What are the three main areas of finance?

There are three primary areas of business finance, which include:

1. Corporate Finance
2. Investments
3. Financial Markets and Institutions

While there is some overlap, each of these areas also covers distinct aspects of managing the financials of a
business.

Corporate Finance

Corporate finance is the area of finance that incorporates the actions of the company when it comes to making
decisions about financing. In other words, every time a business owner buys something, they have to figure out
how to pay for it. For instance, when a company buys inventory, the company has to figure out a way to pay for
that inventory.

Other areas of corporate finance include budgeting, managing working capital, financial analysis, financial
statement development, and more.

Investments

Another area of finance is investments. Within a business, particularly a large business, the firm may invest in
assets ranging from short-term securities to long-term securities like stocks and bonds. The business invests for
the same reason individuals invest—to earn a return.

Companies invest in both financial assets such as stocks of other firms and in physical assets such as buying a
new building or new equipment.

Financial Markets and Institutions

Financial markets and financial institutions comprise the third area of business finance. Financial markets
include everything from the stock and bond markets, the primary and second markets, and the money and
capital markets.

What are specific activities with a firm`s finance staff is involved

The financial staff's task is to acquire and then help operate resources so as to maximize the value of the firm.
Here are some specific activities:

1. Forecasting and planning. The financial staff must coordinate the planning process. This means they must
interact with people from other departments as they look ahead and lay the plans that will shape the firm's
future.

2. Major investment and financing decisions. A successful firm usually has rapid growth in sales, which
requires investments in plant, equipment, and inventory. The financial staff must help determine the optimal
sales growth rate, help decide what specific assets to acquire, and then choose the best way to finance those
assets. For example, should the firm finance with debt, equity, or some combination of the two, and if debt is
used, how much should be long term and how much short term?
3. Coordination and control. The financial staff must interact with other personnel to ensure that the firm is
operated as efficiently as possible. All business decisions have financial implications, and all managers-
financial and otherwise-need to take this into account. For example, marketing decisions affect sales growth,
which in turn influences investment requirements. Thus, marketing decision makers must take account of how
their actions affect and are affected by such factors as the availability of funds, inventory policies, and plant
capacity utilization.

4. Dealing with the financial markets. The financial staff must deal with the money and capital markets. As
we shall see in Chapter 5, each firm affects and is affected by the general financial markets where funds are
raised, where the firm's securities are traded, and where investors either make or lose money.

5. Risk management. All businesses face risks, including natural disasters such as fires and floods,
uncertainties in commodity and security markets, volatile interest rates, and fluctuating foreign exchange rates.
However, many of these risks can be reduced by purchasing insurance or by hedging in the derivatives markets.
The financial staff is responsible for the firm's overall risk management program, including identifying the risks
that should be managed and then managing them in the most efficient manner.

What are agency costs and who bears them

An agency cost is a cost of reducing agency conflict among the owner/ principal (stockholders) and managers
(agent). We can also say the cost which is bears by the company to reduce the agency conflict is basically
known as agency cost and this cost must be maintained by the respective parties or by the company. To reduce
agency conflict some effective measure can be taken which is cost worthy.
Agency costs must bear by shareholders. In the absence of any effort whatever to affect managerial behavior,
and hence with zero agency costs, there will almost certainly be some loss of shareholder wealth due to
improper managerial actions. Conversely, agency costs would be very high if shareholders attempted to ensure
that every single managerial action coincided exactly with shareholder interests. Thus, the optimal amount of
agency costs to be borne by shareholders should be viewed like any other investment decision.
Mechanism that encourages managers to act in the best interest of stockholders
Four primary mechanisms are used to motivate managers to act in stockholders' best interests:

 Managerial compensation
 Direct intervention by stockholders
 Threat of firing
 Threat of takeovers

1.Managerial Compensation

Managerial compensation should be constructed not only to retain competent managers, but to align managers'
interests with those of stockholders as much as possible.

 This is typically done with an annual salary plus performance bonuses and company shares.
 Company shares are typically distributed to managers either as:
o Performance shares, where managers will receive a certain number shares based on the
company's performance.
o Executive stock options, which allow the manager to purchase shares at a future date and price.
With the use of stock options, managers are aligned closer to the interest of the stockholders as
they themselves will be stockholders.

2.Direct Intervention by Stockholders

Today, the majority of a company's stock is owned by large institutional investors, such as mutual funds and
pensions. As such, these large institutional stockholders have the ability to exert influence on mangers and, as a
result, the firm's operations.

3.Threat of Firing

If stockholders are unhappy with current management, they can encourage the existing board of directors to
change the existing management, or stockholders may even re-elect a new board of directors that will
accomplish the task.

4.Threat of Takeovers

If a stock price deteriorates because of management's inability to run the company effectively, competitors or
stockholders may take a controlling interest in the company and bring in their own managers.

What is the price paid to borrow money called?

Interest- The price that people pay to borrow money. When people make loan payments, interest is a part of
the payment. Interest Rate- The cost of borrowing money expressed as a percentage of the amount
borrowed (principal).
What four fundamental factors affect the cost of money?
The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time
preferences for consumption, (3) risk, and (4) inflation
Which fluctuate more, long term or short term interest rates

There is a greater probability that interest rates will rise (and thus negatively affect a bond's market price) within
a longer time period than within a shorter period. As a result, investors who buy long-term bonds but then
attempt to sell them before maturity may be faced with a deeply discounted market pricewhen they want to sell
their bonds. With short-term bonds, this risk is not as significant because interest rates are less likely to
substantially change in the short term. Short-term bonds are also easier to hold until maturity, thereby
alleviating an investor's concern about the effect of interest rate driven changes in the price of bonds.

Long-term bonds have greater duration than short-term bonds. Because of this, a given interest rate change will
have greater effect on long-term bonds than on short-term bonds. This concept of duration can be difficult to
conceptualize, but just think of it as the length of time that your bond will be affected by an interest rate change.
For example, suppose interest rates rise today by 0.25%. A bond with only one coupon payment left until
maturity will be underpaying the investor by 0.25% for only one coupon payment.
Most investors are risk averse
Most investors are risk averse which means:
A. they will always invest in the investment with the lowest possible risk.
B. they actively seek to minimize their risks.
C. they avoid the stock market due to the high degree of risk.
D. they will assume more risk only if they are compensated by higher expected return
How does risk aversion affect rates of return?
In a market dominatedby risk-averse investors, riskier securities must have higher expected returns, as
estimatedby the marginal investor, than less risky securities. If this situation does not exist, buyingand selling in
the market will force it to occur.
What is bond?
A bond is a fixed income instrument that represents a loan made by an investor to a borrower (typically
corporate or governmental). A bond could be thought of as an I.O.U. between the lender and borrower that
includes the details of the loan and its payments. Bonds are used by companies, municipalities, states, and
sovereign governments to finance projects and operations. Owners of bonds are debtholders, or creditors, of the
issuer. Bond details include the end date when the principal of the loan is due to be paid to the bond owner and
usually includes the terms for variable or fixed interest payments made by the borrower.
Key characteristics of bonds
Bonds of all kinds operate on the same basic principle: You as the investor loan money to the bond's issuer, and
the issuer pays you interest on the loan, typically twice a year. All bonds have three characteristics that never
change:
1. Face value:
The principal portion of the loan, usually either $1,000 or $5,000. It's the amount you get back from the issuer
on the day the bond matures. A bond's price, which is in constant flux, can be more or less than the face value.
2. Maturity:
The day the bond comes due. A 30-year bond, for example, comes due 30 years from the day it is issued. Most
bonds mature within 30 years, but maturities can be as short as a year or even shorter. Short-term bonds are
usually called notes.
3. Coupon:
Because bonds used to come with attached coupons that investors had to clip and redeem for their interest
payments (now it's all done electronically), the size of the interest payment is still called the coupon. A bond
with an 8% coupon pays 8% of the face value of the bond a year, in two installments. Assuming a face value of
$1,000, that's two $40 payments.
Describe how the annual bond valuation formula is changed to evaluate semi-annual coupon bonds

Advantages of short term and long term debt

Advantages of Short-Term Loans

Fast Approval

A short-term loan is suitable for people who need quick access to cash. Just like a payday loan, a short-term
loan application can be approved within a few hours depending on the lender. In some cases, you will have
access to the funds within the same day or the following business day.

You Pay Less Interest

Typically, the longer you owe the lender, the higher the interest you will pay. However, with a short-term loan,
you will be paying back everything within a shorter period which means you pay less interest as well. You will
still save some money even if the interest rate is higher compared to that of long-term loans.

It Can Help You Improve Your Credit Rating

Unlike the long-term loans, you have a luxury of choosing a short-term loan that will suit personal
circumstances. For example, if you have a bad credit history, then you can take a short-term loan for a few
months to help you improve your credit score. As long as you repay the loan on time, you will see your credit
rating improve.

Offers Flexibility and Reduces Stress

These types of loans provide convenience and flexibility. You can apply for a short-term loan any time of the
day since most lenders have websites. You will also avoid the stress of owing the lender money for a longer
period and watching the interest accrue which can turn into emotional and psychological torture.

Disadvantages of Short-Term Loans

They are High-Cost Loans

Typically, short-term loans attract high-interest rates and high monthly payment. Since you are financing the
principal debt over a shorter period, you may end up paying a significant amount of money every month
compared to what you will pay if you are servicing a long-term loan.

It Can Have a Negative Impact on Your Credit Score

Although you can use a short-term loan to build your credit score, the consequences can be dire if you fail to
repay it on time. Your new debt to income ratio plus the high-cost new loan will drastically bring down your
credit rating.

Can Make You Fall into a Cycle of Borrowing

The flexibility, convenience, and easy availability of short-term loans can make you a seasonal borrower. You
may find yourself hooked towards borrowing whenever you need some money which is a risky not good. This
means that you may end up spending more than you can afford or waste a lot of money.

Disadvantages of short term and long term debt

Define cash conversion cycle
The cash conversion cycle (CCC) is a metric that expresses the time (measured in days) it takes for a company
to convert its investments in inventory and other resources into cash flows from sales. Also called the Net
Operating Cycle or simply Cash Cycle, CCC attempts to measure how long each net input dollar is tied up in
the production and sales process before it gets converted into cash received.

This metric takes into account how much time the company needs to sell its inventory, how much time it takes
to collect receivables, and how much time it has to pay its bills without incurring penalties.

Why some trade credit is called free while other credit is called costly
Define financial management
financial Management means planning, organizing, directing and controlling the financial activities such as
procurement and utilization of funds of the enterprise. It means applying general management principles to
financial resources of the enterprise.
Distinguish between money market and capital market
 BASIS FOR
MONEY MARKET CAPITAL MARKET
COMPARISON

Meaning A segment of the financial market where A section of financial market where long
lending and borrowing of short term term securities are issued and traded.
securities are done.

Nature of Market Informal Formal

Financial instruments Treasury Bills, Commercial Papers, Shares, Debentures, Bonds, Retained
Certificate of Deposit, Trade Credit etc. Earnings, Asset Securitization, Euro
Issues etc.

Institutions Central bank, Commercial bank, non- Commercial banks, Stock exchange, non-
financial institutions, bill brokers, banking institutions like insurance
acceptance houses, and so on. companies etc.

Risk Factor Low Comparatively High

Liquidity High Low

Purpose To fulfill short term credit needs of the To fulfill long term credit needs of the
business. business.

Time Horizon Within a year More than a year

Merit Increases liquidity of funds in the economy. Mobilization of Savings in the economy.

Return on Investment Less Comparatively High

What is business finance?

Business finance includes the information contained in financial documents such as profit and loss
statements, balance sheets and cash flow statements. It also covers strategies that businesses typically use to
manage their money, such as leveraging future rather than present value. Armed with this knowledge about
how money flows and grows, you will have the tools to make strategic decisions for managing your business's
finances and take advantage of opportunities.

For example, you may have a choice between two loan products, one of which has a higher interest rate and
flexible terms, while the other has a lower interest rate but rigid terms. Understanding business finance gives
you the know-how to evaluate how much you will likely spend repaying either of these loans in longer or
shorter repayment times.
Importance of business finance
. Debt Ratios:
Importance of business finance are more significance than money in your hand. Many businesses have some
level of debt, mostly in the startup stages. Excessively debt contrasted with revenues / profits and assets can
leave you into much bigger problems than making your loan repayments. Vendors and suppliers usually run
credit checks and may restrict what you can buy on credit or keep payment that is tight. Debt ratios can affect
your capability to attract investors including venture capital firms and to acquire or rent area that is commercial.

3. Managing Operation Expenses:

For the short-term, businesses require finance in the type of working capital to meet operational costs such as
for instance remunerative payments, raw materials, inventory, interest repayments, etc. An importance of
business finance is to make proper short-term financial planning decisions as good finance flow is vital to keep
the operations consistently ongoing. Though maintain money that is adequate is always important, it’s
especially important in the starting stages since profits takes some time to match the cash outflows.

 4. Asset Creation:

In the long-term, finance is required for buying assets like machinery, land, equipment, etc. to expand the
production scale. Scaling up production will create assets, help the business grow and penetrate areas that are
current. The business must have capital that is enough doing so and cannot be determined by short-term
finances because of this. Either they must have savings or should know the importance of business finance and
able to raise and infuse capital investment through equity or debt financing.

5. New Products and Opportunities in the Markets:

There is significance of business finance and appropriate financial management that is also important to an
established company will maybe not manage to explore more opportunities in the markets or develop and test
newer solutions / items without finance. Finance has a great importance in business as it is required for research
and testing purposes as well in terms of advertising and marketing purposes.

Identify some factors beyond a firm control that influence its stock prices
Here are some company-specific factors that can affect the share price:

 news releases on earnings and profits, and future estimated earnings

 announcement of dividends
 introduction of a new product or a product recall
 securing a new large contract
 employee layoffs
 anticipated takeover or merger
 a change of management
 accounting errors or scandals

What is the difference between stock price maximisation and profit maximisation?

Under what conditions might profit maximisation not lead to stock price maximisation?

What is difference between commercial and investment bank

BASIS FOR
INVESTMENT BANK COMMERCIAL BANK
COMPARISON

Meaning Investment bank refers to a financial Commercial bank is a bank that provides
institution, that offers services like services like accepting deposits, lending
underwriting of securities, brokerage money, payment on standing order and many
services and so on. more.

Offers Customer specific service Standardized service

Associated with Performance of financial market. Nation's economic growth and demand for
credit

Customer base Few hundreds only Millions

Banker to Individuals, government and corporations. All citizens

Income Fees, commissions or profit on trading Fees and interest income

activities.

What is Beta? Why is beta theoretically correct measure of a stock`s riskiness

Beta is a statistical measure of the volatility of a stock versus the overall market. It's generally used as both a
measure of systematic risk and a performance measure. The market is described as having a beta of 1. The beta
for a stock describes how much the stock’s price moves in relation to the market. If a stock has a beta above 1,
it's more volatile than the overall market. As an example, if an asset has a beta of 1.3, it's theoretically 30%
more volatile than the market. Stocks generally have a positive beta since they are correlated to the market.
What security market line
The security market line (SML) is a line drawn on a chart that serves as a graphical representation of the capital
asset pricing model (CAPM), which shows different levels of systematic, or market, risk of various marketable
securities plotted against the expected return of the entire market at a given point in time. 
What happens to SML graph when risk aversion increase or decrease
What is the Security Market Line (SML)?

Security market line (SML) is the graphical representation of the Capital Asset Pricing Model (CAPM). SML
gives the expected return of the market at different levels of systematic or market risk. It is also called
‘characteristic line’ where the x-axis represents beta or the risk of the assets and y-axis represents the expected
return.

A dollar in hand today is worth more than a dollar to be received next year
The time value of money, or TVM, assumes a dollar in the present is worth more than a dollar in
the future because of variables such as inflation and interest rates. ... The later money is received, the less value
it holds, and $1 today is worth more than $1 received at a date in the future.
Difference between an ordinary annuity and an annuity due
BASIS FOR
ORDINARY ANNUITY ANNUITY DUE
COMPARISON

Meaning Ordinary annuity is one in which the inflow or Annuity due is described as the series of
outflow of cash fall due for payment at the end cash flows occurring at the beginning of
of each period. each period.

Payment Belongs to the period preceding its date. Belongs to the period following its date.

Appropriate for Payments Receipts

Example Housing loan, payment of mortgage, coupon Rental lease payments, life insurance
bearing bonds, etc. premium, etc.

Define floating rate bonds

A floating-rate note (FRN) is a debt instrument with a variable interest rate. The interest rate for an FRN is tied
to a benchmark rate. Benchmarks include the U.S. Treasury note rate, the Federal Reserve funds rate—known
as the Fed funds rate—the London Interbank Offered Rate (LIBOR), or the prime rate.
The sources of short time financing
Short-Term Funds: Source # 1. Indigenous Bankers:
Private money-leaders and other country bankers used to be the only sources of finance prior to the
establishment of commercial banks. They used to charge very high rates of interest and exploited the customers
to the largest extent possible.

Now-a-days with the development of commercial banks they have lost their monopoly. But even today some
business houses have to depend upon indigenous bankers for obtaining loans to meet their working capital
requirements.

Short-Term Funds: Source # 2. Trade Credit:

ADVERTISEMENTS:

Trade credit refers to the credit extended by the suppliers of goods in the normal course of business. As present
day commerce is built upon credit, the trade credit arrangement of a firm with its suppliers is an important
source of short-term finance. The credit-worthiness of a firm and the confidence of its suppliers are the main
basis of securing trade credit.
It is mostly granted on an open account basis whereby supplier sends goods to the buyer for the payment to be
received in future as per terms of the sales invoice. It may also take the form of bills payable whereby the buyer
signs a bill of exchange payable on a specified future date.

When a firm delays the payment beyond the due date as per the terms of sales invoice, it is called stretching
accounts payable. A firm may generate additional short-term finances by stretching accounts payable, but it
may have to pay penal interest charges as well as to forgo cash discount.

If a firm delays the payment frequently, it adversely affects the creditworthiness of the firm and it may not be
allowed such credit facilities in future.

ADVERTISEMENTS:

The main advantages of trade credit as a source of short-term finance include:

(i) It is easy and convenient method of finance.

(ii) It is flexible as the credit increases with the growth of the firm.

(iii) It is informal and spontaneous source of finance.

However, the biggest disadvantage of this method of finance is charging of higher prices by the suppliers and
loss of cash discount.

Short-Term Funds: Source # 3. Installment Credit:

This is another method by which the assets are purchased and the possession of goods is taken immediately but
the payment is made in Installment over a pre-determined period of time. Generally, interest is charged on the
unpaid price or it may be adjusted in the price.
But, in any case, it provides funds for sometimes and is used as a source of short-term working capital by many
business houses which have difficult funds position.

Short-Term Funds: Source # 4. Advances:

Some business houses get advances from their customers and agents against orders and this source is a short-
term source of finance for them. It is a cheap source of finance and in order to minimise their investment in
working capital, some firms having long production cycle, especially the firms manufacturing industrial
products prefer to take advance from their customers.

Short-Term Funds: Source # 5. Factoring:

Another method of raising short-term finance is through account receivable credit offered by commercial banks
and factors. A commercial bank may provide finance by discounting the bills or invoices of its customers. Thus,
a firm gets immediate payment for sales made on credit.

A factor is a financial institution which offers services relating to management and financing of debts arising
out of credit sales. Factoring is becoming popular all over the world on account of various services offered by
the institutions engaged in it.

Short notes

Inventory conversion period

The inventory conversion period is the time required to obtain materials for a product, manufacture it, and
sell it. The inventory conversion period is essentially the time period during which a company must invest
cash while it converts materials into a sale. The calculation is:

Inventory  ÷ (Cost of sales ÷ 365)

Receivables collection period

The average collection period is the amount of time it takes for a business to receive payments owed by its
clients in terms of accounts receivable (AR). Companies calculate the average collection period to make sure
they have enough cash on hand to meet their financial obligations.

The average collection period is calculated by dividing the average balance of accounts receivable by total net
credit sales for the period and multiplying the quotient by the number of days in the period.

Payable deferral period

The Payables Deferral Period is the average length of time between when a company purchases supplies,
materials, and labor from its suppliers on accounts payable and when it pays for them. Here is the formula:

Payables Deferral Period = Payables/Cost of Goods Sold/365 = # Days

Using these three formulas and information from the balance sheet and income statement, we have gotten the
information we need to calculate the cash conversion cycle. Here is the calculation:

Cash Conversion Cycle (CCC) = Inventory Conversion Period + Receivables Collection Period - Payables
Deferral Period

CAPM model
The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected
return for assets, particularly stocks. CAPM is widely used throughout finance for pricing risky securities and
generating expected returns for assets given the risk of those assets and cost of capital.
Time lines

Balloon lines
Trade credit
Trade credit is the creditextended to you by suppliers who let you buy now and pay later. Any time you take
delivery of materials, equipment or other valuables without paying cash on the spot, you're using trade credit
Agency relationship
Perpetuity
Perpetuity refers to an infinite amount of time. In finance, perpetuity is a constant stream of identical cash flows
with no end. The present value of a security with perpetual cash flows can be determined as:

The concept of a perpetuity is also used in a number of financial theories, such as in the
Amortisation loans
An amortized loan is a loan with scheduled periodic payments that are applied to both principal and interest. An
amortized loan payment first pays off the relevant interest expense for the period, after which the remainder of
the payment reduces the principal. Common amortized loans include auto loans, home loans and personal loans
from a bank for small projects or debt consolidation.
Accrued payables
Definition of Accrued Expenses Payable
Accrued Expenses Payable is a liability account that records amounts that are owed, but the vendors' invoices
have not yet been received and/or have not yet been recorded in Accounts Payable as of the end of the
accounting period. The amounts in this account are usually recorded with accrual adjusting entries made at the
end of the accounting period.
Examples of Accrued Expenses Payable
In addition to the amounts associated with vendors' invoices, accrued expenses may also include wages, interest,
utilities, and other expenses that were incurred and owed, but not yet recorded in the general ledger accounts.
Some of the amounts recorded in Accrued Expenses Payable may be estimated amounts that should supported
by reasonable and documented calculations.

Lockbox plan
A plan or arrangement between either an insurer or agent and a bank to use the bank as the premium collection
facility. Insureds send payments to a post office box or bank lockbox controlled by the bank. The bank
processes the payment directly to the proper account, for a service fee.
Stock divided and stock split

Cash flow synchronization