Assignment on

Topic: Common Terms of Finance

Submitted to:

Mohammad Kamrul Ahsan

Assistant Professor

Department of Business Administration

Metropolitan University, Sylhet

Submitted by:

Marzana Akther

BBA 41st (Finance & Banking)

ID: 171-116-035

Department of Business Administration

Metropolitan University, Sylhet

Submission date:

20th August, 2020

1. What is Finance?

Finance is defined as money management and involves practices such as savings,

borrowing, lending, budgeting, saving and forecasting. Finance also involves

supervision, growth, and debt, finance, credit, investment, properties, and financial-

system liabilities analysis.

2. What are the responsibilities of financial Manager? And function of financial Manager.

Major decisions of finance.

Responsibilities:

Preparation of financial statements, analyzes, and assessments of operating activities.

Track financial details to ensure that regulatory criteria are met. Supervises staff who

report expenses and prepare budgets. Study company tax reports and look for ways to

cut costs. Analyze trends in the market to identify prospects for growing or purchasing

other companies.

Functions:

 Estimating the necessary amount of Capital.

 Determining the nature of property.

 Choice of Fund Sources.

 Acquisition of Money.

 Using the Funds.

 Gain or excess disposal.

 Money Management.

 Economic Supervision.

Decisions:
 Investment Decision, Financing Decision, Dividend Decision, Working Capital

Management Decision.

3. What is leverage?

Leverage results from the use of borrowed capital as a source of funding when investing

in expanding the asset base of the company and through venture capital returns. Leverage

is an investment technique to use borrowed money — specifically, the use of various

financial instruments or borrowed capital — to maximize the future return on an

investment. Leverage can also refer to the amount of debt a firm uses to finance assets.

4. What is capital structure?

The capital structure is the specific combination of the debt and equity of a business to

fund its overall operations and growth. Debt comes in the form of bond issues or loans,

while equity can come in the form of common stock, preferred stock, or retained

earnings. Short-term debt is also used as a part of the capital structure.

5. What is retained earnings and Dividend policy?

Retained earnings (RE) is the amount of net income left to the company after dividends

paid out by its owners. A business creates earnings that can either be positive (revenue)

or negative (loss).

A dividend policy is the method that a company uses to coordinate its dividend payout

to shareholders. When a corporation makes a profit they need to decide what to do with

it. They can either retain the company earnings, or they can distribute the money to

shareholders in the form of dividends.

6. What is Annuity and perpetuity?

 An annuity is an arrangement between you and a corporation in which you make a lump-

sum payment or sequence of payments and receive monthly disbursements in exchange,

starting either immediately or in the future at any time.

A perpetuity is a kind of annuity that endures indefinitely, to perpetuity. The cash flow

stream persists for an indefinite time span.

7. What is time Value of money?

The time value of money is a basic financial principle that makes money worth more than

the same amount of money that will be earned in the present in the future. This is true because

you can spend and earn a return on the money you have right now, thereby generating a

larger amount of capital in the future. The net present value (NPV) of money is also called

the time value of the asset.

8. What is loan amortization?

A loan amortization is where the principal of the debt is paid down in compliance with an

amortization schedule over the life of the loan (that is, amortized), usually by equivalent

payments.

9. What is present value and Future Value?

Present value (PV) is the current value of a future sum of money or stream of cash flows

given a specified rate of return.

Future value refers to the money value at some future time of a present amount of money

or a series of payment.

10. Short note: common stock, debenture, preferred stock, bond, mortgage
 Common stock is a security representing ownership within a corporation. After

shareholders, bondholders, and preferred stockholders are compensated, common

stockholders obtain whatever assets remain in a liquidation.

A debenture is a form of collateral-unsecured bond or other debt instrument. Since

debentures do not have collateral protection, debentures must depend on the

creditworthiness and the issuer's credibility for support.

Preferred stock is a type of stock that promises a fixed dividend. It has preference over

common stock in the payout of dividend and claim on assets but exempted from voting

right regarding the management of the organization.

Bond is an instrument through which an investor lends money to an entity that borrows

the funds for a definite period of time at a fixed interest rate.

A mortgage, or more specifically a mortgage loan, is a long term loan used to fund real

estate transactions. As the creditor, or mortgager, you are repaying the lender, or

mortgagee, the principal of the loan plus interest, slowly building your equity in the

house.

11. What is IRR, NPV, average rate of return? If NPV = 0, what is your decision or what

happen then?

IRR or internal Rate of Return is a discounted method. The IRR of a project is the

discount rate which makes its NPV equal to zero. It is the discount rate which equals the

sum of present value of future cash flows with the initial investment.

NPV or Net Present Value is the classic economic method of evaluating the investment

proposals. It is one of the most important discounted methods explicitly recognizing the

time value of money.

 ARR or Average Rate of Return attempts to calculate a rate of return rather than

determining the time necessary to recapture the original investment. It considers both the

amount and the profits generated.

If NPV=0 then we should invest in the project. Positive NPV investments increases

wealth. Even if the NPV is zero, the project should be accepted.

12. What is camels rating? Its scale?

CAMELS is an international rating system used by regulatory banking authorities to rate

financial institutions, according to the six factors represented by its acronym. The

CAMELS acronym stands for "Capital adequacy, Asset quality, Management, Earnings,

Liquidity, and Sensitivity."

The rating system is on a scale of one to five, with one being the best rating and five

being the worst rating.

 A scale of 1 implies that a bank exhibits a robust performance, is sound, and

complies with risk management practices.

 A scale of 2 means that an institution is financially sound with moderate

weaknesses present.

 A scale of 3 suggests that the institution shows a supervisory concern in several

dimensions.

 A scale of 4 indicates that an institution has unsound practices, thus is unsafe due

to serious financial problems.

 A rating of 5 shows that an institution is fundamentally unsound with inadequate

risk management practices.

13. Decision rules of NPV, IRR, PBP, and ARR.

NPV:

Invest if NPV ≥ 0

Do not invest if NPV < 0

If NPV=0 then we should invest in the project. Positive NPV investments increases

wealth, whereas negative NPV investments decreases wealth. Even if the NPV is zero,

the project should be accepted. A zero NPV implies that project generates cash flows at

a rate just equal to the cost of capital.

IRR:

Invest if IRR ≥ r

Do not invest if < r

If the required rate of return is the return investors expect the firm to earn on the project,

accepting a project with an internal rate of return in excess of the required rate of return

should result in an increase in the market price of share. This is because the firm accepts

a project with a return greater than required to maintain the present market price per

share.

PBP:

If the payback period calculated is less than some maximum acceptable payback period,

the proposal is accepted. If the payback period exceeds the acceptable payback period,

the proposal is rejected.

ARR:

Accept if actual ARR ≥ projected ARR

Do not accept if actual ARR < projected ARR

 Many firms use ARR to accept or reject criterion as well as a method of ranking projects.

As a ranking method, it gives the highest ranking to the project which has the greatest

ARR and lower ranking to the project with lower ARR. The minimum acceptable rate

of ARR is determined by management.

14. What is ROI; ROE?

Return on Investment (ROI) is a success metric used to determine an investment’s

efficacy or to compare the productivity of a variety of different investments. ROI aims

to calculate explicitly the amount of return on a single investment, compared to the cost

of the investment.

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡𝑠 ( 𝑎𝑓𝑡𝑒𝑟 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥 )

Formula: ∗ 100
Shareholder′ sfund or investments

Return on equity (ROE) is a financial performance metric determined by dividing the

net profits by the equity of the shareholders. Because the equity of the shareholders is

equal to the assets of a company less its debt, the return on net assets is considered to be

ROE.

𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒
Formula: Shareholder′ 𝑠 𝑒𝑞𝑢𝑖𝑡𝑦

15. What is EPS, Operating Profit, EBIT, CAPM, and BEP?

The amount earned during the period on behalf of each outstanding share of common

stock, calculated by dividing the period’s total earnings available for the firm’s common

stockholders by the number of shares of common stock outstanding.

Operating profit refers to the measuring of the profits of a company generates from its

core business functions, where the deduction of interest and taxes is excluded from the

calculation
 EBIT (earnings before interest and taxes) is the net income of an enterprise before

deducting income tax expenses and interest expenses. EBIT is used to analyze the

performance of the core operations of a company without the costs of capital structure

and tax expenditures that impact profit.

CAPM or The Capital Asset Pricing Model (CAPM) describes the relationship between

systematic risk, particularly stocks, and expected return on assets. CAPM is commonly

used in finance to price volatile securities and to achieve projected returns on assets due

to the risk of these assets and capital costs.

Break-even point (BEP) is a term that refers to the situation where the revenues and

expenses of a company were equal within a given period of time. This means that the

company did not have net income or net losses-it "broke even." BEP may also refer to

the revenues to be attained to compensate for the expenses incurred during a specific

period.

16. If you discount by the IRR, what will be the result of NPV?

If you discount by the IRR then the NPV will be equal to zero.

17. What is financial statement?

Financial statements are reports prepared by a company’s management to present the

financial performance and position at a point in time.

18. What is DFL, DOL and DTL?

A degree of financial leverage (DFL) is a leverage ratio that measures the sensitivity of

a company’s earnings per share (EPS) to fluctuations in its operating income, as a result

of changes in its capital structure.

 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐸𝑃𝑆
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐸𝐵𝐼𝑇

The degree of operating leverage (DOL) is a multiple that measures how much the

operating income of a company will change in response to a change in sales.

𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐸𝐵𝐼𝑇

𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑠𝑎𝑙𝑒𝑠

If we combine a company’s degree of operating leverage with its degree of financial

leverage, we get the degree of total leverage (DTL), which is a measure of the sensitivity

of the company’s net income to changes in the number of units produced and sold.

𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐸𝑃𝑆

𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑠𝑎𝑙𝑒𝑠

19. What do you mean DFL, DOL =1?

Whenever the percentage change in EPS resulting from a given percentage change in

EBIT is greater than the percentage change in EBIT, financial leverage exists. In other

words, whenever DFL is greater than or equal to 1, there is financial leverage.

Whenever the percentage change in EBIT resulting from a given percentage change in

sales is greater than the percentage change in sales, operating leverage exists. In other

words, as long as DOL is greater than or equal to 1, there is operating leverage.

20. Acid test ratio and its formula.

Acid test or Quick ratio, a supplementary to the current ratio. The Acid test ratio is a

more severe and stringent test of a firm’s ability to pay short-term obligations as and

when they become due.

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡−𝐼𝑛𝑣𝑒𝑠𝑛𝑡𝑜𝑟𝑦
Acid test ratio =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

21. Leverage ratio and its formula.

 A leverage ratio indicates the level of debt incurred by a business entity against several

other accounts in its balance sheet, income statement, or cash flow statement.

𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝑇𝑜𝑡𝑎𝑙 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟 ′ 𝑠 𝐸𝑞𝑢𝑖𝑡𝑦

22. Debt ratio and its formula.

The debt ratio measures the proportion of total assets financed by the firm’s creditors.

The higher this ratio, the greater the amount of other people’s money being used to

generate profits.

𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Debt Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

23. Total Asset Turnover ratio and its formula.

The asset turnover ratio measures the value of a company's sales or revenues relative to

the value of its assets.

𝑆𝑎𝑙𝑒𝑠
Total Asset Turnover = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

24. Stock turnover ratio and its formula.

Stock turnover ratio is used to measure whether the investment in stock in trade is

effectively utilized or not. It reveals the relationship between sales and cost of goods

sold or average inventory at cost price or average inventory at selling price. It indicates

the number of times the stock has been turned over in business during a particular period.

𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑 𝑁𝑒𝑡 𝑠𝑎𝑙𝑒𝑠

Stock Turnover Ratio = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑎𝑡 𝐶𝑜𝑠𝑡 𝑜𝑟 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

25. Current ratio and its formula.

Current ratio establishes the relationship between current asset and current liabilities. It

attempts to measure the ability of a firm to meet its current obligations.

 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
Current ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

26. Standard deviation =1 and Beta =1, what does it mean?

A large standard deviation (≥1), which is the square root of the variance, indicates that

the data points are far from the mean, and a small standard deviation (<1) indicates that

they are clustered closely around the mean.

A beta greater than 1 indicates a stock's price swings more wildly than most stocks. A

beta of 1 or lower indicates that a stock's price is steadier than most stocks.

27. What do you mean risk and return?

Risk refers to the variability of possible returns associated with a given investment. Risk,

along with the return, is a major consideration in capital budgeting decisions. The firm

must compare the expected return from a given investment with the risk associated with

it. Higher levels of return are required to compensate for increased levels of risk. In other

words, the higher the risk undertaken, the more ample the return – and conversely, the

lower the risk, the more modest the return.

28. What do you mean Standard deviation?

The standard deviation measures the dispersion of an investment’s return around the

expected return. It is most common statistical indicator of an asset’s risk.

29. What do you mean systematic and unsystematic risk?

Systematic risk is that portion of total risk which affects invariably all the firms operating

in the same environment. It highlights the possibility of a collapse of the entire financial

system or the stock market causing a catastrophic impact on the entire system in the

country.
 Unsystematic risk is a portion of total risk of an investment is affected by factors those

are only related to a particular company. It is the threat related to a specific security or a

portfolio of securities.

30. What is Beta?

Beta is a measure of the systematic risk of an investment arising from exposure to general

market movements.

31. What are the indicators of a failed Bank?

 Funding issues

 Asset/liability mismatch

 Regulatory issues

 Proprietary trading

 Non-bank activities

 Inappropriate loans to bank insiders

32. What is deposit and types of deposit?

A deposit is a financial term that means money held at a bank. A deposit is a transaction

involving a transfer of money to another party for safekeeping.

There are two types of deposits: demand and time. A demand deposit is a conventional

bank and savings account. You can withdraw the money anytime from a demand deposit

account. Time deposits are those with a fixed time and usually pay a fixed interest rate,

such as a certificate of deposit.

33. What is capital?

 Capital is a term for financial assets, such as funds held in deposit accounts and/or funds

obtained from special financing sources. Capital can also be associated with capital

assets of a company that requires significant amounts of capital to finance or expand.

34. What is financial market? Define primary and secondary market.

Market that transfer funds from those who have excess fund to those who need funds. A

financial market is a broad term describing any marketplace where buyers and sellers

participate in the trade of assets such as equities, bonds, currencies.

Primary market is where new securities are issued and sold through private placement

on IPO (Initial Public Offering).

Secondary market is the market where primary markets securities or existing securities

are sold.

35. Short note: money and capital market

Money market basically refers to a section of the financial market where financial

instruments with high liquidity and short-term maturities are traded.

Capital Market is where long term (more than 1 year) financial instruments are being

transacted. In other words, capital market is the market for buying and selling equity and

debt instruments.

36. Define Investment.

Investment is the act of allocating resources, usually money, with the expectation of

generating an income or profit. You can invest in endeavors, such as using money to

start a business, or in assets, such as purchasing real estate in hopes of reselling it later

at a higher price.

37. What is IPO?

 An Initial Public Offering or IPO is the first time that the stock of a private company is

offered to the public. IPOs are often issued by smaller, younger companies seeking

capital to expand, but they can also be done by large privately-owned companies looking

to become publicly traded.

38. Define Spot rate, bid price and Ask price.

The spot rate is the price quoted for immediate settlement on a commodity, security or

currency.

The bid price refers to the highest price a buyer will pay for a security.

The ask price refers to the lowest price a seller will accept for a security.

39. What do you mean reserve?

Reserves are the cash minimums that must be kept on hand by financial institutions in

order to meet central bank requirements. The bank cannot lend the money but must keep

it in the vault, on-site or at the central bank, in order to meet any large and unexpected

demand for withdrawals.

40. What is primary and secondary reserve?

Primary reserves are the minimum amount of cash required to operate a bank. Primary

reserves also include the legal reserves that are housed in a Federal Reserve or other

correspondent bank.

Assets invested in short-term marketable securities, usually Treasury bills and short-term

government securities. Legal reserve kept in a Central Reserve Bank don't earn interest,

but secondary reserves are a source of supplemental liquidity. These earn interest and

can be used to adjust a bank's reserve position.

41. What Is Letter of Credit (L/C)?

 A letter of credit is a letter from a bank guaranteeing that a buyer's payment to a seller

will be received on time and for the correct amount. In the event that the buyer is unable

to make a payment on the purchase, the bank will be required to cover the full or

remaining amount of the purchase. It may be offered as a facility.

42. Define SLR ratio. What is the Rate of SLR ratio for Bangladesh?

Banks are required to maintain liquid assets in the form of cash, gold and unencumbered

approved securities. The amount of liquid asset need to reserve in the bank is SLR ratio.

At present, the required SLR is 13% daily for conventional banks and 5.5% daily for

Islamic Shari'ah-based banks.

43. What is liquidity?

Liquidity refers to the ease with which an asset, or security, can be converted into ready

cash without affecting its market price

44. What is 5C and 5R?

The five Cs is a system used by lenders to gauge the creditworthiness of potential

borrowers. The system weighs five characteristics of the borrower and conditions of the

loan, attempting to estimate the chance of default and, consequently, the risk of a

financial loss for the lender. The five Cs are character, capacity, capital, collateral, and

conditions.

5R are Risk, Relativity, Reflexive, Recent, and Regret.

45. What is Loan?

Loan is the lending of money by one or more individuals, organizations, or other entities

to other individuals, organizations etc.

46. What is money laundering?

 Money laundering is the illegal process of making large amounts of money generated by

a criminal activity, such as drug trafficking or terrorist funding, appear to have come

from a legitimate source. The money from the criminal activity is considered dirty, and

the process launders it to make it look clean.

47. What do you mean call money, Black money and White money?

Call money is a short-term, interest-paying loan from one to 14 days made by a financial

institution to another financial institution.

Black money is money earned through any illegal activity controlled by country

regulations. Black money proceeds are usually received in cash from underground

economic activity and, as such, are not taxed. Recipients of black money must hide it,

spend it only in the underground economy, or attempt to give it the appearance of

legitimacy through money laundering.

White money is opposite to black money that is earned legally.

48. What is CAMPARI and PARSAR?

The CAMPARI method stands for

 Character

 Ability

 Means

 Purpose

 Amount

 Repayment

 Insurance
 The principles it outlines are used by banks and investors worldwide. It’s an easy way

of making sure that you are fully prepared when you apply for any business finance –

maximizing your chance of securing the funds you need.

PARSAR or The parabolic SAR attempts to give traders an edge by highlighting the

direction an asset is moving, as well as providing entry and exit points.

49. What is clearing house and electronic clear house?

A clearing house acts as an intermediary between a buyer and seller and seeks to ensure

that the process from trade inception to settlement is smooth. Its main role is to make

certain that the buyer and seller honor their contract obligations.

An electronic clearing house is a computer-based electronic network for processing

transactions, usually domestic low value payments, between participating financial

institutions.

50. Difference between debit and credit card?

Credit cards give you access to a line of debt issued by a bank. Debit cards deduct money

directly from your bank account. Credit cards offer better consumer protection through

warranties and fraud protection but are costlier. Debit cards offer less protection, but

they have lower fees. Newer debit cards offer more credit-card-like protection, while

many credit cards no longer charge annual fees.

51. Short note: Home Banking and Mobile Banking.

Home banking is a service that enables a bank client to handle his accounts from a

computer from a place selected in advance, at home or in the office.

 Mobile banking is a service provided by a bank or other financial institution that allows

its customers to conduct financial transactions remotely using a mobile device such as a

smartphone or tablet.

52. What is the basic difference between traditional and Islamic Banking?

The basic difference between traditional and Islamic banking is that an Islamic bank

promotes and encourage Islamic principles and traditional banks are profit-making

organizations that generally aren’t based on religious principles. That said, earning

money is also a primary function of an Islamic commercial bank. Although the bank has

a specific religious purpose, it can’t serve that purpose unless it also meets the objective

of earning money.

53. What is credit risk?

Credit risk is the possibility of a loss resulting from a borrower's failure to repay a loan

or meet contractual obligations. Traditionally, it refers to the risk that a lender may not

receive the owed principal and interest, which results in an interruption of cash flows

and increased costs for collection.

54. What is Electronic banking?

Electronic banking is a form of banking in which funds are transferred through an

exchange of electronic signals rather than through an exchange of cash, checks, or other

types of paper documents.

55. Define bank rate and call money rate.

A bank rate is the interest rate at which a nation's central bank lends money to domestic

banks, often in the form of very short-term loans. Managing the bank rate is a method

by which central banks affect economic activity.

 The call money rate is the interest rate on a type of short-term loan that banks give to

brokers who in turn lend the money to investors to fund margin accounts.

56. Father of finance.

The father of Modern Finance is none other than Dr. Eugene Fama.

57. What is CAPM? Who is the father of CAPM model? Which year he got Novel prize and

which sector?

The CAPM or Capital Asset Pricing Model expressed that the expected return of a

security or a portfolio equals the risk-free rate plus a risk premium.

William Sharpe (1964) published the capital asset pricing model (CAPM). Parallel work

was also performed by Treynor (1961) and Lintner (1965). The model extended Harry

Markowitz’s portfolio theory to introduce the notions of systematic and specific risk.

For his work on the capital asset pricing model, Sharpe shared the 1990 Nobel Prize in

Economics with Harry Markowitz and Merton Miller.