Financial Mangement Unit -1 Represented By The Following Students of Sem 2

12MBA1016 - Amir Khan 15MBA1537 - Sabha 15MBA1572 - Chandni Rani 15MBA1459 - Sumit dadwal 15MBA1485 - Akashdeep Rangra 15MBA1042 - Furqan –Ul-Qureshi15MBA1040 - Mufti Mohd. Murtaza 15MBA1472 - Gurpreet Kaur 15MBA1056 - Kriti

Finance

Money is an arm or a leg. You can either use it or lose it._ Henry Ford

The Sanskrit saying “arthahsachivah” means finance reigns supreme.

Ready money is ‘Alladin lamp’._Byron

Meaning of finance• Finance is the management of the monetary affairs

of a company. ____ Paul G Hastings• Financing is the process of organizing the flow of

funds so that a business firm can carry out its objectives in the most efficient manner and meet its obligations as they fall due. __Ronald

• Finance is the common denominator for a vast range of corporate objectives, and the major part of any corporate plan must be expressed in financial terms. ____________ALKignshott

Finance Finance means to arrange payment for it.

__George Christy and Peter Rodan The act of providing the means of payment. __Encyclopedia Britannica In nutshell finance is closely linked with the flow of

money, the availability of funds at a time, advance knowledge of, or information about financial commitments etc. The focus of finance is on the flow of funds which is justifiable, because the financial manager must take financial decisions based on mainly flow of funds.

FINANCE FUNCTION• There exists an inseparable relationship between finance on one hand

and other functional areas on the other. All business activities, directly or indirectly, involve the acquisition and use of funds. This finance function though has a significant effect on other functions yet it need not necessarily limit or constraint the normal functioning of the enterprise.

• The functions of raising funds, investing them in assets, distributing returns earned from assets to stakeholders and attempting to balance cash flows are respectively called:

• 1) Financing decision;• 2) Investment decision;• 3) Dividend decision;• 4) Liquidity decision.

FINANCE FUNCTION1) Financing Decision: This decision is concerned with, where

from and how to acquire funds. The central issue is the determination of appropriate proportion of debt and equity. An attempt has to be made to have optimal capital structure which means maximizing the value of shares.

The use of debt may increase the return and risk for shareholders and hence, a proper balance has to be struck between return and risk.

The issue of capital structure will be discussed in detail later on.

FINANCE FUNCTION

2) INVESTMENT DECISION: A firm’s investment decision involves capital expenditure, which is generally referred to as capital budgeting. There are two important aspects of investment decisions:

a) The evaluation of the prospective profitability of new investments; b) The measurement of a cut-off rate against which the prospective

return of the new investments could be compared. Risk in investment arises because of uncertain returns. Investment proposals should be evaluated in terms of expected return and risk. There is a broad agreement that the correct cut-off rate is the opportunity cost of capital.

Capital budgeting will be discussed in detail at a later stage.

FINANCE FUNCTION• 3) Dividend Decision: A finance manager is confronted with a

problem that whether a firm should distribute whole of the profits earned or retain them or distribute a part and retain the balance. Called, dividend policy, it should be designed in terms of its impact on the shareholders wealth. A desirable dividend policy is one which maximizes the market value of the firm’s shares. As far as possible a firm should try to have a stable dividend policy.

• Dividend is generally paid in cash.• Dividend policy will be discussed at an appropriate place.

FINANCE FUNCTION• 4) Liquidity Decision: Investment in current assets affects the

firm’s profitability and liquidity. Current assets should be managed efficiently for safeguarding the firm against ill-effects of illiquidity. A conflict generally exists between profitability and liquidity while managing current assets and an all out effort has to be made to have a trade-off between the two.

• For ensuring such a trade-off the finance manager has to develop sound techniques of managing current assets. In this context precise estimates regarding current assets have to be worked out and it has to be made certain that funds are made available when required.

Financial management• Financial management is an applied branch of general management that looks

after the finance function of a business. Management in general deals with effective procurement and utilization of basic inputs like men, machines, methods, materials and markets, and money or finance is a common thread that passes through the wide-spectrum of all business activities; and management of finance is a key variable that determines the success or failure of any business activity.

• Financial management is a dynamic subject and is responsible for operating a business efficiently and effectively. Traditionally the subject of financial management was considered only in narrow sense but the modern concept of financial management has very wide coverage. It has to bring compatibility between conflicting goals of liquidity and profitability.

Financial Management• Financial management, however, should not be taken to be a profit-

extracting device. No doubt finances have to be so planned as to contribute to profit-making activities within an organization, as finance cannot be generated without profits. But there is much more. Financial management implies a more comprehensive concept than the simple objective of profit making or efficiency.

• Its broader mission is to maximize the value of the firm so that interests of different sections of society remain undisturbed and protected.

• Financial management is an integrated and composite subject. It welds together substantial material that is found in accounting, economics, mathematics, systems analysis and behavioral sciences and uses other disciplines as its tool.

Financial Management Financial management deals with how the corporation obtains the

funds and how it uses them”.--- Hoagland “The term financial management refers to the application of skills in

the manipulation, use and control of funds”.--- Mock, Schultz and Shuckett

“Financial management is the custodian of corporate funds. It has to plan, organise and control the finances of the enterprise”. ---S A Sherlekar

It can be concluded by saying that financial management is not only concerned with procurement of funds but it also deals with three decision-making areas called investment decisions, financing decisions and dividend decisions.

Financial Management• Strategic Financial Management: It is a part of financial

management. Over a period of time, a number of techniques have evolved in the context of financial management. Some techniques are aimed at the management of short term funds, like funds flow analysis, cash flow analysis and operating ratio etc. Some techniques on the other hand aim at managing long-term funds, study of portfolios and study of asset deployment etc. Strategic financial management combines the knowledge of financial management, economics and business environment to forecast and manage the future of the enterprise.

• Financial management emerged as a distinct field of study at the turn of 20th century. Its evolution can be divided into three broad phases (though the demarcating lines between these phases are somewhat arbitrary)__the traditional phase, the transitional phase, and the modern phase.

Traditional PhaseThe traditional phase lasted for about four decades. Following were its

important features:1) The focus of financial management was mainly on certain episodic

events like formation, issuance of capital, major expansion, merger, reorganization and liquidation in the lifecycle of the firm.

2) The approach was mainly descriptive and institutional. 3) The approach placed great emphasis on long term problems. 4) The outsiders like investment bankers, lenders and other outside

interest point of view was dominant.5) Financial management was not considered to be a managerial

function. A typical work of the traditional phase is The Financial Policy Of Corporations by Arthur S Dewing.

Transitional Phase The Transitional Phase began around the early

1940s and continued through the early 1950s. Though the nature of financial management during this period was similar to that of the traditional phase, greater emphasis was placed on the day-to-day problems faced by financial managers in the areas of funds analysis, planning and control. The focus shifted to Working Capital Management.

A representative work of this phase is Essays On Business Finance by Wilford J. Eitman et al.

Modern Phase

The Modern Phase began in mid 1950s and has witnessed an accelerated pace of development with the infusion of ideas from economic theory and application of quantitative methods of analysis. The distinctive features of the modern phase are:

1) The central concern of financial management is considered to be a rational matching of funds to their uses so as to maximize the wealth of the shareholders.

2) The approach of financial management has become more analytical.

3) It covers security markets and studies security analysis and portfolio management.

Modern----4) It covers fund management of government, profitable and

non-profitable social oriented institutions like educational institutions, hospitals clubs and NGOs.

5) It provides coverage to international fund flow management, foreign exchange and risk management.

6) Finance has assumed the position of a managerial function and is no longer an outsider looking approach. It deals with three decision-making areas called investment decisions, financing decisions and dividend decisions.

7) Modern financial management covers various tools and techniques of evaluation, important being, funds flow analysis, cash flow analysis, capital budgeting, cost of capital, leverages, working capital management, eva, mva and capm etc.

Scope Of Financial Management

As already discussed the scope of financial management has increased manifold i.e. from simply raising of funds to investment decisions, financing decisions and dividend decisions.

The scope of financial management may broadly be classified into five A’s viz.

1)Anticipation of the financial needs of the organization; 2)Acquisition of the necessary capital and determining the

sources of finance; 3)Allocation of funds which with the deployment of total funds

between the different components of fixed and current assets;

Scope----

4) Appropriation which basically considers the division of total earnings between the dividend distribution and retention of profits in the business and

5)Assessment which deals with the control over financial activities.

Objectives of Financial Management

Basic ObjectivesOther Objectives

Basic Objectives: 1) Profit Maximisation 2) Wealth Maximisation

Profit Maximization

Profit maximisation implies that a firm either produces maximum output for a given amount of input, or uses minimum input for producing a given output. Profit earning is the main aim of every business activity.

A business being an economic institution must earn profit to cover its costs and provide funds for growth. Profit is the measure of efficiency. Profits provide protection against risks. Accumulated profits help an organization to face market oscillations. Thus profit maximisation is considered to be the main objective of a business enterprise .Profit is considered as the most appropriate measure of a firm’s performance.

Points in favour of Profit maximisation.

Profit is a barometer through which the performance of a business unit can be gauged.

Profit ensures maximum welfare of all the stakeholders. Profit maximisation increases the confidence of management

for modernization, expansion and diversification. Profit maximisation attracts the investors to invest. Profits indicate efficient utilization of funds. Profits ensure survival during adverse business conditions.

Points Against Profit Maximisation

• It may encourage corrupt and unethical practices.• It ignores time value of money.• It does not take into account the element of risk.• It attracts cut throat competition.• Huge amount of profit may attract Government intervention.• Huge profits may invite problems from workers who may demand

increased wages and salaries.• Customers may feel exploited.• Profit maximisation may adversely affect the long term liquidity

position of the company.

Points Against----

• The term profit is vague and it cannot be defined precisely.

• The effect of dividend policy on the market price of shares is not considered.

• All said and done there is no denying the fact that no organization can ignore the aspect of profit. The point to be taken care of is that it is earned following ethical practices. The interests of all the stakeholders should be kept in mind. The point of view of the society at large should not be ignored.

Wealth Maximisation

The goals of the management should be such all the stakeholders are benefited. A financial action that has a positive NPV creates wealth for shareholders and, therefore, is desirable. Between mutually exclusive projects the one with the highest NPV should be adopted. This is referred to as the principle of value additivity. The wealth will be maximized if NPV criteria is followed in making financial decisions.

The objective of wealth maximisation takes care of the questions of the timing and risk of the expected benefits. It is important to emphasize that benefits are measured in terms of cash flows. In investment and financing decisions, it is the flow of cash that is important, not the accounting profits.

Elements Of Wealth Maximisation

• Increase in profits• Reduction in costs• Judicious choice regarding sources of funds• Minimum risk• Long term value

Points in Favour of Wealth Maximisation

• As the net present value of cash flows is considered, the net effect of investments and benefits can be measured in quantitative terms.

• It considers the concept of time value of money. The present values of cash inflows and outflows helps the management to achieve the overall objective of the company.

• It takes care of the interests of all the stakeholders.• It guides the management in formulating a consistent

dividend policy.

Points in Favour• It considers the impact of risk factor and while

calculating the NPV at a particular discount rate, adjustment is made to cover the risk that is associated with investments.

• It implies long run survival and growth of the firm.

• It leads to maximizing stockholders’ utility or value maximisation of equity shareholders through increase in stock price per share.

Point Against Wealth Maximisation• It may not be socially desirable.• There is some confusion as to whether the

objective is to maximize stockholders’ wealth or the wealth of the firm , the latter includes other financial claimholders also such as debenture holders and preference shareholders etc.

• Because of divorce between ownership and management, the latter may be more interested in maximizing managerial utility than shareholders wealth.

Risk Return Trade Off

Financial decisions incur different degrees of risk. Financial decisions of a firm are guided by the risk return trade-off. These decisions are interrelated and jointly affect the market value of its shares by influencing return and risk of the firm. The relationship between return and risk can be expressed as follows:

Return= Risk free rate+Risk premium Risk free rate is a rate obtainable from a default-free Government security.

Risk free rate is a compensation for time and risk premium for risk. Higher the risk of an action, higher will be the risk premium leading to higher required return on that action. A proper balance between return and risk should be maintained.

Risk---- To maximize the market value of a firm’s shares. Such balance is

called risk-return trade-off, and every financial decision involves this trade off.

The financial manager , in a bid to maximize shareholders’ wealth, should strive to maximize returns in relation to the given risk; he or she should seek courses of actions that avoid unnecessary risks. To ensure maximum return, funds flowing in and out of the firm should be constantly monitored to ensure that they are safeguarded and properly utilized. The financial reporting system must be designed to provide timely and accurate picture of the firm’s activities.

• All said and done, both the basic objectives of financial

management are important, though in the present day set up , wealth maximisation has emerged to be the premier.

• There is no harm in maximizing the profits, if they are earned in a fair, just, transparent and judicious manner. Profits earned by resorting to unethical, corrupt and undesirable practices are not welcome. Profits earned in a fair manner will certainly lead to the achievement of ultimate object of financial management.

Other ObjectivesEnsuring a fair return to shareholdersBuilding up reserves for growth and

expansionEnsuring maximum operational

efficiency by efficient and effective utilization of finances.

Ensuring financial discipline in the organization

Maintenance of liquid assets

Ob. Of Financial Management• Hampton has given the following objectives of financial

management:• Profit Risk Approach to Financial Management:• 1. Maximize profits;• 2. Minimize risk;• 3. Maintain control;• 4. Achieve flexibility.• Liquidity-Profitability Approach to Financial Goals:• 1. Maximize liquidity;• 2. Maximize profitability.

FINANCIAL SYSTEM• The financial system refers to a system of borrowing and

lending of funds or the demand for and supply of funds of all individuals, institutions, companies and of the Government. Financial system involves industrial finance, agricultural finance, developmental finance and Government finance.

• Functions of Financial System: Financial system performs the following interrelated functions which are essential to a modern economy: The crucial role of financial system is through saving-investment process, what we call Capital Formation. The purpose of the financial system is to mobilize the savings

•

FIN. SYSTEM• effectively and allocating the same efficiently among

the ultimate users of funds i.e. investors.• 1. It provides a payment mechanism for the exchange

of goods and services.• 2. It enables in pooling of funds for undertaking large

scale enterprises.• 3. It provides a system for spatial and temporal

transfer of resources.• 4. It provides a way for managing uncertainty and

minimizing risk.• 5. It generates information that helps in coordinating

FIN. SYSTEM• decentralized decision-making.• 6. It helps in dealing with the incentive problem when

one party has an informational advantage.• ASSETS: Broadly speaking an asset whether tangible or

intangible is any possession that has value in exchange. A tangible asset is one the value of which depends on its physical properties. The examples of such assets are Land and Building, Plant and Machinery and vehicles etc. An intangible asset represents claim to some future benefits. Financial assets, for instance, are intangible assets as they represent claims to future cash flows.

FIN. SYSTEM• The entity that offers future cash flows is called the

Issuer of the financial asset and the owner of the financial asset is called the Investor. Financial assets are traded in the financial market and generally include the following:

• Cash and Bank balance(coins, notes and bank balance)• Securities:• i) Debt(short term such as bank overdraft and trade

credit etc. and long term such as bonds, mortgages and debentures etc.)

• Ii) Equity

FIN. SYSTEM• In case of a debt security the owner is generally entitled

to a fixed amount whereas in equity the entitlement in on the residual amount.

• In recent years, however, there has been a proliferation in the range of financial assets/products which are available in the financial market. These include Derivatives which generally include Futures and Options. Derivatives are financial assets whose values are derived from the underlying assets such as shares, bonds, commodities and properties etc. They are used either as hedging (reduction of risk) or speculative instruments.

Production MarketingFinance

Finance function is the most important of all business functions.

Business Activities

Areas of finance

Financial services

Financial management

Financial services is concerned with the design and delivery of advice and financial products to individuals, businesses and governments.

Financial management is concerned with the duties of the financial managers in the business firm.

Financial management is an applied branch of management that looks after the finance function of a business.

“Financial management is the operational activity of the business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations”.

Financial Management

• Financial management deals with how the corporation obtains the funds and how it uses them”-- Hoagland

Financial Management

• Financial management emerged as a distinct field of study at the turn of 20th century. Its evolution can be divided into three broad phases:

Evolution

Traditional

Transitional

Modern

Traditional phase lasted for about four decades. Following were its important features:

1) The focus of financial management was mainly on certain episodic events like formation, issuance of capital, major expansion, merger, reorganization and liquidation in the lifecycle of the firm.

2) The approach was mainly descriptive and institutional.

3) The approach placed great emphasis on long term problems.

4) Financial management was not considered to be a managerial function.

Traditional Phase

• The Transitional Phase began around the early 1940s and continued through the early 1950s.

• Nature of financial management during was similar to that of the traditional phase.

• Greater emphasis was placed on the day-to-day problems faced by financial managers in the areas of funds analysis, planning and control.

Transitional Phase

The distinctive features of the modern phase are:1) The central concern is considered to be a rational

matching of funds to their uses so as to maximize the wealth of the shareholders.

2) The approach is more logical.

3) Covers security markets and studies security analysis and portfolio management.

Modern Phase

Traditional Approach

• Procurement of funds needed by business

• Utilization of funds beyond its purview

Modern approach

•Includes both raising of funds as well as effective utilization.•Finance function does not stop only by raising funds.

Thus, the new approach is an analytical way of dealing with financial problems of a firm.

Scope of financial management

Estimating Financial RequirementsDeciding capital StructureSelecting a Source of FinanceSelecting a pattern of InvestmentCash ManagementImplementing Financial ControlsProper use of Surpluses

Investment Decision

Dividend

Decision

Financing Decision

Liquidity

Decision

Functions of financial management

Business Activities

Raising funds

• Financing decision

Investing in assets

• Investment decision

Distributing returns

• Dividend decision

Balancing flows

• Liquidity Function

There exists an inseparable relationship between finance on one hand and other functional areas on the other. All business activities, directly or indirectly, involve the acquisition and use of funds. This finance function though has a significant effect on other functions yet it need not necessarily limit or constraint the normal functioning of the enterprise.

The functions of raising funds, investing them in assets, distributing returns earned from assets to stakeholders and attempting to balance cash flows are respectively called:1) Financing decision2) Investment decision3) Dividend decision4) Liquidity decision

Finance Function

This decision is concerned with, where from and how to acquire funds. The central issue is the determination of appropriate proportion of debt and equity. An attempt has to be made to have optimal capital structure which means maximizing the value of shares.

The use of debt may increase the return and risk for shareholders and hence, a proper balance has to be struck between return and risk.

Financing Decisions

A firm’s investment decision involves capital expenditure, which is generally referred to as capital budgeting. There are two important aspects of investment decisions: a) The evaluation of the prospective profitability of new investments; b) The measurement of a cut-off rate against which the prospective return of the new investments could be compared. Risk in investment arises because of uncertain returns. Investment proposals should be evaluated in terms of expected return and risk. There is a broad agreement that the correct cut-off rate is the opportunity cost of capital.

Investment Decisions

A finance manager is confronted with a problem that whether a firm should distribute whole of the profits earned or retain them or distribute a part and retain the balance. Called, dividend policy, it should be designed in terms of its impact on the shareholders wealth. A desirable dividend policy is one which maximizes the market value of the firm’s shares. As far as possible a firm should try to have a stable dividend policy.Dividend is generally paid in cash or in form of Bonus shares.

Dividend Decision

Investment in current assets affects the firm’s profitability and liquidity. Current assets should be managed efficiently for safeguarding the firm against ill-effects of illiquidity. A conflict generally exists between profitability and liquidity while managing current assets and an all out effort has to be made to have a trade-off between the two. For ensuring such a trade-off the finance manager has to develop sound techniques of managing current assets. In this context precise estimates regarding current assets have to be worked out and it has to be made certain that funds are made available when required.

Liquidity Decision

Objectives of Financial Management

Basic ObjectivesOther Objectives

Basic Objectives: 1) Profit Maximisation 2) Wealth Maximisation

Profit Maximization Profit maximization implies that a firm either produces

maximum output for a given amount of input, or uses minimum input for producing a given output. Profit earning is the main aim of every business activity.

A business being an economic institution must earn profit to cover its costs and provide funds for growth. Profit is the measure of efficiency. Profits provide protection against risks. Accumulated profits help an organization to face market oscillations. Thus profit maximization is considered to be the main objective of a business enterprise .Profit is considered as the most appropriate measure of a firm’s performance.

Points in favour of Profit maximisation.

Profit is a barometer through which the performance of a business unit can be measured.

Profit ensures maximum welfare of all the stakeholders.

Profit maximization increases the confidence of management for modernization, expansion and diversification.

Profit maximization attracts the investors to invest.

Profits indicate efficient utilization of funds.

Profits ensure survival during adverse business conditions.

Points Against Profit Maximisation• It may encourage corrupt and unethical practices.• It ignores time value of money.• It does not take into account the element of risk.• It attracts cut throat competition.• Huge amount of profit may attract Government

intervention.• Huge profits may invite problems from workers who

may demand increased wages and salaries.• Customers may feel exploited.• Profit maximization may adversely affect the long term

liquidity position of the company.

Points Against----

• The term profit is vague and it cannot be defined precisely.

• The effect of dividend policy on the market price of shares is not considered.

• All said and done there is no denying the fact that no organization can ignore the aspect of profit. The point to be taken care of is that it is earned following ethical practices. The interests of all the stakeholders should be kept in mind. The point of view of the society at large should not be ignored.

Wealth Maximisation The goals of the management should be such all the

stakeholders are benefited. A financial action that has a positive NPV creates wealth for shareholders and, therefore, is desirable. Between mutually exclusive projects the one with the highest NPV should be adopted. This is referred to as the principle of value additivity. The wealth will be maximized if NPV criteria is followed in making financial decisions.

The objective of wealth maximization takes care of the questions of the timing and risk of the expected benefits. It is important to emphasize that benefits are measured in terms of cash flows. In investment and financing decisions, it is the flow of cash that is important, not the accounting profits.

Elements Of Wealth Maximisation

• Increase in profits• Reduction in costs• Judicious choice regarding sources of

funds• Minimum risk• Long term value

Points in Favour of Wealth Maximisation

• As the net present value of cash flows is considered, the net effect of investments and benefits can be measured in quantitative terms.

• It considers the concept of time value of money. The present values of cash inflows and outflows helps the management to achieve the overall objective of the company.

• It takes care of the interests of all the stakeholders.• It guides the management in formulating a

consistent dividend policy.

Points in Favour• It considers the impact of risk factor and while

calculating the NPV at a particular discount rate, adjustment is made to cover the risk that is associated with investments.

• It implies long run survival and growth of the firm.

• It leads to maximizing stockholders’ utility or value maximization of equity shareholders through increase in stock price per share.

Point Against Wealth Maximisation• It may not be socially desirable.• There is some confusion as to whether the

objective is to maximize stockholders’ wealth or the wealth of the firm , the latter includes other financial claimholders also such as debenture holders and preference shareholders etc.

• Because of divorce between ownership and management, the latter may be more interested in maximizing managerial utility than shareholders wealth.

Risk Return Trade Off Financial decisions incur different degrees of risk.

Financial decisions of a firm are guided by the risk return trade-off. These decisions are interrelated and jointly affect the market value of its shares by influencing return and risk of the firm. The relationship between return and risk can be expressed as follows:

Return= Risk free Rate+ Risk premium Risk free rate is a rate obtainable from a default-free

Government security. Risk free rate is a compensation for time and risk premium for risk. Higher the risk of an action, higher will be the risk premium leading to higher required return on that action. A proper balance between return and risk should be maintained.

Risk---- To maximize the market value of a firm’s shares. Such

balance is called risk-return trade-off, and every financial decision involves this trade off.

The financial manager , in a bid to maximize shareholders’ wealth, should strive to maximize returns in relation to the given risk; he or she should seek courses of actions that avoid unnecessary risks. To ensure maximum return, funds flowing in and out of the firm should be constantly monitored to ensure that they are safeguarded and properly utilized. The financial reporting system must be designed to provide timely and accurate picture of the firm’s activities.

• All said and done, both the basic objectives of

financial management are important, though in the present day set up , wealth maximization has emerged to be the premier.

• There is no harm in maximizing the profits, if they are earned in a fair, just, transparent and judicious manner. Profits earned by resorting to unethical, corrupt and undesirable practices are not welcome. Profits earned in a fair manner will certainly lead to the achievement of ultimate object of financial management.

Other Objectives

Ensuring a fair return to shareholdersBuilding up reserves for growth and

expansionEnsuring maximum operational

efficiency by efficient and effective utilization of finances.

Ensuring financial discipline in the organization

Maintenance of liquid assets

Objectives Of Financial Management• Hampton has given the following objectives of

financial management:Profit Risk Approach to Financial Management:• 1. Maximize profits;• 2. Minimize risk;• 3. Maintain control;• 4. Achieve flexibility.

Liquidity-Profitability Approach to Financial Goals:• 1. Maximize liquidity;• 2. Maximize profitability.

Capital Market

Capital Market

• Institutional arrangement for lending and borrowing of long term funds.

• Consists of series of channels through which the savings of the community are made available for industrial and commercial enterprises and public authorities.

Functions

• Mobilization of financial resources on a nation wide scale.

• Leads to economic growth at a faster rate.

• Directs the flow of savings into most profitable channels

Primary Market Or New Issue Market

• Primary market is a market for raising long term sources of finance.

• New securities that have never been previously issued are offered.

• Both the new and existing companies can raise capital from this market.

• Facilitate the transfer of funds from willing investors to entrepreneurs setting up new companies or going in for expansion, growth or modernization.

Securities dealt in primary market

Securities

Ownership securities

Equity Shares

Preference shares

No par stoc

k

Creditorship securities

Debentures

Ownership securities

1. Equity Shares

• Equity shareholders are the real owners of the company.• Have a control over the working of the company.• Paid dividend after paying it to preference shareholders.• Rate of dividend depend upon the profits of the

company.• No dividend in case of no profits.• Cannot be redeemed during the lifetime of the company.

Characteristics of equity shares

Maturity Right to income

Claims on assets Voting rights

Pre-emptive right

2. Preference Shares• These shares have certain preferences as compared to

other types of shares.• Fixed rate of dividend is paid on preference share capital.

2 Preferences

Preference for payment of dividend

Features of preference shares

Features

Maturity

Claims on

incomeControl

Claims on

assets

Types of preference shares• Cumulative preference

shares• Non-cumulative

preference shares• Convertible preference

shares• Non-Convertible

preference shares• Redeemable preference

shares• Irredeemable preference

shares• Participating preference

shares• Non-Participating

preference shares

3. No Par Stock• Shares having no face value• Capital of the company issuing such shares is divided into a

number of specified shares without any specific denomination• Share certificate of the company states number of shares held

by the owner without mentioning any face value• Value of such share determined by dividing the real net worth

of the company with the total number of shares of the company

• Dividend is paid on per share

Creditorship securities

Debentures or Bonds

• It is a document under the company’s seal which provides for the payment of a principal sum and interest thereon at regular intervals.

• Debenture holder is the creditor of the company.• A fixed rate of dividend is paid on the debentures.

Types of Debentures

Unsecured debentures

Secured debentures

Bearer debentures

Redeemable debentures

Convertible debentures

Irredeemable debentures

Features of Debentures

Maturity

Claims on income

Claims on assets

Control