as interest is now or to not tax dividend distributions Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Principles of Finance/L1MBA Quick Quiz What are the Differences between a Partnership and a Corporation? Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Partnership vs. Corporation Issues Partnership Corporation Starting ………… ……… Transferability of ownership ………… ……… Taxation ………… ……… Owners and Mangers ………… ……… Life Duration ………… ……… Liability ………… ……… Capital Size ………… ……… Raising of Fund ………… ……… Ayesha Saimoon

Principles of Finance/L1MBA Goals of The Corporation Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Financial Goals of the Corporation Principles of Finance/L1MBA Financial Goals of the Corporation Two opinion Profit Maximization Wealth Maximization The primary financial goal is shareholder wealth maximization, which translates to maximizing stock price. Do firms have any responsibilities to society at large? Is stock price maximization good or bad for society? Should firms behave ethically? Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Is stock price maximization the same as profit maximization? Principles of Finance/L1MBA Is stock price maximization the same as profit maximization? No, despite a generally high correlation amongst stock price, EPS, and cash flow. Current stock price relies upon current earnings, as well as future earnings and cash flow. Some actions may cause an increase in earnings, yet cause the stock price to decrease (and vice versa). Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Principles of Finance/L1MBA Quick Quiz! What are the Limitations/Criticisms of the Profit maximization? Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

The Agency Problems & Relationships Principles of Finance/L1MBA The Agency Problems & Relationships Agency problem Conflict of interest between principal and agent Agency relationship An agency relationship exists whenever a principal hires an agent to act on their behalf. Stockholders (principals) hire managers (agents) to run the company Within a corporation, agency relationships exist between: Shareholders and managers Shareholders and creditors Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Examples of Agency Problem Principles of Finance/L1MBA Examples of Agency Problem Common example of an agency relationship is a real estate broker – in particular if you break it down between a buyers agent and a sellers agent. A classic conflict of interest is when the agent is paid on commission, so they may be less willing to let the buyer know that a lower price might be accepted or they may elect to only show the buyer homes that are listed at the high end of the buyers price range. Direct agency costs – the purchase of something for management that can’t be justified from a risk-return standpoint, monitoring costs. Indirect agency costs – management’s tendency to forgo risky or expensive projects that could be justified from a risk-return standpoint. Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Principles of Finance/L1MBA Tools for Mitigating the Agency Problems Managers are naturally intended to act in their own best interests. But the following factors affect managerial behavior: Managerial compensation plans Direct intervention by shareholders The threat of firing The threat of takeover Kazi Zulfiqar Hasan, Senior Lecturer in Finance Ayesha Saimoon

Preparation!! Following are the sample questions to take preparation!! Explain the Term “Finance”. Discuss the different principles of Finance. Discuss the main functions of Finance (or the responsibilities of a Financial manager). Define and discuss the Characteristics of Sole proprietorship, partnership and Corporation. Differentiate between partnership and Corporation. What is agency problems and Agency Relationships? What are the ways to reduce/mitigate the agency problem. Discuss in details. Ayesha Saimoon