1 The Financial Environment

Definitions Investment means the sacrifice of current amount (taka) for future amount. The Investment Environment encompasses the kind of marketable securities that exist and where and how they are bought and sold. The Investment Process is concerned with how an investor should proceed in making decisions about what marketable securities to invest in, how extensive the investment should be, and when the investments should be made. 2

Financial System Clients and Their Needs Household Sector –Primary Need: Invest Funds Business Sector –Primary Need: Raise Funds Government Sector –Primary Need: Raise Funds

The Investment Process A five step procedure for making investment decision:  Set investment policy  Perform security analysis  Construct a portfolio  Revise the portfolio  Evaluate the performance of the portfolio.

10 Three Areas of Finance Corporate Financial ManagementCorporate Financial Management –Viewpoint of an individual firm InvestmentsInvestments –Viewpoint of individual investors Financial Markets and IntermediariesFinancial Markets and Intermediaries –Viewpoint of a third party facilitating investor-firm interactions

11 How do we use corporate resources efficiently to further the goals of the firm?How do we use corporate resources efficiently to further the goals of the firm? Decisions are based on The Principles of FinanceDecisions are based on The Principles of Finance Corporate Financial Management

12 Investments The study of financial transactions from the viewpoint of investors outside the firm.The study of financial transactions from the viewpoint of investors outside the firm. Examples include:Examples include:  How do we place a taka/dollar value on a share of stock or a bond issued by the corporation?  How do we assess the risk of these financial securities?  How do we manage a ‘portfolio’ of financial securities to achieve a stated objective of the investor?

13 Financial Markets and Intermediaries The study of markets where financial securities (such as stocks and bonds) are bought and sold.The study of markets where financial securities (such as stocks and bonds) are bought and sold. The study of financial institutions (such as commercial banks, investment banking firms, and insurance companies) that help the flow of money from savers to demanders of money.The study of financial institutions (such as commercial banks, investment banking firms, and insurance companies) that help the flow of money from savers to demanders of money.

14 Security Markets Firms make direct transactions in financial markets.Firms make direct transactions in financial markets. The concepts and principles that apply to financial markets also apply to the management of real assets.The concepts and principles that apply to financial markets also apply to the management of real assets. Security markets provide information and signals that help managers make decisions.Security markets provide information and signals that help managers make decisions.

15 Why Security Markets Exist Security markets facilitate the transfer of capital (i.e financial) assets from one owner to another.Security markets facilitate the transfer of capital (i.e financial) assets from one owner to another. They provide liquidity.They provide liquidity. –Liquidity refers to how easily an asset can be transferred without loss of value. A side benefit of security markets is that the transaction price provides a measure of the value of the asset.A side benefit of security markets is that the transaction price provides a measure of the value of the asset.

16 Security Markets Money versus Capital MarketsMoney versus Capital Markets Primary versus Secondary MarketsPrimary versus Secondary Markets

17 Money Markets Market for short-term claims with original maturity of one year or less.Market for short-term claims with original maturity of one year or less. High-grade securities with little or no risk of default.High-grade securities with little or no risk of default. Examples:Examples:  Treasury Bills (T-Bills & Repos)  Commercial Paper  Certificates of Deposit

18 Securities Market Securities Market

19 Capital Markets Market for long-term securities with original maturity of more than one year.Market for long-term securities with original maturity of more than one year. Securities may be of considerable risk.Securities may be of considerable risk. Examples:Examples:  Stocks  Corporate bonds  Government bonds

20 Stocks Shares of a stock represent equity (or ownership) in a corporation.Shares of a stock represent equity (or ownership) in a corporation. Stockholders have the right to vote and the right to dividends.Stockholders have the right to vote and the right to dividends. Common stock shares represent residual ownership in the firm.Common stock shares represent residual ownership in the firm. Dividends on preferred stock shares are usually fixed, and generally must be paid before dividends are paid to common stockholders.Dividends on preferred stock shares are usually fixed, and generally must be paid before dividends are paid to common stockholders.

21 Bonds Represent long-term debt securities - a promise to pay interest and repay the borrowed money (principal) on pre-specified terms.Represent long-term debt securities - a promise to pay interest and repay the borrowed money (principal) on pre-specified terms. Issued by corporations as well as governments.Issued by corporations as well as governments. Bonds are also referred to as fixed income securities.Bonds are also referred to as fixed income securities.

22 Options Grants the holder the right to buy (or sell) the underlying security at a fixed price, within a fixed time period.Grants the holder the right to buy (or sell) the underlying security at a fixed price, within a fixed time period. A call option gives the holder the right to buy the underlying security.A call option gives the holder the right to buy the underlying security. A put option gives the holder the right to sell the underlying security.A put option gives the holder the right to sell the underlying security.

23 Forward and Futures Contracts An agreement to buy (or sell) something at a fixed price at a fixed point in the future.An agreement to buy (or sell) something at a fixed price at a fixed point in the future. Unlike options, this entails an obligation - both parties to the transaction must fulfill their obligations.Unlike options, this entails an obligation - both parties to the transaction must fulfill their obligations. You can lock in a buying (selling) price for the underlying asset.You can lock in a buying (selling) price for the underlying asset. Futures contracts are similar to forward contracts, but are usually standardized and are traded in the markets.Futures contracts are similar to forward contracts, but are usually standardized and are traded in the markets.

24 Primary Markets A primary market is a market for newly created securities.A primary market is a market for newly created securities. The proceeds from the sale of securities in primary markets go to the issuing entity (IPO).The proceeds from the sale of securities in primary markets go to the issuing entity (IPO). A security can trade only once in the primary market.A security can trade only once in the primary market.

25 Secondary Markets A secondary market is a market for previously issued securities.A secondary market is a market for previously issued securities. The issuing firm is not directly affected by transactions in the secondary markets.The issuing firm is not directly affected by transactions in the secondary markets. A security can trade an unlimited number of times in secondary markets.A security can trade an unlimited number of times in secondary markets. The volume of trade in secondary markets is much higher than in primary markets.The volume of trade in secondary markets is much higher than in primary markets.

26 Investment Bankers An investment banker specializes in marketing new securities in the primary market.An investment banker specializes in marketing new securities in the primary market. Examples of investment bankers:Examples of investment bankers:  Merrill Lynch –Dehring, Bunting & Golding Ltd. –Sigma Manufacturers Merchant Bank –etc.

27 Brokers and Dealers These generally participate in the secondary markets.These generally participate in the secondary markets. A broker helps investors in buying or selling securities.A broker helps investors in buying or selling securities. A broker charges commissions, but never takes title to the security.A broker charges commissions, but never takes title to the security. A dealer buys securities from sellers, and sells them to buyers (hopefully at a higher price!)A dealer buys securities from sellers, and sells them to buyers (hopefully at a higher price!)

28 Financial Intermediaries These are institutions that assist in the financing of firms.These are institutions that assist in the financing of firms. Examples include: commercial banks and pension funds.Examples include: commercial banks and pension funds. These institutions invest in securities of other firms, but they are themselves financed by other financial claims.These institutions invest in securities of other firms, but they are themselves financed by other financial claims.

Investment as a Career Insurance Company (Investment Analyst) Bank Credit Rating Firm Securities Services Company Brokerage House Investment Consultant Finance Company Other Financial Institutions Corporations