Class – 1

What is Finance
• Finance can be defined as the science and art of managing money. Every enterprise,
whether big, medium, small, needs finance to carry on its operations and to achieve its
target. In fact, finance is so indispensable today that it is rightly said to be the blood of an
enterprise. Without adequate finance, no enterprise can possibly accomplish its objectives.
• Business finance can be broadly defined as the activity
concerned with the planning, raising controlling and administrating the funds used in the
business.
• Finance is the study of how people and businesses evaluate investments and raise capital
to fund them. (-- How to get and use money)
• Three questions addressed by the study of finance
1. What long-term investments should the firm undertake? (capital budgeting
decisions – how to spend the money?)
2. How should the firm fund these investments? (capital structure decisions -- How
to get the money?)
3. How can the firm best manage its cash flows as they arise in its day-to-day
operations? (working capital management decisions – how to manage cash
(liquid) money?)
Objectives and functions of Finance
Objective:
• Procurement of money needed by business;
• Keeping and increasing the invested money through sound financial policies and program;
and
• Generating income or profit for the business.
Function:
• Financial planning, forecasting of cash receipts and disbursements
• Raising of funds, either equity capital or fixed interest capital which includes both
preference share capital and loan capital (securing of funds);
• Use and allocation of funds and
• Financial controls.
Why study finance
• Knowledge of financial tools is critical to making good decisions in both professional
world and personal lives.
• Finance is an integral part of corporate world
• Many personal decisions require financial knowledge (for example: buying a house,
planning for retirement, leasing a car)
Traditional view and Modern view of Finance
Traditional Approach to Finance Function : The traditional approach to the scope of finance
refers to its subject matter in the academic literature in the initial stages of its evolution as a
separate branch of study.
According to this approach, the scope of finance is confined to the raising of funds. Hence, the
scope of finance was treated by the traditional approach in the narrow sense of procurement of
funds by corporate enterprise to meet their financial needs.
Since the main emphasis of finance function at that period was on the procurement of funds, the
subject was called corporation finance till the mid-1950's and covered discussion on the financial
instruments, institutions and practices through which funds are obtained.
These are the broad features of the subject matter of corporation finance, which has no concern
with the decisions of allocating firm's funds.
The traditional approach to the scope and functions of finance has now been discarded as it
suffers from many serious limitations:
(i) It is outsider-looking in approach that completely ignores internal decision making as to the
proper utilization of funds.
(ii) The focus of traditional approach was on procurement of long-term funds. Thus, it ignored the
important issue of working capital finance and management.
(iii) The issue of allocation of funds, which is so important today, is completely ignored.
(iv) It does not lay focus on day to day financial problems of an organization.
Modern Approach to Finance Function: According to this approach, financial management
considers the broader and analytical viewpoint. According to this approach, financial management
is concerned with both acquisition of funds and their effective and optimum utilization. This
viewpoint not only considers the sporadic events but also the long term and short-term financial
problems. Three decisions are taken under financial management :-
i. Investment Decision
ii. Financing Decision
iii. Dividend Decision
Traditional Approach Modern Approach

Narrowly defined concept of FM Comparatively a wide concept

Only concerned with raising long term funds Concerns both raising as well as use of funds

Era before 1950 Era after 1950

Applicable only to large joint stock companies Applicable to all the business entities

Only long-term decisions were taken Long as well as short term decisions are taken

Outside looking approach Both, inside as well as outside orientation.

It is a descriptive approach It is an analytical approach

Goal of Finance
• Goal of finance or a finance manager is to optimize the corporate objectives, vision and
mission of a business organization. Way of doing the above said things are two :
1. Profit Maximization
2. Wealth Maximization
Profit Maximization: According to this approach, a firm should undertake all those activities
which add to its profits and eliminates all others which reduce its profits.
Criticism:
(i) Ambiguity
(ii) Time Value of Money
(iii) Risk Factor
 • Wealth Maximization: Financial theory asserts that the wealth maximization is the single
substitute for a stake holder’s utility. When the firm maximizes the shareholder’s wealth,
the individual stakeholders can use this wealth to maximize his individual utility. It means
that by maximizing stakeholder’s wealth the firm is operating consistently toward
maximizing
stakeholder’s utility.

Maximum Maximum Maximum

Utility stockholde current
r’s stock

Agency problem and Finance

• Agency problem is the likelihood that managers may place personal goals ahead of
corporate goals.
• Reason of agency problem:

1. Agent is risk-averter & principal is risk-seeker.

2. Agent has shorter duration than the principal in the organization
3. Earnings of agent are fixed
4. Principals do not directly take part in management decision
5. Information asymmetry

• Resolving agency problem:

Market AgencyForces
Cost
1. Monitoring Expenditures
Agency Cost
1. Monitoring Expenditures
1. Behavior of
2. Bonding Expenditures 2. Bonding Expenditures
3. Structuring Expenditures( 3. Structuring Expenditures( incentive
security market
incentive and performance and performance plan)
plan)
participants
2. Hostile
• Finance and Economics
Takeover
• Finance and Accounting
Major areas & Opportunities in Finance: Management Finance
• Managerial finance is concerned with the duties of the financial manager in the business
firm.
• The financial manager actively manages the financial affairs of any type of business,
whether private or public, large or small, profit-seeking or not-for-profit.
• They are also more involved in developing corporate strategy and improving the firm’s
competitive position.
• Increasing globalization has complicated the financial management function by requiring
them to be proficient in managing cash flows in different currencies and protecting
against the risks inherent in international transactions.
• Changing economic and regulatory conditions also complicate the financial management
function.
TABLE 1.1 STRENGTHS AND WEAKNESSES OF THE COMMON LEGAL FORMS OF
BUSINESS ORGANIZATION
FIGURE 1.1 CORPORATE ORGANIZATION

The Managerial Finance Function

• The size and importance of the managerial finance function depends on the size of the
firm.
• In small companies, the finance function may be performed by the company president or
accounting department.
• As the business expands, finance typically evolves into a separate department linked to
the president as was previously described in Figure 1.1.
• The firm’s finance (treasurer) and accounting (controller) functions are closely-related
and overlapping.
• In smaller firms, the financial manager generally performs both functions.
FIGURE 1.2 FINANCIAL ACTIVITIES

Goal of the Firm: What about other stakeholders

• Stakeholders include all groups of individuals who have a direct economic link to the
firm including employees, customers, suppliers, creditors, owners, and others who have a
direct economic link to the firm.
• The "Stakeholder View" prescribes that the firm make a conscious effort to avoid actions
that could be detrimental to the wealth position of its stakeholders.
• Such a view is considered to be "socially responsible."
Class – 2
Financial Markets
• A system consisting of individuals, institutions, instruments, and procedures that brings
together borrowers and savers .
• A conceptual “mechanism” rather than a physical location or a specific type of
organization or structure
• A financial market is a market in which people trade financial securities, commodities,
and value at low transaction costs and at prices that reflect supply and demand. Securities
include stocks and bonds, and commodities include precious metals or agricultural
products
Types of Financial Markets
• Money vs Capital Markets
• Debt vs Equity Markets
• Primary vs Secondary Markets
Money VS Capital Markets
• Money Markets
– Maturities less than or equal to one year
 • Capital Markets
– Maturities greater than one year
Debt VS Equity Markets
• Debt Markets
– Loans/liabilities/debts are traded
• Equity Markets
– Stocks or Ownerships are traded
Primary VS Secondary Markets
• Primary Markets
– New securities are traded
– The only market in which the issuer is directly involved in the transaction
• Secondary Markets
– Preowned securities (those that are not new issues) are traded
Financial Institutions
• Facilitates the transfer of funds from savers to borrowers through different financial
products
• Also called financial intermediary
• Financial intermediation
• Intermediaries those channel the savings of individuals, businesses, and governments into
loans or investments
Benefits of Financial Intermediary
 Reduced costs
 Risk diversification
 Funds pooling
 Financial flexibility
Major Financial Intermediaries
• Commercial Banks
• Non-Banking Financial Institutions
• Mutual Fund
• Insurance Companies
• Investment Banks
• Brokerage Firm
Commercial Banks
• A financial institution working as an intermediary between depositors and borrowers. It
receives money from those who want to save in the form of deposits & it lends money to
those who need it.
• Financial depository institutions allowed or licensed by the central banks to accept
deposits for doing lending business.
• A financial institution working as an intermediary between depositors and borrowers. It
receives money from those who want to save in the form of deposits & it lends money to
those who need it.
• Financial depository institutions allowed or licensed by the central banks to accept
deposits for doing lending business.
Non Bank Financial Institutions
• A financial institution that does not have a full banking license or is not supervised by a
national or international banking regulatory agency
– NBFIs cannot issue pay-orders or demand drafts
– NBFIs cannot receive demand deposits
– NBFIs cannot be involved in foreign exchange financing