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Financial market

n economics, a financial market is a mechanism that allows people to buy and sell (trade) financialsecurities (such as stocks and bonds), commodities (such
as precious metals or agricultural goods), and other fungible items of value at low transaction costs and at prices that reflect the efficient-market hypothesis.

Both general markets (where many commodities are traded) and specialized markets (where only one commodity is traded) exist. Markets work by placing
many interested buyers and sellers in one "place", thus making it easier for them to find each other. An economy which relies primarily on interactions between
buyers and sellers to allocate resources is known as a market economy in contrast either to a command economy or to a non-market economy such as a gift
economy.

In finance, financial markets facilitate:

 The raising of capital (in the capital markets)

 The transfer of risk (in the derivatives markets)

 The transfer of liquidity (in the money markets)

 International trade (in the currency markets)

– and are used to match those who want capital to those who have it.

Typically a borrower issues a receipt to the lender promising to pay back the capital. These receipts aresecurities which may be freely bought or sold. In return
for lending money to the borrower, the lender will expect some compensation in the form of interest or dividends.

In mathematical finance, the concept of a financial market is defined in terms of a continuous-time Brownian motion stochastic process.
Definition

In economics, typically, the term market means the aggregate of possible buyers and sellers of a certain good or service and the transactions between them.

The term "market" is sometimes used for what are more strictly exchanges, organizations that facilitate the trade in financial securities, e.g., a stock
exchange or commodity exchange. This may be a physical location (like the NYSE) or an electronic system (like NASDAQ). Much trading of stocks takes place
on an exchange; still, corporate actions (merger, spinoff) are outside an exchange, while any two companies or people, for whatever reason, may agree to sell
stock from the one to the other without using an exchange.

Trading of currencies and bonds is largely on a bilateral basis, although some bonds trade on a stock exchange, and people are building electronic systems for
these as well, similar to stock exchanges.

Financial markets can be domestic or they can be international.


Types of financial markets

The financial markets can be divided into different subtypes:

 Capital markets which consist of:

 Stock markets, which provide financing through the issuance of shares or common stock, and enable the subsequent trading thereof.

 Bond markets, which provide financing through the issuance of bonds, and enable the subsequent trading thereof.

 Commodity markets, which facilitate the trading of commodities.

 Money markets, which provide short term debt financing and investment.

 Derivatives markets, which provide instruments for the management of financial risk.

 Futures markets, which provide standardized forward contracts for trading products at some future date; see also forward market.

 Insurance markets, which facilitate the redistribution of various risks.

 Foreign exchange markets, which facilitate the trading of foreign exchange.

The capital markets consist of primary markets and secondary markets. Newly formed (issued) securities are bought or sold in primary markets. Secondary
markets allow investors to sell securities that they hold or buy existing securities.The transaction in primary market exist between investors and public while
secondary market its between investors
Raising the capital

To understand financial markets, let us look at what they are used for, i.e. what where firms make the capital to invest

Without financial markets, borrowers would have difficulty finding lenders themselves. Intermediaries such as banks help in this process. Banks take deposits
from those who have money to save. They can then lend money from this pool of deposited money to those who seek to borrow. Banks popularly lend money
in the form of loans and mortgages.

More complex transactions than a simple bank deposit require markets where lenders and their agents can meet borrowers and their agents, and where
existing borrowing or lending commitments can be sold on to other parties. A good example of a financial market is a stock exchange. A company can raise
money by selling shares to investors and its existing shares can be bought or sold.

The following table illustrates where financial markets fit in the relationship between lenders and borrowers:
Relationship between lenders and borrowers

Financial Financial
Lenders Borrowers
Intermediaries Markets

Individuals Banks Interbank Individuals


Companies Insurance Companies Stock Exchange Companies
Pension Funds Money Market Central Government
Bond Market Municipalities
Mutual Funds
Foreign Exchange Public Corporations

Lenders

Who have enough money to Lend or to give someone money from own pocket at the condition of getting back the principal amount or with some interest or
charge, is the Lender.
Individuals & Doubles

Many individuals are not aware that they are lenders, but almost everybody does lend money in many ways. A person lends money when he or she:

 puts money in a savings account at a bank;

 contributes to a pension plan;

 pays premiums to an insurance company;

 invests in government bonds; or

 invests in company shares.


Companies

Companies tend to be borrowers of capital. When companies have surplus cash that is not needed for a short period of time, they may seek to make money
from their cash surplus by lending it via short term markets called money markets.

There are a few companies that have very strong cash flows. These companies tend to be lenders rather than borrowers. Such companies may decide to
return cash to lenders (e.g. via a share buyback.) Alternatively, they may seek to make more money on their cash by lending it (e.g. investing in bonds and
stocks.)
Borrowers

Individuals borrow money via bankers' loans for short term needs or longer term mortgages to help finance a house purchase.

Companies borrow money to aid short term or long term cash flows. They also borrow to fund modernisation or future business expansion.

Governments often find their spending requirements exceed their tax revenues. To make up this difference, they need to borrow. Governments also borrow on
behalf of nationalised industries, municipalities, local authorities and other public sector bodies. In the UK, the total borrowing requirement is often referred to
as the Public sector net cash requirement (PSNCR).

Governments borrow by issuing bonds. In the UK, the government also borrows from individuals by offering bank accounts and Premium Bonds. Government
debt seems to be permanent. Indeed the debt seemingly expands rather than being paid off. One strategy used by governments to reduce the value of the debt
is to influence inflation.

Municipalities and local authorities may borrow in their own name as well as receiving funding from national governments. In the UK, this would cover an
authority like Hampshire County Council.

Public Corporations typically include nationalised industries. These may include the postal services, railway companies and utility companies.

Many borrowers have difficulty raising money locally. They need to borrow internationally with the aid of Foreign exchange markets.

Borrower's having same need can form them into a group of borrowers. It can also take an organizational form. just like Mutual Fund. They can provide
mortgaze on weight basis. The main advantage is that it lowers their cost of borrowings.
Derivative products

During the 1980s and 1990s, a major growth sector in financial markets is the trade in so called derivative products, or derivatives for short.

In the financial markets, stock prices, bond prices, currency rates, interest rates and dividends go up and down, creating risk. Derivative products are financial
products which are used to control risk or paradoxically exploit risk. It is also called financial economics.

Derivative products or instruments help the issuers to gain an unusual profit form issuing the instruments. For using the help of these products a contract have
to be made. Derivative contracts are mainly 3 types: 1. Future Contracts 2. Forward Contracts 3. Option Contracts.
Currency markets

Main article: Foreign exchange market

Seemingly, the most obvious buyers and sellers of currency are importers and exporters of goods. While this may have been true in the distant past,[when?] when
international trade created the demand for currency markets, importers and exporters now represent only 1/32 of foreign exchange dealing, according to
the Bank for International Settlements.[1]

The picture of foreign currency transactions today shows:

 Banks/Institutions

 Speculators

 Government spending (for example, military bases abroad)

 Importers/Exporters

 Tourists
Analysis of financial markets

See Statistical analysis of financial markets, statistical finance---

Much effort has gone into the study of financial markets and how prices vary with time. Charles Dow, one of the founders of Dow Jones &
Company and The Wall Street Journal, enunciated a set of ideas on the subject which are now called Dow Theory. This is the basis of the so-
called technical analysis method of attempting to predict future changes. One of the tenets of "technical analysis" is that market trends give an indication
of the future, at least in the short term. The claims of the technical analysts are disputed by many academics, who claim that the evidence points rather to
the random walk hypothesis, which states that the next change is not correlated to the last change.

The scale of changes in price over some unit of time is called the volatility. It was discovered by Benoît Mandelbrot that changes in prices do not follow
a Gaussian distribution, but are rather modeled better by Lévy stable distributions. The scale of change, or volatility, depends on the length of the time unit
to a power a bit more than 1/2. Large changes up or down are more likely than what one would calculate using a Gaussian distribution with an
estimated standard deviation.

A new area of concern is the proper analysis of international market effects. As connected as today's global financial markets are, it is important to realize
that there are both benefits and consequences to a global financial network. As new opportunities appear due to integration, so do the possibilities of
contagion. This presents unique issues when attempting to analyze markets, as a problem can ripple through the entire connected global network very
quickly. For example, a bank failure in one country can spread quickly to others, which makes proper analysis more difficult.
Financial market slang

 Poison pill, when a company issues more shares to prevent being bought out by another company, thereby increasing the number of outstanding
shares to be bought by the hostile company making the bid to establish majority.

 Quant, a quantitative analyst with a PhD[citation needed] (and above) level of training in mathematics and statistical methods.

 Rocket scientist, a financial consultant at the zenith of mathematical and computer programming skill. They are able to invent derivativesof
frightening complexity and construct sophisticated pricing models. They generally handle the most advanced computing techniques adopted by the
financial markets since the early 1980s. Typically, they are physicists and engineers by training; rocket scientists do not necessarily build rockets for a
living.

 White Knight, a friendly party in a takeover bid. Used to describe a party that buys the shares of one organization to help prevent against a hostile
takeover of that organization by another party.

Corporate finance

Corporate finance is the field of finance dealing with financial decisions check that business enterprisesmake and the tools and analysis used to make these
decisions. The primary goal of corporate finance is tomaximize corporate value[1] while managing the firm's financial risks. Although it is in principle different
frommanagerial finance which studies the financial decisions of all firms, rather than corporations alone, the main concepts in the study of corporate finance
are applicable to the financial problems of all kinds of firms.

The discipline can be divided into long-term and short-term decisions and techniques. Capital investmentdecisions are long-term choices about which projects
receive investment, whether to finance that investment with equity or debt, and when or whether to pay dividends to shareholders. On the other hand, short
term decisions deal with the short-term balance of current assets and current liabilities; the focus here is on managing cash, inventories, and short-term
borrowing and lending (such as the terms on credit extended to customers).[citation needed]

The terms corporate finance and corporate financier are also associated with investment banking. The typical role of an investment bank is to evaluate the
company's financial needs and raise the appropriate type of capital that best fits those needs. Thus, the terms “corporate finance” and “corporate financier”
may be associated with transactions in which capital is raised in order to create, develop, grow or acquire businesses.
Capital investment decisions

Capital investment decisions[2] are long-term corporate finance decisions relating to fixed assets and capital structure. Decisions are based on several inter-
related criteria. (1) Corporate management seeks to maximize the value of the firm by investing in projects which yield a positive net present
value when valued using an appropriate discount rate in consideration of risk. (2) These projects must also be financedappropriately. (3) If no such
opportunities exist, maximizing shareholder value dictates that management must return excess cash to shareholders (i.e., distribution via dividends). Capital
investment decisions thus comprise an investment decision, a financing decision, and a dividend decision.
[edit]The investment decision
Main article: Capital budgeting

Management must allocate limited resources between competing opportunities (projects) in a process known as capital budgeting.[3] Making this investment, or
capital allocation, decision requires estimating the value of each opportunity or project, which is a function of the size, timing and predictability of future cash
flows.
[edit]Project valuation
Further information: Business valuation, stock valuation, and fundamental analysis

In general,[4] each project's value will be estimated using a discounted cash flow (DCF) valuation, and the opportunity with the highest value, as measured by
the resultant net present value (NPV) will be selected (applied to Corporate Finance by Joel Dean in 1951; see also Fisher separation theorem, John Burr
Williams: theory). This requires estimating the size and timing of all of the incremental cash flows resulting from the project. Such future cash flows are
then discounted to determine their present value (see Time value of money). These present values are then summed, and this sum net of the initial investment
outlay is the NPV. See Financial modeling.

The NPV is greatly affected by the discount rate. Thus, identifying the proper discount rate - often termed, the project "hurdle rate"[5] - is critical to making an
appropriate decision. The hurdle rate is the minimum acceptable return on an investment—i.e. the project appropriate discount rate. The hurdle rate should
reflect the riskiness of the investment, typically measured by volatility of cash flows, and must take into account the financing mix. Managers use models such
as the CAPM or the APT to estimate a discount rate appropriate for a particular project, and use the weighted average cost of capital (WACC) to reflect the
financing mix selected. (A common error in choosing a discount rate for a project is to apply a WACC that applies to the entire firm. Such an approach may not
be appropriate where the risk of a particular project differs markedly from that of the firm's existing portfolio of assets.)

In conjunction with NPV, there are several other measures used as (secondary) selection criteria in corporate finance. These are visible from the DCF and
include discounted payback period, IRR, Modified IRR, equivalent annuity, capital efficiency, and ROI. Alternatives (complements) to NPV
include MVA / EVA (Joel Stern, Stern Stewart & Co) and APV (Stewart Myers). See list of valuation topics.
[edit]Valuing flexibility
Main articles: Real options analysis and decision tree

In many cases, for example R&D projects, a project may open (or close) the paths of action to the company, but this reality will not typically be captured in a
strict NPV approach.[6] Management will therefore (sometimes) employ tools which place an explicit value on these options. So, whereas in a DCF valuation
the most likely or average or scenario specific cash flows are discounted, here the “flexibile and staged nature” of the investment is modelled, and hence "all"
potential payoffs are considered. The difference between the two valuations is the "value of flexibility" inherent in the project.

The two most common tools are Decision Tree Analysis (DTA)[7][8] and Real options analysis (ROA);[9] they may often be used interchangeably:

 DTA values flexibility by incorporating possible events (or states) and consequent management decisions. (For example, a company would build a factory
given that demand for its product exceeded a certain level during the pilot-phase, and outsource production otherwise. In turn, given further demand, it
would similarly expand the factory, and maintain it otherwise. In a DCF model, by contrast, there is no "branching" - each scenario must be modelled
separately.) In the decision tree, each management decision in response to an "event" generates a "branch" or "path" which the company could follow; the
probabilities of each event are determined or specified by management. Once the tree is constructed: (1) "all" possible events and their resultant paths are
visible to management; (2) given this “knowledge” of the events that could follow, and assuming rational decision making, management chooses the actions
corresponding to the highest value path probability weighted; (3) this path is then taken as representative of project value. See Decision theory: Choice
under uncertainty.

 ROA is usually used when the value of a project is contingent on the value of some other asset or underlying variable. (For example, theviability of
a mining project is contingent on the price of gold; if the price is too low, management will abandon the mining rights, if sufficiently high, management
will develop the ore body. Again, a DCF valuation would capture only one of these outcomes.) Here: (1) using financial option theory as a framework, the
decision to be taken is identified as corresponding to either a call option or a put option; (2) an appropriate valuation technique is then employed - usually a
variant on the Binomial options model or a bespoke simulation model, while Black Scholes type formulae are used less often; see Contingent claim
valuation. (3) The "true" value of the project is then the NPV of the "most likely" scenario plus the option value. (Real options in corporate finance were first
discussed by Stewart Myers in 1977; viewing corporate strategy as a series of options was originally per Timothy Luehrman, in the late 1990s.)
[edit]Quantifying uncertainty
Further information: Sensitivity analysis, Scenario planning, and Monte Carlo methods in finance

Given the uncertainty inherent in project forecasting and valuation,[8][10] analysts will wish to assess the sensitivity of project NPV to the various inputs (i.e.
assumptions) to the DCF model. In a typical sensitivity analysis the analyst will vary one key factor while holding all other inputs constant, ceteris paribus. The
sensitivity of NPV to a change in that factor is then observed, and is calculated as a "slope": ΔNPV / Δfactor. For example, the analyst will determine NPV at
various growth rates in annual revenue as specified (usually at set increments, e.g. -10%, -5%, 0%, 5%....), and then determine the sensitivity using this
formula. Often, several variables may be of interest, and their various combinations produce a "value-surface" (or even a "value-space"), where NPV is then
a function of several variables. See also Stress testing.

Using a related technique, analysts also run scenario based forecasts of NPV. Here, a scenario comprises a particular outcome for economy-wide, "global"
factors (demand for the product, exchange rates, commodity prices, etc...) as well as for company-specific factors (unit costs, etc...). As an example, the
analyst may specify various revenue growth scenarios (e.g. 5% for "Worst Case", 10% for "Likely Case" and 25% for "Best Case"), where all key inputs are
adjusted so as to be consistent with the growth assumptions, and calculate the NPV for each. Note that for scenario based analysis, the various combinations
of inputs must be internally consistent, whereas for the sensitivity approach these need not be so. An application of this methodology is to determine an
"unbiased" NPV, where management determines a (subjective) probability for each scenario – the NPV for the project is then the probability-weighted
average of the various scenarios.

A further advancement is to construct stochastic[11] or probabilistic financial models – as opposed to the traditional static and deterministicmodels as above.
[10]
For this purpose, the most common method is to use Monte Carlo simulation to analyze the project’s NPV. This method was introduced to finance by David
B. Hertz in 1964, although it has only recently become common: today analysts are even able to run simulations in spreadsheet based DCF models, typically
using an add-in, such as Crystal Ball. Here, the cash flow components that are (heavily) impacted by uncertainty are simulated, mathematically reflecting their
"random characteristics". In contrast to the scenario approach above, the simulation produces several thousand random but possible outcomes, or "trials";
see Monte Carlo Simulation versus “What If” Scenarios. The output is then a histogram of project NPV, and the average NPV of the potential investment – as
well as its volatility and other sensitivities – is then observed. This histogram provides information not visible from the static DCF: for example, it allows for an
estimate of the probability that a project has a net present value greater than zero (or any other value).

Continuing the above example: instead of assigning three discrete values to revenue growth, and to the other relevant variables, the analyst would assign an
appropriate probability distribution to each variable (commonly triangular or beta), and, where possible, specify the observed or supposed correlation between
the variables. These distributions would then be "sampled" repeatedly - incorporating this correlation - so as to generate several thousand random but possible
scenarios, with corresponding valuations, which are then used to generate the NPV histogram. The resultant statistics (average NPV and standard deviation of
NPV) will be a more accurate mirror of the project's "randomness" than the variance observed under the scenario based approach. These are often used as
estimates of the underlying "spot price" and volatility for the real option valuation as above; see Real options valuation: Valuation inputs. A more robust Monte
Carlo model would include the possible occurrence of risk events (e.g., a credit crunch) that drive variations in one or more of the DCF model inputs.
[edit]The financing decision
Main article: Capital structure
Achieving the goals of corporate finance requires that any corporate investment be financed appropriately.[12] As above, since both hurdle rate and cash flows
(and hence the riskiness of the firm) will be affected, the financing mix can impact the valuation. Management must therefore identify the "optimal mix" of
financing—the capital structure that results in maximum value. (See Balance sheet, WACC, Fisher separation theorem; but, see also the Modigliani-Miller
theorem.)

The sources of financing will, generically, comprise some combination of debt and equity financing. Financing a project through debt results in a liability or
obligation that must be serviced, thus entailing cash flow implications independent of the project's degree of success. Equity financing is less risky with respect
to cash flow commitments, but results in a dilution of share ownership, control and earnings. The cost of equity is also typically higher than the cost of
debt (see CAPM and WACC), and so equity financing may result in an increased hurdle rate which may offset any reduction in cash flow risk.

Management must also attempt to match the financing mix to the asset being financed as closely as possible, in terms of both timing and cash flows.

One of the main theories of how firms make their financing decisions is the Pecking Order Theory, which suggests that firms avoid external financing while they
have internal financing available and avoid new equity financing while they can engage in new debt financing at reasonably low interest rates. Another major
theory is the Trade-Off Theory in which firms are assumed to trade-off the tax benefits of debtwith the bankruptcy costs of debt when making their decisions.
An emerging area in finance theory is right-financing whereby investment banks and corporations can enhance investment return and company value over time
by determining the right investment objectives, policy framework, institutional structure, source of financing (debt or equity) and expenditure framework within a
given economy and under given market conditions. One last theory about this decision is the Market timing hypothesis which states that firms look for the
cheaper type of financing regardless of their current levels of internal resources, debt and equity.
[edit]The dividend decision
Main article: The Dividend Decision

Whether to issue dividends,[13] and what amount, is calculated mainly on the basis of the company's unappropriated profit and its earning prospects for the
coming year. The amount is also often calculated based on expected free cash flows i.e. cash remaining after all business expenses, and capital investment
needs have been met.

If there are no NPV positive opportunities, i.e. projects where returns exceed the hurdle rate, then - finance theory suggests - management must return excess
cash to investors as dividends. This is the general case, however there are exceptions. For example, shareholders of a "Growth stock", expect that the
company will, almost by definition, retain earnings so as to fund growth internally. In other cases, even though an opportunity is currently NPV negative,
management may consider “investment flexibility” / potential payoffs and decide to retain cash flows; see above and Real options.

Management must also decide on the form of the dividend distribution, generally as cash dividends or via a share buyback. Various factors may be taken into
consideration: where shareholders must pay tax on dividends, firms may elect to retain earnings or to perform a stock buyback, in both cases increasing the
value of shares outstanding. Alternatively, some companies will pay "dividends" from stock rather than in cash; see Corporate action. Today, it is generally
accepted that dividend policy is value neutral - i.e. the value of the firm would be the same, whether it issued cash dividends or repurchased its stock
(see Modigliani-Miller theorem).
[edit]Working capital management

Main article: Working capital

Decisions relating to working capital and short term financing are referred to as working capital management.[14] These involve managing the relationship
between a firm's short-term assets and its short-term liabilities.

As above, the goal of Corporate Finance is the maximization of firm value. In the context of long term, capital investment decisions, firm value is enhanced
through appropriately selecting and funding NPV positive investments. These investments, in turn, have implications in terms of cash flow and cost of capital.

The goal of Working capital management is therefore to ensure that the firm is able to operate, and that it has sufficient cash flow to service long term debt,
and to satisfy both maturing short-term debt and upcoming operational expenses. In so doing, firm value is enhanced when, and if, the return on
capital exceeds the cost of capital; See Economic value added (EVA).
[edit]Decision criteria

Working capital is the amount of capital which is readily available to an organization. That is, working capital is the difference between resources in cash or
readily convertible into cash (Current Assets), and cash requirements (Current Liabilities). As a result, the decisions relating to working capital are always
current, i.e. short term, decisions.

In addition to time horizon, working capital decisions differ from capital investment decisions in terms of discounting and profitability considerations; they are
also "reversible" to some extent. (Considerations as to Risk appetite and return targets remain identical, although some constraints - such as those imposed
by loan covenants - may be more relevant here).

Working capital management decisions are therefore not taken on the same basis as long term decisions, and working capital management applies different
criteria in decision making: the main considerations are (1) cash flow / liquidity and (2) profitability / return on capital (of which cash flow is probably the more
important).

 The most widely used measure of cash flow is the net operating cycle, or cash conversion cycle. This represents the time difference between cash payment
for raw materials and cash collection for sales. The cash conversion cycle indicates the firm's ability to convert its resources into cash. Because this
number effectively corresponds to the time that the firm's cash is tied up in operations and unavailable for other activities, management generally aims at a
low net count. (Another measure is gross operating cycle which is the same as net operating cycle except that it does not take into account the creditors
deferral period.)

 In this context, the most useful measure of profitability is Return on capital (ROC). The result is shown as a percentage, determined by dividing relevant
income for the 12 months by capital employed; Return on equity (ROE) shows this result for the firm's shareholders. As above, firm value is enhanced
when, and if, the return on capital, exceeds the cost of capital. ROC measures are therefore useful as a management tool, in that they link short-term policy
with long-term decision making.
[edit]Management of working capital

Guided by the above criteria, management will use a combination of policies and techniques for the management of working capital.[15] These policies aim at
managing the current assets (generally cash and cash equivalents, inventories and debtors) and the short term financing, such that cash flows and returns are
acceptable.

 Cash management. Identify the cash balance which allows for the business to meet day to day expenses, but reduces cash holding costs.

 Inventory management. Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials - and
minimizes reordering costs - and hence increases cash flow; see Supply chain management; Just In Time (JIT); Economic order quantity (EOQ); Economic
production quantity (EPQ).

 Debtors management. Identify the appropriate credit policy, i.e. credit terms which will attract customers, such that any impact on cash flows and the cash
conversion cycle will be offset by increased revenue and hence Return on Capital (or vice versa); see Discounts and allowances.

 Short term financing. Identify the appropriate source of financing, given the cash conversion cycle: the inventory is ideally financed by credit granted by
the supplier; however, it may be necessary to utilize a bank loan (or overdraft), or to "convert debtors to cash" through "factoring".
[edit]Relationship with other areas in finance

[edit]Investment banking

Use of the term “corporate finance” varies considerably across the world. In the United States it is used, as above, to describe activities, decisions and
techniques that deal with many aspects of a company’s finances and capital. In the United Kingdom and Commonwealthcountries, the terms “corporate
finance” and “corporate financier” tend to be associated with investment banking - i.e. with transactions in which capital is raised for the corporation.[16] These
may include

 Raising seed, start-up, development or expansion capital

 Mergers, demergers, acquisitions or the sale of private companies

 Mergers, demergers and takeovers of public companies, including public-to-private deals

 Management buy-out, buy-in or similar of companies, divisions or subsidiaries - typically backed by private equity

 Equity issues by companies, including the flotation of companies on a recognised stock exchange in order to raise capital for development and/or to
restructure ownership

 Raising capital via the issue of other forms of equity, debt and related securities for the refinancing and restructuring of businesses

 Financing joint ventures, project finance, infrastructure finance, public-private partnerships and privatisations

 Secondary equity issues, whether by means of private placing or further issues on a stock market, especially where linked to one of the transactions listed
above.

 Raising debt and restructuring debt, especially when linked to the types of transactions listed above
[edit]Financial risk management
Main article: Financial risk management

Risk management and Global Association of Risk Professionals is the process of measuring risk and then developing and implementing strategies to manage
that risk. Financial risk management focuses on risks that can be managed ("hedged") using traded financial instruments (typically changes in commodity
prices, interest rates, foreign exchange rates and stock prices). Financial risk management will also play an important role in cash management.

This area is related to corporate finance in two ways. Firstly, firm exposure to business and market risk is a direct result of previous Investment and Financing
decisions. Secondly, both disciplines share the goal of enhancing, or preserving, firm value.

All[citation needed] large corporations have risk management teams, and small firms practice informal, if not formal, risk management. There is a fundamental debate
on the value of "Risk Management" and shareholder value that questions a shareholder's desire to optimize risk versus taking exposure to pure risk (a risk
event that only has a negative side, such as loss of life or limb). The debate links value of risk management in a market to the cost of bankruptcy in that market.

Derivatives are the instruments most[citation needed] commonly used in financial risk management. Because unique derivative contracts tend to be costly to create
and monitor, the most cost-effective financial risk management methods usually involve derivatives that trade on well-established financial
markets or exchanges. These standard derivative instruments include options, futures contracts, forward contracts, andswaps. More customized and second
generation derivatives known as exotics trade over the counter aka OTC.

See: Financial engineering; Financial risk; Default (finance); Credit risk; Interest rate risk; Liquidity risk; Market risk; Operational risk;Volatility
risk; Settlement risk; Value at Risk;.
[edit]Personal and public finance

Corporate finance utilizes tools from almost all areas of finance. Some of the tools developed by and for corporations have broad application to entities
other than corporations, for example, to partnerships, sole proprietorships, not-for-profit organizations, governments, mutual funds, and personal wealth
management. But in other cases their application is very limited outside of the corporate finance arena. Because corporations deal in quantities of money
much greater than individuals, the analysis has developed into a discipline of its own. It can be differentiated from personal finance and public finance.
[edit]Related professional qualifications

Qualifications related to the field include:[citation needed]

 Finance qualifications:

 Degrees: Masters degree in Finance (MSF), Master of Financial Economics

 Certifications: Chartered Financial Analyst (CFA), Certified Valuation Analyst (CVA), Corporate Finance Qualification (CF), Certified International
Investment Analyst (CIIA), Association of Corporate Treasurers (ACT), Certified Market Analyst (CMA/FAD) Dual Designation, Master Financial
Manager (MFM), Master of Finance & Control (MFC), Certified Treasury Professional (CTP), Association for Financial Professionals, Certified
Merger & Acquisition Advisor (CM&AA)

 Business qualifications:

 Degrees: Master of Business Administration (MBA), Master of Management (MM), Master of Science in Management (MSM), Master of
Commerce (M Comm), Doctor of Business Administration (DBA)

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RBI/2009-10/513
A.P. (DIR Series) Circular No.57
June 29, 2010
To
All Category - I Authorised Dealer Banks
Madam / Sir,
Export of Goods and Software – Realisation and
Repatriation of export proceeds – Liberalisation
Attention of Authorised Dealer Category-I (AD Category-I) banks is invited to A.P.(DIR Series) Circular No.70 dated June 30, 2009 increasing the period of realisation and
repatriation to India of the amount representing the full export value of goods or software exported, from six months to twelve months from the date of export, subject to
review after one year.
2. The issue has since been reviewed and it has been decided, in consultation with the Government of India, to extend the above relaxation up to March 31, 2011.
3. The provisions in regard to period of realisation and repatriation to India of the full export value of goods or software exported by a unit situated in a Special Economic
Zone (SEZ) as well as exports made to warehouses established outside India remains unchanged.
4. AD Category - I banks may bring the contents of this circular to the notice of their constituents and customers concerned.
5. The Directions contained in this circular have been issued under sections 10(4) and 11(1) of the Foreign Exchange Management Act (FEMA), 1999 (42 of 1999) and are
without prejudice to permissions/approvals, if any, required under any other law.
Yours faithfully,
( G. Jaganmohan Rao)
Chief General Manager

HDFC Bank extends the following facilities to eligible exporters:

Pre-shipment Credit

Pre-shipment Credit is offered to an exporter by way of packing credit to enable him to finance
purchase/import of raw materials, processing and packing of the goods meant for exports.

Post-shipment Credit

Post-shipment Credit is offered to an exporter to finance export sales receivables after the date of
shipment of goods till the date of realisation of export proceeds.

We offer our clients a choice of the following services:

Negotiation/ payment/ acceptance of export documents under letter of credit.


Purchase/ discount of export documents under confirmed orders/export contracts etc.
Advances against export bills sent on collection basis
Advances against exports on consignment basis
Advances against undrawn balance on exports
Advances against approved deemed exports

To meet your export financing needs, we offer customised packing /post shipment credit in rupee
terms or foreign currency, tailor-made to match your profile.
Pre-Shipment Finance
A pre requisite to avail of pre-shipment financing is that the Exporter should have a credit facility in place with a bank. Each bank has a credit process that
determines the amount of funding the bank can give the company.
1. Who is eligible for pre-shipment credit?
An exporter who holds an export order or Letter of Credit (LC) in his own name to perform an export contract can avail of pre-shipment credit.
Banks may also grant pre-shipment advances without insisting on prior lodgment of LCs or purchase orders. This is known as the "Running Account
Facility".
2. What is the purpose of this finance?
Pre-shipment finance can be availed of only for the specific purpose of procuring raw materials / purchasing / manufacturing / processing / transporting /
warehousing / packing and shipping the goods meant for export.
3. How much financing can I as an exporter get?
This is ‘need based financing’, - which means that banks will lend an amount to you after factoring in a particular margin (this margin is calculated as a
percentage of the value of the order). The margin differs from bank to bank. Margins are stipulated for the following reasons :
• to ensure that the exporter has some stake in the transaction
• to cover any erosion in the value of goods, and
• to ensure that there is no lending against the exporter's profit margin.
The banking practice is that the exporter can obtain 90% of the FOB value of the order or 75% of the CIF value of the order.
1. What is the tenor of this funding?
The RBI has allowed banks to grant this funding at a concession for a maximum period of 180 days. This period can be extended by the bank without
referring to RBI for a further period of 90 days. Banks grant this extension in cases where the exporter faces genuine hardships in completing his order.
If an extension is required beyond 270 days (i.e. 180+90 days), the RBI has the discretion to grant another (maximum) extension of 90 days. However,
if the exports do not take place at the end of this period, the bank will charge interest from day one, at a rate left to the bank’s discretion.

2. In what currency's can the exporter obtain pre-shipment credit?


Most often the pre-shipment borrowal is in the domestic currency, in the case of an exporter based in India, the Indian Rupee. However in some cases,
the exporter may want to borrow in foreign currency because his product has a large import component or he finds the cost of borrowing in foreign
currency lower than borrowing in the local currency. Borrowing in foreign currency is feasible when the cost of Rupee borrowing (less the currency
premium) is greater than the cost of borrowing in the foreign currency. This is discussed in greater detail in " when does foreign currency risk arise?"
This will be easier to understand with the help of an example. Let us assume that an exporters’ exports and imports are both payable in US Dollars. Let
us also assume that the import component is significant at, say, 70%. In this case, the exporter is open to the effects of currency movements both at the
time of import, and then at the time of export. Borrowing in USD can hence partially hedge his currency risk on the export side, since his exports are
also going to be in the same currency.
The above facility, allowed to exporters to avail of pre-shipment credit in foreign currency, is termed as ‘Pre-Shipment Credit in Foreign Currency’ or
PCFC.
3. What is the cost of pre-shipment finance ?
Pre-shipment credit :
Upto 180 days - 10%
Between 180 –270 days - 13%
Over 270 days - Commercial rates which are likely to be higher than the rate applicable upto 270 days.
USD Lending (PCFC) - Maximum of Libor + 1.5 pct
4. What are the ways in which I can liquidate the pre-shipment finance ?
The pre-shipment facility can be liquidated by proceeds of export bills negotiated, purchased or discounted. As far as possible, banks don't encourage
liquidation by debit to cash credit account.
Another interesting thing is that, once the goods are shipped out and documents tendered to the bank, the pre-shipment advance is converted to post-shipment
advance.
In the case of PCFC credit, pre-shipment finance is liquidated by discounting bills under the ‘Rediscounting of Export Bills Abroad’ scheme. PCFC can be
liquidated by discounting of export bills, or by grant of foreign currency loans by a bank. Once the exporter avails of PCFC, he willnot be eligible for post-
shipment credit in rupees; he will have to avail of post-shipment funding in the same currency in which he availed of the pre-shipment funding.

Internal Foreign Exchange Hedging Techniques


The following figure makes a brief comparison of some of the internal foreign exchange techniques from the pros and cons aspects relative to others.

Techniques Description Pros Cons

Borrowing and lending Creates a synthetic forward by Useful when forwards, Utilises costly managerial
borrowing and lending at home and futures or swaps markets resources. May be prohibited
abroad. For example, a long forward are thin-particularly for by legal restrictions.
foreign-exchange position is long-dated maturates.
equivalent to borrowing at home,
converting the proceeds to foreign
exchange and investing them abroad.
The converse holds for a short forward
foreign-exchange position.

Commodity hedging Going short (long) a commodity Commodity markets are Price changes of commodities,
contract denominated in a foreign usually deep, particularly in terms of home currency,
currency to hedge a foreign currency for maturities up to a may not exactly offset price
to hedge a foreign exchange assets year. changes in the asset (liability)
(liability). to be hedged.
Leading and lagging Equating foreign exchange assets and Avoids unnecessary Appropriate matches may not
liabilities by speeding up or slowing hedging costs. be available. Utilises costly
down receivables or payables. managerial resources.

Matching Equating assets and liabilities Avoids unnecessary Appropriate matches may not
denominated in each currency. hedging costs. be available.

Source: Abuaf (1988)


If the company organises its international transactions within the company itself, it is called internal technique. It is also noted that internal techniques use methods of exposure
management which are part of a firm’s regulatory financial management and do not resort to special contractual relationship outside the group of company itself.
These techniques aim to reduce or prevent exposed positions from arising. The main forms of internal techniques are netting, matching, pricing policies and asset liability
management and leading and lagging.

Financial risk management


Financial risk management is the practice of creating economic value in a firm by using financial instruments to manage exposure to risk, particularly credit risk and market risk. Other types include Foreign

exchange, Shape, Volatility, Sector, Liquidity, Inflation risks, etc. Similar to general risk management, financial risk management requires identifying its sources, measuring it, and plans to address them.

Financial risk management can be qualitative and quantitative. As a specialization of risk management, financial risk management focuses on when and how to hedge using financial instruments to manage

costly exposures to risk.

In the banking sector worldwide, the Basel Accords are generally adopted by internationally active banks for tracking, reporting and exposing operational, credit and market risks.

When to use financial risk management

Finance theory (i.e., financial economics) prescribes that a firm should take on a project when it increasesshareholder value. Finance theory also shows that firm managers cannot create value for

shareholders, also called its investors, by taking on projects that shareholders could do for themselves at the same cost.

When applied to financial risk management, this implies that firm managers should not hedge risks that investors can hedge for themselves at the same cost. This notion was captured by the hedging

irrelevance proposition: In a perfect market, the firm cannot create value by hedging a risk when the price of bearing that risk within the firm is the same as the price of bearing it outside of the firm. In

practice, financial markets are not likely to be perfect markets.

This suggests that firm managers likely have many opportunities to create value for shareholders using financial risk management. The trick is to determine which risks are cheaper for the firm to manage

than the shareholders. A general rule of thumb, however, is that market risks that result in unique risks for the firm are the best candidates for financial risk management.

The concepts of financial risk management change dramatically in the international realm. Multinational Corporations are faced with many different obstacles in overcoming these challenges. There has been

some research on the risks firms must consider when operating in many countries, such as the three kinds of foreign exchange exposure for various future time horizons: transactions exposure,[1] accounting

exposure,[2] and economic exposure.[3]

Megaprojects (sometimes also called "major programs") have been shown to be particularly risky in terms of finance. Financial risk management is therefore particularly pertinent for megaprojects and

special methods have been developed for such risk management.[4][5]

Foreign exchange exposure perception and management of Turkish SMEs.


This article aimed at analysing the foreign exchange (FX) exposure perception and management of small and medium-sized enterprises (SMEs) in Turkey. FX exposure is divided into three groups of translation
exposure, transaction exposure and economic exposure. Of these groups, only transaction and economic exposures are relevant to the wealth-maximizing firm. Drawing on a survey of 412 SMEs located throughout
Turkey, this study explores the perceptions of managers regarding transaction and economic exposure as well as how they manage these two exposure groups. The survey results show that the term of FX exposure is
conceptually perceived as economic exposure which also covers transaction exposure. However, the SMEs focus to manage the transaction exposure rather than the economic exposure. In managing the transaction
exposure, the SMEs heavily rely on internal hedging techniques while they are not even aware of the nature of external hedging techniques.

Cet article a pour but d'analyser la position de change et la gestion de petites et moyennes entreprises (PME) en Turquie. Trois facteurs influencent la position de change d'une entreprise : le risque de conversion, le
risque de transaction et le risque economique. De ce groupe, seul le risque de transaction et le risque economique sont pertinents pour les entreprises qui ont pour but de maximiser leurs profits. En s'appuyant sur une
enquete aupres de 412 PME situees un peu partout en Turquie, l'etude se penche sur la perception qu'ont les dirigeants d'entreprises face au risque de transaction et au risque economique, ainsi que sur la facon dont
ils gerent ces deux facteurs de risque. Les resultats de l'enquete revelent que la position de change est percue comme etant le risque economique qui englobe aussi le risque de transaction. Par contre, les PME
s'attardent a gerer le risque de transaction au lieu du risque economique. Afin de gerer le risque de transaction, les PME ont recours surtout a des techniques de couverture interne, car ils ne connaissent pas les
techniques de couverture externe.

Purchasing Power Parity

The Law of One Price


The Law of One Price states that in an efficient market where there is free flow of goods, services and capital a commodity has only one price regardless of the country in which it is purchased. The idea behind the Law
of One Price is that if a commodity costs more in one country than the other, arbitrage will be possible by moving the commodity from the country with lower price to the one with the higher price.

Purchasing Power Parity


The Purchasing Power Parity is based on the Law of One Price. It states that exchange rate will adjust so that a commodity will cost the same regardless of the country in which it is purchased in.

Relative Purchasing Power Parity


Relative Purchasing Power Parity further evolved from the concept of Purchasing Power Parity. Basically it relates the concept of Purchasing Power Parity with the concept of inflation. It states that the inflation in one
country over the inflation of the other country determines the exchange rate between these two countries.

Relative Purchasing Power Parity spreadsheet


Based on the Relative Purchasing Power Parity, the expected exchange rate in the future is calculated as follows:

Expected exchange rate in the future = Current Spot Exchange Rate * ((1 + (Inflation of Foreign County - Inflation of Home Country)) ^ Number of Periods)

In the spreadsheet, the following formula is used to calculate the Expected exchange rate in N periods.

=F4*((1+(F6-F5))^F7)
Interest Rate Parity
The Interest Rate Parity states that the interest rate difference between two countries is equal to the percentage difference between the forward exchange rate and the spot exchange rate. The formula for the Interest
Rate Parity is shown below. This is also the formula used by the InterestRateParity worksheet.

Forward exchange rate for settlement at period N = Current Spot Exchange Rate * ((1+Foreign country nominal risk free interest rate)/(1+US nominal risk free interest rate))

Interest Rate Parity spreadsheet

An approximation of the exchange rate which supports N periods is calculated in the InterestRateParityApproximation worksheet. The formula used is as below :

Forward exchange rate for settlement at period N = Current Spot Exchange Rate*((1+(Foreign country nominal risk free interest rate-US nominal risk free interest rate)) ^ Number of Periods)

International Fisher Effect


Both the Interest Rate Parity theory and the Purchasing Power Parity theory allows us to estimate the future expected exchange rate. The Interest Rate Parity theory relates exchange rate with risk free interest rates
while the Purchasing Power Parity theory relates exchange rate with inflation rates. Putting them together basically tell us that risk free interest rates are related to inflation rates. This brings us to the International
Fisher Effect. The International Fisher Effect states that the real interest rates are equal across countries. Real interest rates are approximately the risk free rate minus the inflation rate.

International Fisher Effect spreadsheet


The InternationalFisherEffect table worksheets simply approximate the real interest rates of a foreign country compared to US.

International Fisher effect


From Wikipedia, the free encyclopedia

The International Fisher effect is a hypothesis in international finance that says that the difference in the nominal interest rates between two countries determines the movement of the nominal exchange

rate between their currencies, with the value of the currency of the country with the lower nominal interest rate increasing. This is also known as the assumption of Uncovered Interest Parity.

Motivation

The Fisher hypothesis says that the real interest rate in an economy is independent of monetary variables. If we add to this the assumption that real interest rates are equated across countries, then the

country with the lower nominal interest rate would also have a lower rate ofinflation and hence the real value of its currency would be risen over time.[1]

[edit]Capital Market Integration

The generalized Fisher effect holds that real interest rates must be the same across borders. However, validity of the generalized Fisher effect requires capital market integration.

In order for the generalized Fisher theorem to hold, capital markets must be integrated. That is, capital must be allowed to flow freely across borders. In general, the capital markets of developed

countries are integrated. However, in many less developed countries, we can observe currency restrictions and other regulation that inhibit integration.

[edit]Example

Suppose that the current spot exchange rate for U.S. Dollars into British Pounds is $1.4339 per pound. If the current interest rate is 5 percent in the U.S. and 7 percent in Britain, what is the expected spot

exchange per pound rate 12 months from now according to the International Fisher Effect?
The International Fisher Effect estimates future exchange rates based on the relationship in nominal interest rates. Multiplying the current spot exchange rate by the nominal annual U.S. interest rate and

dividing by the nominal annual British interest rate yields the estimate of the spot exchange rate 12 months from now ($1.4339 * 1.05) / 1.07 = $1.4071.

Interest rate parity


According to interest rate parity the difference between the (risk free) interest rates paid on two currencies
should be equal to the differences between the spot and forward rates.
If interest rate parity is violated, then anarbitrage opportunity exists. The simplest example of this is what would
happen if the forward rate was the same as the spot rate but the interest rates were different, then investors
would:
1. borrow in the currency with the lower rate
2. convert the cash at spot rates
3. enter into a forward contract to convert the cash plus the expected interest at the same rate
4. invest the money at the higher rate
5. convert back through the forward contract
6. repay the principal and the interest, knowing the latter will be less than the interest received.
Therefore, we can expect interest rate parity to apply. However, there is evidence of forward rate bias.
Covered interest rate parity
Assuming the arbitrage opportunity described above does not exist, then the relationship for US dollars and
pounds sterling is:
(1 + r£)/(1+r$) = (£/$f)/(£/$s)
where r£ is the sterling interest rate (till the date of the forward),
r$ is the dollar interest rate,
£/$f is the forward sterling to dollar rate,
£/$s is the spot sterling to dollar rate
Unless interest rates are very high or the period considered is long, this is a very good approximation:
r£ = r$ + f
where f is the forward premium: (£/$f)/(£/$s) -1
The above relationship is derived from assuming that covered interest arbitrage opportunities should not last,
and is therefore called covered interest rate parity.
Uncovered interest rate parity
Assuming uncovered interest arbitrage leads us to a slightly different relationship:
r = r2 + E[ΔS]
where E[ΔS] is the expected change is exchange rates.
This is called uncovered interest rate parity.
As the forward rate will be the market expectation of the change in rates, this is equivalent to covered interest
rate parity - unless one is speculating on market expectations being wrong.
The evidence on uncovered interest rate parity is mixed.
Purchasing power parity
Purchasing power parity (PPP) is a theory of long-term equilibrium exchange rates based on relative price levels of two countries. The idea originated with the School of Salamanca in the 16th

century [1] and was developed in its modern form by Gustav Cassel in 1918.[2] The concept is founded on the law of one price, the idea that in absence of transaction costs and official barriers to trade,

identical goods will have the same price in different markets when the prices are expressed in terms of one currency.[3]

In its "absolute" version, the purchasing power of differentcurrencies is equalized for a given basket of goods. In the "relative" version, the difference in the rate of change in prices at home and abroad—the

difference in the inflation rates—is equal to the percentage depreciation or appreciation of the exchange rate.

Deviations from the theory imply differences in purchasing power of a "basket of goods" across countries, which means that for the purposes of many international comparisons, countries' GDPs or other

national income statistics need to be "PPP adjusted" and converted into common units. The best-known purchasing power adjustment is the Geary–Khamis dollar (the "international dollar"). The real

exchange rate rate is then equal to the nominal exchange rate, adjusted for differences in price levels. If purchasing power parity held exactly, then the real exchange rate would always equal one. However,

in practice the real exchange rates exhibit both short run and long run deviations from this value, for example due to reasons illuminated in the Balassa–Samuelson theorem.

There can be marked differences between purchasing power adjusted incomes and those converted via market exchange rates.[4] For example, the World Bank's World Development Indicators

2005estimated that in 2003, one Geary-Khamis dollar was equivalent to about 1.8 Chinese yuan by purchasing power parity[5]—considerably different from the nominal exchange rate. This discrepancy has

large implications; for instance, when converted via the nominal exchange rates GDP per capita in India is about US$1,100 while on a PPP basis it is about US$3,000. This means that if calculated at

nominal exchange rates, India has the eleventh largest economy, while at PPP-adjusted rates, it has the fourth largest economy in the world. At the other extreme, Denmark's nominal GDP per capita is

around US$62,100, but its PPP figure is only US$37,304.