Unit 1

 Business Finance:-

Business Finance is the life blood of business. Business Finance is not only a requirement but also a
sustaining need for the business. Business Finance being the most crucial factor of every business
requires special attention on its procurement source, on its management, on its investment, in big
business houses a team is forced in this conduct known as the Finance Committee.

In this section we will know about the meaning, nature and significance of business, also we will
discuss the financial sources and its importance.  

 Business Finance Meaning

The raising and management of funds by the business organizations is called business finance.
Planning the financial need, analysing the requirement, controlling the operations are the
responsibilities of the financial manager, this person is closely related to the top-level management
team. 

Business finance refers to the funds needed to start a business, operate it, and expand it in the
future. Funds are needed to acquire tangible assets like furniture, machinery, buildings, offices, and
factories, as well as intangible assets such as patents, technical experience, and trademarks, among
other things.

Aside from the assets listed above, the day-to-day operational operations of a corporation also
require cash. Purchasing raw goods, paying employees, bills, and collecting money from clients are
all examples of this activity. To sustain and expand a business, you must have a significant quantity
of money.

In large firms, major financial decisions are taken by this financial committee, they are responsible
for the annual budget and so forth. 

In small companies, the owner-manager conducts the financial operations all by themselves. The
business finance which requires day-to-day attention is conducted by the lower level staff. They
work in the sections of handling the cash, receipts, disbursements, borrowings from the commercial
banks and this is done on a regular and continuous basis and they also form cash budgets. 

 Nature of Business Finance

The nature of the business finance is enumerated in the points mentioned below –

1. Business Finance consists of different kinds of funds – short, medium and long term as and when
required by the business.

2. Any type of business needs this business finance, it is utmost for the organization.

3. The volume required differs from business to business, small business requires less business finance
in contrast to the large business firms. 

4. In different times of the business season, requirements differ. In peak seasons business demands for
huge business finance.

5. The amount of business finance determines the scale of operations conducted by the company. 
  Significance of Business Finance
To highlight the significance of business finance, we point the following as mentioned:

1. A firm with a good amount of business finance will require less time and hassles to start the business
venture.

2. With the business finance in hand, the owners can buy the raw materials as needed for production. 

3. The business firm can easily pay his dues and other payments with the help of business finance. 

4. Uncertain risk and Contingencies can be tackled with business finance in hand.

5. Good financial capacity of the business will attract talented workforce, also highly efficient
technology can also be available with a strong financial background.  
  
 Need and Importance of Sources of Business Finance  
The main resources of Business Finance are revenues from business operations, investor’s own
finances, venture capital, loans from financial institutions. Businesses need finances to meet their
day-to-day finances which can be covered by these sources. 
The importances of the sources of business finance are:

1. Meeting Goals.

2. Short term activities

3. Long term activities

4. Achieving financial goals.

All such activities are governed and administered by the financial department in each organization.
Businesses need this finance to sustain their growth. Companies pool money from the public in
return of shares of the company, this also a type of procurement of business finance.

 Goals and Objective of the business:-

Business goals are a broader overview of what that business wishes to achieve. They identify where
the company would like to be and what they want to be doing. This will serve as a guiding mantra for
staff, especially at the executive and management level and should inform all projects and business
decisions. For example, a firm might set one of their business goals as:

“To achieve consistent year-on-year revenue growth of at least 10%”.

Business objectives are the individual actions and tasks that will build towards the achievement of
the goals of the business. For example, continuing from the previously stated business goal, the
objectives used to achieve such growth may be:

“Expand customer base in order to increase sales”

“Scale up production in line with revenue growth”
“Improve revenue streams through increasing perceived product value”
“Increase marketing budget according to revenue”

 MEANING AND DEFINITION OF FINANCIAL MANAGEMENT

Meaning of Financial Management

The word “Financial Management” is the composition of two words i.e. „Financial‟ and

„Management‟. Financial means procuring or raising of money supply (funds) and allocating (using)
those resources (funds) on the basis of monetary requirements of the business. The word

„Management‟ means planning, organizing, coordinating and controlling human activities with
reference to finance function for achieving goals/ objectives of organization. Besides raising and
utilization of funds, finance also includes distribution of funds in the form of dividend to
shareholders and retention of profit for growth and developments.

Definition of Financial Management

Howard and Upton: Financial management “as an application of general managerial principles to the
area of financial decision-making.

Weston and Brigham: Financial management “is an area of financial decision-making, harmonizing
individual motives and enterprise goals”.Joshep and Massie: Financial management “is the
operational activity of a business that is responsible for obtaining and effectively utilizing the funds
necessary for efficient operations.

 Objectives of Financial Management

Effective procurement and efficient use of finance lead to proper utilization of the finance by the
business concern. It is the essential part of the financial manager. Hence, the financial manager must
determine the basic objectives of the financial management. Objectives of Financial Management
may be broadly divided into two parts such as:

1. Profit maximization

2. Wealth maximization.

Wealth

Profit

Objectives

Profit Maximization

Main aim of any kind of economic activity is earning profit. A business concern is also functioning
mainly for the purpose of earning profit. Profit is the measuring techniques to understand the
business efficiency of the concern. Profit maximization is also the traditional and narrow approach,
which aims at, maximizes the profit of the concern. Profit maximization consists of the following
important features.
1. Profit maximization is also called as cashing per share maximization. It leads to maximize the
business operation for profit maximization.

2. Ultimate aim of the business concern is earning profit; hence, it considers all the possible ways to
increase the profitability of the concern.

3. Profit is the parameter of measuring the efficiency of the business concern. So, it shows the entire
position of the business concern.

4. Profit maximization objectives help to reduce the risk of the business.

Favourable Arguments for Profit Maximization

The following important points are in support of the profit maximization objectives of the business
concern:

(i) Main aim is earning profit.

(ii) Profit is the parameter of the business operation.

(iii) Profit reduces risk of the business concern.

(iv) Profit is the main source of finance.

(v) Profitability meets the social needs also.

Unfavourable Arguments for Profit Maximization

The following important points are against the objectives of profit maximization:

(i) Profit maximization leads to exploiting workers and consumers.

(ii) Profit maximization creates immoral practices such as corrupt practice, unfair trade practice, etc.

(iii) Profit maximization objectives leads to inequalities among the stake holders such as customers,
suppliers, public shareholders, etc.

Drawbacks of Profit Maximization

Profit maximization objective consists of certain drawback also:

(i) It is vague: In this objective, profit is not defined precisely or correctly. It creates some
unnecessary opinion regarding earning habits of the business concern.

(ii) It ignores the time value of money: Profit maximization does not consider the time value of
money or the net present value of the cash inflow. It leads certain differences between the actual
cash inflow and net present cash flow during a particular period.

(iii) It ignores risk: Profit maximization does not consider risk of the business concern. Risks may be
internal or external which will affect the overall operation of the business concern.

Wealth Maximization
Wealth maximization is one of the modern approaches, which involves latest innovations and
improvements in the field of the business concern. The term wealth means shareholder wealth or
the wealth of the persons those who are involved in the business concern. Wealth maximization is
also known as value maximization or net present worth maximization. This objective is a universally
accepted concept in the field of business. Favourable Arguments for Wealth Maximization

(i) Wealth maximization is superior to the profit maximization because the main aim of the business
concern under this concept is to improve the value or wealth of the shareholders.

(ii) Wealth maximization considers the comparison of the value to cost associated with the business
concern. Total value detected from the total cost incurred for the business operation. It provides
extract value of the business concern.

(iii) Wealth maximization considers both time and risk of the business concern.

(iv) Wealth maximization provides efficient allocation of resources.

(v) It ensures the economic interest of the society.

Unfavourable Arguments for Wealth Maximization

(i) Wealth maximization leads to prescriptive idea of the business concern but it may not be suitable
to present day business activities.

(ii) Wealth maximization is nothing, it is also profit maximization, it is the indirect name of the profit
maximization.

(iii) Wealth maximization creates ownership-management controversy.

(iv)Management alone enjoy certain benefits.

(v) The ultimate aim of the wealth maximization objectives is to maximize the profit.

(vi)Wealth maximization can be activated only with the help of the profitable position of the
business concern.

 Approaches to Financial Management

Financial management approach measures the scope of the financial management in various fields,
which include the essential part of the finance. Financial management is not a revolutionary concept
but an evolutionary. The definition and scope of financial management has been changed from one
period to another period and applied various innovations. Theoretical points of view, financial
management approach may be broadly divided into two major parts.

The traditional view of financial management:-

The traditional view of financial management looks into the following functions that a Finance
manager of a business firm will perform:
(a) Arrangement of short term and long-term funds from financial institutions.
(b) Mobilization of funds through financial instruments like equity shares, preference shares,
debentures, bonds etc.

(c) Orientation of finance functions with the accounting function and compliance of legal provisions
relating to funds procurement, use and distribution.

With the increase in complexity of modern business situation, the role of a Finance manager is not
just confined to procurement of funds, but his area of functioning is extended to judicious and
efficient use of funds available to the firm, keeping in view the objectives of the firm and
expectations of the providers of funds.

Approach # 2. Modern View:

The globalization and liberalization of world economy has caused to bring tremendous reforms in
financial sector which aims at promoting diversified, efficient and competitive financial system in the
country. The financial reforms coupled with diffusion of information technology have caused to
increase competition, mergers, takeovers, cost management, quality improvement, financial
discipline etc.

Globalization has caused to integrate the national economy with the world economy and it has
created a new financial environment which brings new opportunities and challenges to the
individual business concern. This has led to total reformation of the finance function and its
responsibilities in the organization.

Financial management in India has changed substantially in scope and complexity in view of recent
Government policy. Today’s Finance managers are seized with problems of financial distress and are
trying to overcome it by innovative means. In the current economic scenario, financial management
has assumed much greater significance.

It is now a question of survival of entities in the total spectrum of economic activity, with pragmatic
readjustment of financial management. The information age has given a fresh perspective on the
role of financial management and Finance managers. With the shift in paradigm it is imperative that
the role of Chief Finance Officer (CFO) changes from Controller to a Facilitator.

In view of modern approach, the Finance manager is expected to analyse the firm and to
determine the following:
(i) The total funds requirement of the firm,
(ii) The assets to be acquired, and
(iii) The pattern of financing the assets.
The Finance manager of a modern business firm will generally involve in the following three types
of decisions:
(1) Investment decisions,
(2) Finance decisions, and
(3) Dividend decisions.

(1) Investment Decisions:

Investment decisions are those which determine how scarce resources in terms of funds available
are committed to projects. The project may be as small as purchase of equipment or as big as
acquisition of an entity.

Investment in fixed assets requires supporting investment in working capital in the form of
inventory, receivables, cash etc. Investment which enhances internal growth is termed as ‘internal
investment’ and acquisition of entities represents ‘external investment’.

The investment decisions should aim at investment in assets only when they are expected to earn a
return greater than a minimum acceptable return, which is also called as ‘hurdle rate’. The minimum
return should reflect whether the money raised from debt or equity meets the returns on
investments made elsewhere on similar investments.

The hurdle rate has to be set at higher for riskier projects and has to reflect the financing mix used
i.e., the proportion of debt and equity. The Finance function involves not only in investment
decisions, but also in disinvestment decisions, for example withdrawing from unsuccessful projects
or restructuring with a strategic motive.

Investment decisions relate to the careful selection of viable and profitable investment proposals,
allocation of funds to the investment proposals with a view to obtain net present value of the future
earnings of the company and to maximize its value.

It is the function of a Finance manager to carefully analyze the different alternatives of investment,
determination of investment levels in different assets i.e., fixed assets and current assets.

The investment decisions of a Finance manager cover the following areas:

(a) Ascertainment of total volume of funds, a firm can commit.
(b) Appraisal and selection of capital investment proposals.
(c) Measurement of risk and uncertainty in the investment proposals.
(d) Prioritizing of investment decisions.
(e) Funds allocation and its rationing.
(f) Determination of fixed assets to be acquired.
(g) Determination of levels of investments in current assets viz., inventory, receivables, cash,
marketable securities etc., and its management.
(h) Buy or lease decisions.
(i) Asset replacement decisions.
(j) Restructuring, reorganization, mergers and acquisitions.
(k) Securities analysis and portfolio management etc.

(2) Finance Decisions:

The financing objective assets that the mix of debt and equity chosen to finance investments should
maximize the value of investments made. The debt equity mix should minimize the hurdle rate
allows the firm to take more new investments and increase the value of existing investments.

Financing decisions relate to acquiring the optimum finance to meet financial objectives and seeing
that working capital is effectively managed. Financing decisions call for good knowledge of costs of
raising finance, procedures in hedging risk, different financial instruments and obligations attached
to them etc. Important principle to consider in financing is that long-term assets should be financed
with long-term debt and short-term assets should be financed with short-term debt.

Firms that violate this basic rule do so at their own risk. It is one of the important functions of a
Finance manager is procurement of funds for the firm’s investment proposals and its working capital
requirements.

In fund raising decisions, he should keep in view the cost of funds from various sources,
determination of debt-equity mix, the advantages and disadvantages of debt component in the
capital mix, impact of taxation and depreciation in maximization of earnings per share to the equity
holders, consideration of control and financial strain on the firm in determining level of gearing,
impact of interest and inflation rates on the firm etc.

The Finance manager involved in the following finance decisions:

(a) Determination of degree or level of gearing.
(b) Determination of financing pattern of long-term funds requirement.
(c) Determination of financing pattern of medium and short-term funds requirement.
(d)Raising of funds through issue of financial instruments viz., equity shares, preference shares,
debentures, bonds etc.
(e)Arrangement of funds from banks and financial institutions for long-term, medium-term and
short-term needs.
(f) Arrangement of finance for working capital requirement.
(g) Consideration of interest burden on the firm.
(h) Consideration of debt level changes and its impact on firm’s bankruptcy.
(i) Taking advantage of interest and depreciation in reducing the tax liability of the firm.
(j) Consideration of various modes of improving the earnings per share and the market value of the
share.
(k) Consideration of cost of capital of individual components and weighted average cost of capital to
the firm.
(l) Analysis of impact of different levels of gearing on the firm and individual shareholder.
(m) Optimization of financing mix to improve return to the equity shareholders and maximiza tion of
wealth of the firm and value of the shareholders’ wealth.
(n) Portfolio management.
(o) Consideration of impact of over capitalization and under capitalization on the firm’s profitability.
(p) Consideration of foreign exchange risk exposure of the firm and decisions to hedge the risk.
(q) Study of impact of stock market and economic conditions of the country on modes of financing.
(r) Maintenance of balance between owners’ capital to outside capital.
(s) Maintenance of balance between long-term funds and short-term funds.
(t) Evaluation of alternative use of funds.
(u) Setting of budgets and review of performance for control action.
(v) Preparation of cash-flow and funds flow statements and analysis of performance through ratios
to identify the problem areas and its correction, etc.
For financing decisions, the capital structure is broadly divided into:
(a) Equity, and
(b) Debt.

(3) Dividend Decisions:

Dividend decisions concerned with the determination of quantum of profits to be distributed to the
owners and the frequency of such payments. The dividend decisions will affect in two ways (a) the
amount to be paid out and its influence on share price, and (b) the amount of profit to be retained
for internal investment which maximizes the value of firm and ultimately improves the share value
of the firm.

The level and regular growth of dividends represent a significant factor in determining a profit-
making company’s market value and the value of its shares in the stock market. The dividend
decisions of a Finance manager is mainly concerned with the decisions relating to the distribution of
earnings of the firm among its equity holders and the amounts to be retained by the firm.

The Finance manager will involve in taking the following dividend decisions:
(a) Determination of dividend and retention policies of the firm.
(b) Consideration of impact of levels of dividend and retention of earnings on the market value of
the share and the future earnings of the company.
(c) Consideration of possible requirement of funds by the firm for expansion and diversification
proposals for financing existing business requirements.
(d) Reconsideration of distribution and retentions policies in boom and recession periods.
(e) Considering the impact of legal and cash-flow constraints on dividend decisions.
The investment, finance and dividend decisions are interrelated to each other and, therefore, the
Finance manager while taking any decision should consider the impact from all the three angles
simultaneously.
In the words of Ezra Solomon “the function of financial management is to review and control
decision to commit and recommit funds to new and on-going uses. Thus in addition to raising funds,
Financial management is directly concerned with production, marketing and other, functions within
an enterprise whatever decisions are made about the acquisition or distribution of assets”.

This statement will reflect the modern view of financial management. From the point of view of
modern corporate firm, financial management is related not only to fund raising but encompasses
the wider perspective of managing the finances for the company efficiently. Hence, Financial
management is nothing but managerial decision making on asset mix, capital mix and profit
allocation.

The corporate finance theory centres around three important objectives of a finance function:
(a) Allocation of funds i.e. investment decisions,
(b) Generation of funds i.e. financing decisions, and
(c) Distribution of funds i.e., dividend decisions.

 What Is Financial Planning?

Financial planning is the practice of putting together a plan for your future, specifically around how
you will manage your finances and prepare for all of the potential costs and issues that may arise.
The process involves evaluating your current financial situation, identifying your goals and then
developing and implementing relevant recommendations.

Financial planning is holistic and broad, and it can encompass a variety of services, which we detail
below. Rather than focusing on a single aspect of your finances, it views clients as real people with a
variety of goals and responsibilities. It then addresses a number of financial realities to figure out
how to best enable people to make the most of their lives.

Financial planning is not the same as asset management. Asset management generally refers to
managing investments for a client. This includes choosing the stocks, bonds, mutual funds and other
investments in which a client should invest their money.

However, the same professionals who offer asset management services can also offer financial
planning. A financial planner is effectively one type of financial advisor. Advisors can earn
certifications focused on financial planning, the most notable of which is “certified financial planner
(CFP).”

Principles of Financial Planning:-

  Meeting all your interrelated goals from your working years through retirement
 Minimizing the impact of taxes on your savings
 Funding educational costs for your children or grandchildren
 Building a cash reserve to meet emergency needs
 Providing for your family in the event of your death or disability
 Reducing taxes on lifetime gifts and estate transfers
 Ensuring the orderly transfer or sale of a family business
 Establishing a discipline to your investment strategy that aligns with your goals

Financial Planning Steps:-

Certified Financial Planners (CFPs) follow seven financial planning steps to create recommendations

for their clients. These steps are considered to be the practice standards for CFPs. They should be
followed to comply with the Certified Financial Planner Board of Standards' Code of Ethics and
Standards of Conduct if the planner and client agree the standards are part of the scope of
engagement between them.

These steps could also be learned and applied by individuals for their own benefit if they wanted to
act as their own nonprofessional financial planner.

What Are the 7 Steps of Financial Planning?

The seven steps of financial planning start with getting to know the client's current financial situation
and goals and end with continually measuring performance toward those goals and updating them
as necessary.

1. Understanding the client's personal and financial circumstances.

2. Identifying and selecting goals.
3. Analyzing the client's current course of action and potential alternative course(s) of action.
4. Developing the financial planning recommendation(s).
5. Presenting the financial planning recommendation(s).
6. Implementing the financial planning recommendation(s).
7. Monitoring progress and updating.1

Note

The CFPB defines financial planning as "a collaborative process that helps maximize a Client’s
potential for meeting life goals through Financial Advice that integrates relevant elements of the
Client’s personal and financial circumstances." 1

Step 1: Understanding the Client's Personal and Financial Circumstances

The CFP begins their financial planning process by asking their clients questions designed to help
them get a clear picture of who the client is and what they want. Some of the questions are
qualitative and lead to a better understanding of the client's health, family relationships, values,
earnings potential, risk tolerance, goals, needs, priorities, and current financial plan.

Some of the questions are quantitative and lead to a better understanding of the client's income,
expenses, cash flow, savings, assets, liabilities, liquidity, taxes, employee and government benefits,
insurance coverage, and estate plans. 1
 The advisor may ask open-ended questions to uncover necessary information to start the plan. This
information may include a range of topics, from financial goals to feelings about market risk to
dreams about retiring in the Caribbean.

The advisor will also analyze the client's financial information to ensure they have a clear
understanding of where their client stands.

Note

For example, if you are working on retirement planning, some of the key information needed is your
annual income, savings rate, years until proposed retirement, age when you are eligible to receive
Social Security or a pension, how much you've saved to date, how much you will save in the future,
and the expected rate of return on your investments.

Step 2: Identifying and Selecting Goals

The advisor will use their financial expertise to help their client select goals. They'll ask clarifying
questions to help identify those goals. For example, what is your time horizon? Do you want to
accomplish this goal in five years, 10 years, 20 years, or 30 years? What is your risk tolerance? Are
you willing to accept a high relative market risk to achieve your investment goals, or will a
conservative portfolio be a better option for you?

Together, the financial planner and client will prioritize which goals are most important.

Step 3: Analyzing the Client's Current Course of Action

Next, the advisor will analyze the client's current course of action to see if it's moving them toward
their financial goals. If it's not, the advisor will identify alternative courses of action and let the client
know the advantages and disadvantages of each option.

Step 4: Developing the Financial Planning Recommendation(s)

The financial planner selects one or more recommendations that they believe will help meet the
client's goals. They evaluate each recommendation, considering:

 What assumptions were made to develop the recommendation

 How the recommendation meets the client's goals
 How it integrates with other aspects of the client's financial plans
 How high a priority the recommendation is
 Whether the recommendation is independent or needs to be implemented with other
recommendations1

Step 5: Presenting the Financial Planning Recommendations

In this step, the financial planner presents the recommendations and the thought process behind
the recommendations. This helps the client make an informed decision about whether the
recommendations are a good fit.

Step 6: Implementing the Financial Planning Recommendation(s)

Implementing the plan means putting the plan to work. But as simple as this sound, many people
find that implementation is the most difficult step in financial planning. Although you have the plan
developed, it takes discipline and desire to put it into action. You may begin to wonder what may
happen if you fail. This is where inaction can grow into procrastination.
If the financial planner has implementation responsibilities, you'll also clarify what those are so you
know exactly what steps your CFP is taking on your behalf.

Note

Successful investors will tell you that just getting started is the most important aspect of success.
You don't need to start at a high level of savings or an advanced level of investment strategy. You
could learn how to invest with just one fund or you could start saving a few dollars per week to build
up to your first investment.

Step 7: Monitoring Progress and Updating

It's called "financial planning" for a reason: Plans evolve and change just like life. Once the plan is
created, it's essentially a piece of history. This is why the plan needs to be monitored and tweaked
from time to time. Think of what can change in your life, such as marriage, the birth of children,
career changes, and more.

These life events may require new perspectives or changes to your financial plans. Now think about
events or changes beyond your control, such as tax laws, interest rates, inflation, stock market
fluctuations, and economic recessions.

Your CFP will work with you to ensure your plan is meeting your goals, and if it's not, they'll
recommend changes.

The Bottom Line

Now that you know the seven steps of financial planning, you can apply them to any area of personal
finance, including insurance planning, tax planning, cash flow (budgeting), estate planning, investing,
and retirement. While you can do it yourself, professionals can provide invaluable advice and a
neutral perspective on your finances.

Whether you do it yourself or hire an advisor, remember to keep referring back to the steps as
significant life or financial changes occur. You may also want to do what professional financial
planners do and sit down and revaluate your plan periodically, such as once per year.
 Unit 2
1. Financial Markets, Institutions and instruments:

A financial market is a word that describes a marketplace where bonds, equity, securities, currencies
are traded. Few financial markets do a security business of trillions of dollars daily, and some are
small-scale with less activity. These are markets where businesses grow their cash, companies
decrease risks, and investors make more cash.
Meaning of Financial Markets

A Financial Market is referred to space, where selling and buying of financial assets and securities
take place. It allocates limited resources in the nation’s economy. It serves as an agent between the
investors and collector by mobilising capital between them.
In a financial market, the stock market allows investors to purchase and trade publicly companies
share. The issue of new stocks are first offered in the primary stock market, and stock securities
trading happen in the secondary market.
Types of Financial Markets

 Over the Counter (OTC) Market – They manage public stock exchange, which is not listed on the
NASDAQ, American Stock Exchange, and New York Stock Exchange. The OTC market dealing with
companies are usually small companies that can be traded in cheap and have less regulation.
 Bond Market – A financial market is a place where investors loan money on bond as security for a
set if time at a predefined rate of interest. Bonds are issued by corporations, states, municipalities,
and federal governments across the world.
 Money Markets – They trade high liquid and short maturities, and lending of securities that matures
in less than a year.
 Derivatives Market –They trades securities that determine its value from its primary asset. The
derivative contract value is regulated by the market price of the primary item — the derivatives
market securities, including futures, options, contracts-for-difference, forward contracts, and swaps.
 Forex Market – It is a financial market where investors trade in currencies. In the entire world, this is
the most liquid financial market.

2. List of Functions of Financial Markets

The functions of financial markets are not limited to just being trading spaces for buyers and sellers.
Let’s take a look at some of the other functions of financial markets in order to understand them
better.  

o They enable the mobilisation of money

Think about it. When you save a portion of your income, the money just sits idle till you decide to
use it for something. But financial markets allow you to mobilise your savings by providing you with
a way to invest. Financial markets thereby help connect individuals and businesses that require
capital with those who are in possession of the said capital.      
 They also help you redirect the stagnated money back into the economy and put it to good use,
instead of merely leaving it idle. After all, the economy of a nation can only be successful if there’s
adequate circulation of money. 

o They help determine the price of assets 

The price of an asset fluctuates based on its demand and supply. Remember grade school
economics? When the demand is greater than the supply, the price of goods rises. And when the
supply is greater than the demand, the price falls. That’s how demand and supply help determine
the price of goods. And this principle applies to financial markets as well. 

Clearly, demand and supply are two of the most important forces out there, driving global economic
systems constantly and consistently. An economy cannot exist in balance without either demand or
supply. And since financial markets are powered entirely by these two forces, they help determine
the price of the financial assets being traded. Without these markets, the prices of financial assets
would be unregulated and nearly impossible to determine fairly.

o They ensure liquidity of the assets

Liquidity is essentially a metric that determines the ability of an asset to be quickly purchased, sold,
or converted to cash. Let’s simplify it even further with a comparative example. 

Gold is considered to be a highly liquid form of investment since it can be quickly sold and converted
to cash. That’s because of the high levels of demand for the yellow metal. A real estate property, on
the other hand, is generally considered to be much less liquid because it cannot be sold off as
quickly. 

Financial markets act as fair platforms for sale and purchase of assets. By allowing you to purchase
and sell the said assets smoothly, they also ensure that these financial assets are liquid. In other
words, you don’t have to go too far to find a buyer or a seller in these markets. 

o They help save time and money

Building up on the idea of liquidity and considering the fact that you can find a buyer or a seller
almost instantly, financial markets save a lot of time for everyone involved. That’s not all. They also
save you a lot of effort, which you may have otherwise spent on finding probable buyers or sellers. 

Furthermore, thanks to the financial markets going completely electronic, the costs and fees
associated with each transaction have reduced significantly. This, in turn, helps you save a lot of
money.

o Price discovery

The financial market facilitates the price determination of the various financial securities that are
being traded. The underlying principle is the manifestation of the basic economic concept of
demand and supply, which helps in identifying what the market is willing to pay for a particular
financial instrument. So, the financial market is the platform where the prices of the financial
securities are determined irrespective of whether it is newly issued or an existing financial asset.

o Funds mobilization
 Another major criterion for capital allocation is the return expected by the investors, and the
participants in the financial market determine it. The companies seeking capital must be aware of
the required rate as it is a critical factor while raising funds. Consequently, the financial market
determines how the available funds from the investors will get allocated to the companies or
individuals who need funds to support their business requirements. In this way, the financial
market helps in mobilizing the funds from the savings of the investors to the capital of the
businesses.

o Liquidity

In the absence of an organized financial market, the investors will not be able to trade and hence
will be forced to hold the financial securities or instruments until any liquidity event. In the case of
debt instruments, the liquidity event will be when the issuer is contractually obligated to pay at
the time of maturity. In the case of equity instruments, the liquidity event will be when at the time
of the liquidation of the company, either voluntarily or involuntarily. This is where the financial
market comes into play as it provides trading opportunities to the investors so that they can easily
buy and sell the financial instruments at their fair value as per the market at any point in time.
Thus, the financial market provides liquidity to the investors wherein they can sell their holdings
freely and convert the securities into cash.

o Risk sharing

The individuals who undertake the investments are different from the investors who lend their
money. Through the risk-sharing function, the financial market ensures that the investors are well
aware of the risks associated with the investment before entering into one. In this way, the
financial market helps in transferring the risk of the investment from the person undertaking the
investments to the investors who are making those investments.

o Intermediary

The industries require funds for expanding their business, and for this purpose, they need
investors. On the other hand, the investors require a healthy return on investments, and for this,
they need the industries. So, both industries and investors need each other to fulfill their goals.
Consequently, the financial market acts as an intermediary and provides the perfect platform
where the industries can easily raise the funds they need while the investors can find the
investment opportunities that they seek for good returns.

o Market efficiency

Investors seek different types of information before they start putting their money into buying and
selling any financial securities. In the absence of the financial market, this information can only be
obtained in exchange for a significant amount of time and money. However, the financial market
ensures that all these data are made available to investors without any substantial amount of
money. In this way, it helps in reducing transaction costs.

o Capital formation

The funds that will otherwise sit idle as savings are converted into capital for businesses with the
help of the financial market. In other words, it provides the channel through which the savings
flow from the investors to the businesses and help them in their capital formation.
1. What is a Financial Instrument?
Financial instruments are contracts for monetary assets that can be purchased, traded, created,
modified, or settled for. In terms of contracts, there is a contractual obligation between involved
parties during a financial instrument transaction.

For example, if a company were to pay cash for a bond, another party is obligated to deliver a
financial instrument for the transaction to be fully completed. One company is obligated to provide
cash, while the other is obligated to provide the bond.

Basic examples of financial instruments are cheques, bonds, securities.

There are typically three types of financial instruments: cash instruments, derivative instruments,
and foreign exchange instruments.

Types of Financial Instruments

1. Cash Instruments

Cash instruments are financial instruments with values directly influenced by the condition of the
markets. Within cash instruments, there are two types; securities and deposits, and loans.

Securities: A security is a financial instrument that has monetary value and is traded on the stock
market. When purchased or traded, a security represents ownership of a part of a publicly-traded
company on the stock exchange.

Deposits and Loans: Both deposits and loans are considered cash instruments because they
represent monetary assets that have some sort of contractual agreement between parties.

2. Derivative Instruments

Derivative instruments are financial instruments that have values determined from underlying
assets, such as resources, currency, bonds, stocks, and stock indexes.
The five most common examples of derivatives instruments are synthetic agreements, forwards,
futures, options, and swaps. This is discussed in more detail below.

Synthetic Agreement for Foreign Exchange (SAFE): A SAFE occurs in the over-the-counter (OTC)
market and is an agreement that guarantees a specified exchange rate during an agreed period of
time.

Forward: A forward is a contract between two parties that involves customizable derivatives in
which the exchange occurs at the end of the contract at a specific price.

Future: A future is a derivative transaction that provides the exchange of derivatives on a

determined future date at a predetermined exchange rate.

Options: An option is an agreement between two parties in which the seller grants the buyer the
right to purchase or sell a certain number of derivatives at a predetermined price for a specific
period of time.

Interest Rate Swap: An interest rate swap is a derivative agreement between two parties that
involves the swapping of interest rates where each party agrees to pay other interest rates on their
loans in different currencies.

3. Foreign Exchange Instruments

Foreign exchange instruments are financial instruments that are represented on the foreign market
and primarily consist of currency agreements and derivatives.

In terms of currency agreements, they can be broken into three categories.

Spot: A currency agreement in which the actual exchange of currency is no later than the second
working day after the original date of the agreement. It is termed “spot” because the currency
exchange is done “on the spot” (limited timeframe).

Outright Forwards: A currency agreement in which the actual exchange of currency is done
“forwardly” and before the actual date of the agreed requirement. It is beneficial in cases of
fluctuating exchange rates that change often.

Currency Swap: A currency swap refers to the act of simultaneously buying and selling currencies
with different specified value dates.

Sources of financing –
 1. Equities
The securities market has two interdependent and inseparable segments, the new issues (primary)
market and the stock (secondary) market. The primary market provides the channel for creation and
sale of new securities, while the secondary market deals in securities previously issued. The Stock
market or Equities market is where listed securities are traded in the secondary market. Currently
more than 1300 securities are available for trading on the Exchange.

Current Volume and Turnover

As on Jan 04, 2023 16:00 IST

Traded Volume (shares in

Traded Value (Rs crores)
lakh)

30,012.56 46,602.28

2. Debt Segment
a) Debt:-
Wholesale Debt Market (WDM) segment of the Exchange commenced operations on June 30, 1994.
This provided the first formal screen-based trading facility for the debt market in the country. It has
now been merged under the New Debt Market as the Negotiated Trade Reporting Platform.

b) Corporate Bonds:-

Corporate bonds are debt securities issued by private and public corporations. Companies issue
corporate bonds to raise money for a variety of purposes, such as building a new plant, purchasing
equipment, or growing the business. When one buys a corporate bond, one lends money to the
"issuer," the company that issued the bond. In exchange, the company promises to return the
money, also known as "principal," on a specified maturity date. Until that date, the company usually
pays you a stated rate of interest, generally semiannually. While a corporate bond gives an IOU from
the company, it does not have an ownership interest in the issuing company, unlike when one
purchases the company's equity stock.

Yield is a critical concept in bond investing, because it is the tool used to measure the return of one
bond against another. It enables one to make informed decisions about which bond to buy. In
essence, yield is the rate of return on bond investment. However, it is not fixed, like a bond's stated
interest rate. It changes to reflect the price movements in a bond caused by fluctuating interest
rates. The following example illustrates how yield works.

You buy a bond, hold it for a year while interest rates are rising and then sell it.

You receive a lower price for the bond than you paid for it because, no one would otherwise accept
your bond's now lower-than-market interest rate.

Although the buyer will receive the same amount of interest as you did and will also have the same
amount of principal returned at maturity, the buyer's yield, or rate of return, will be higher than
yours, because the buyer paid less for the bond.

Yield is commonly measured in two ways, current yield and yield to maturity.

Current yield

The current yield is the annual return on the amount paid for a bond, regardless of its maturity. If
you buy a bond at par, the current yield equals its stated interest rate. Thus, the current yield on a
par-value bond paying 6% is 6%.
However, if the market price of the bond is more or less than par, the current yield will be different.
For example, if you buy a Rs. 1,000 bond with a 6% stated interest rate at Rs. 900, your current yield
would be 6.67% (Rs. 1,000 x .06/Rs.900).

Yield to maturity

It tells the total return you will receive if you hold a bond until maturity. It also enables you to
compare bonds with different maturities and coupons. Yield to maturity includes all your interest
plus any capital gain you will realize (if you purchase the bond below par) or minus any capital loss
you will suffer (if you purchase the bond above par).

Valuation of Corporate Bonds

Corporate bonds tend to rise in value when interest rates fall, and they fall in value when interest
rates rise. Usually, the longer the maturity, the greater is the degree of price volatility. By holding a
bond until maturity, one may be less concerned about these price fluctuations (which are known as
interest-rate risk, or market risk), because one will receive the par, or face, value of the bond at
maturity. The inverse relationship between bonds and interest rates—that is, the fact that bonds are
worth less when interest rates rise and vice versa can be explained as follows:

When interest rates rise, new issues come to market with higher yields than older securities, making
those older ones worth less. Hence, their prices go down.

When interest rates decline, new bond issues come to market with lower yields than older
securities, making those older, higher-yielding ones worth more. Hence, their prices go up.

As a result, if one sells a bond before maturity, it may be worth more or less than it was paid for.

3. Derivative Market:-

A) Equities Derivatives

Equity derivative is a class of derivatives whose value is at least partly derived from one or more
underlying equity securities. Options and futures are by far the most common equity derivatives.
This section provides you with an insight into the daily activities of the equity derivatives market
segment on NSE. 2 major products under Equity derivatives are Futures and Options, which are
available on Indices and Stocks.

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Instrument wise Volume and Turnover

 As on Jan 04, 2023 15:30:09 IST

No. of Premium
Product Turnover (cr.)*
contracts Turnover (cr.)

Index Futures 4,16,511 41,086.90 -

Stock Futures 7,38,566 52,440.29 -

Index Options 20,69,94,214 2,09,04,526.47 58,131.71

Stock Options 25,27,914 1,87,808.96 3,080.41

F&O Total 21,06,77,205 2,11,85,862.62 61,212.12

c) Commodity Derivatives

Commodity Derivatives markets are a good source of critical information and indicator of market
sentiments. Since, commodities are frequently used as input in the production of goods or services,
uncertainty and volatility in commodity prices and raw materials makes the business environment
erratic, unpredictable and subject to unforeseeable risks.

Volatility in raw material costs affects businesses and can be significant given that commodity prices
are driven by supply and demand from domestics as well as global markets. Ability to manage or
mitigate risks by using suitable hedging in commodity derivative products, can positively affect
business performance. Futures & Options, are by far the most common Commodity Derivatives
products offered on an Exchange, that are well structured and regulated through robust mechanisms
and controls.

4. Public Deposit

As the name indicates, public deposits are those deposits made directly to an institution by the
general public. On deposits of the general public, companies pay higher interest rates than banks.
Those who choose to deposit money with an organisation fill out the deposit paperwork. A deposit
receipt is a kind of debt acknowledgement issued by a company.
 Businesses can fulfil their medium and short-term financial demands by utilising public deposits.
Because depositors earn a greater interest rate than banks, the corporations can borrow at a
cheaper cost than borrowing from banks. The deposits help both the depositors and the
organisation. Accepting public deposits for up to three years is ordinarily permissible.

Merits
 No Security
A public deposit is an unsecured deposit. There is usually no charge on the company’s assets when it
comes to public deposits. This means that the company can raise loans based on its assets. The
company’s assets can secure any future mortgage. As a result, the company becomes more
creditworthy.
 Economical
Public deposits are relatively inexpensive to obtain. Commissions on prospectuses and underwriters
are not necessary. A public deposit pays a lower interest rate than a borrowed fund. A public deposit
has a lower interest rate than a debenture or loan from a bank. Also, no underwriting commissions,
brokerages, etc., are charged. Public deposit interest is tax-deductible, which reduces the tax bill.
This results in public deposits being cheaper than private deposits.
 An Easy Procedure
Obtaining and issuing public deposits require fewer legal formalities. In a company’s case, there is no
need to get listed on a stock market like shares or debentures, and no permission is required from
the controller of capital. Deposits from the public are an excellent source of business financing.
There are no complicated legal procedures. Each depositor must simply be given an advertisement
and a receipt by the company collecting deposits.
 Diluted in no way
Due to the lack of voting rights for depositors, the organisation’s control does not further erode.
 Equity Trading
Deposits held by the public are paid interest at a fixed rate. As a result, a company can declare
higher dividends to equity shareholders during times of good earnings.
 Broad Contacts
An organisation can establish contacts with its target market by depositing public money. As a result,
these contacts are helpful in the future if you ever intend to sell shares or debentures.

Demerits
 Limitation
Legal restrictions limit the number of funds raised through public deposits. The maximum amount of
public deposits is 25% of the share capital plus the free reserves. Small and newly founded
companies often have difficulty getting funds through public deposits.
 Irregularities
Uncertainty and unreliability are the characteristics of public deposits. It is possible that deposits do
not respond during a depressed market on the capital market. Additionally, the company’s deposits
are not stable. Public funding may not be timely, as the public may be unreactive when a company
needs money.
 An ideal solution for short-term financial needs
The maturity period of public deposits is between six months and three years, so a company cannot
rely on them for long-term financing. A large number of public deposits may prove challenging to
collect, mainly if the deposits are large.
 Speculation
Companies with easy access to public funds may be tempted to raise more funds than they can
profitably utilise. In some cases, unused funds may be held in reserve for unexpected expenses. The
company’s management may engage in over-trading and speculation, which harms the business.
 Capital market growth hindered by
The presence of public deposits hampers a healthy capital market. Industrial securities are in short
supply due to the widespread use of public deposits.

5. Retained Earnings

Retained Earnings (RE) are the accumulated portion of a business’s profits that are not distributed as
dividends to shareholders but instead are reserved for reinvestment back into the business.
Normally, these funds are used for working capital and fixed asset purchases (capital expenditures)
or allotted for paying off debt obligations.
Term Loan
 A term loan provides borrowers with a lump sum of cash upfront in exchange for specific
borrowing terms. Term loans are normally meant for established small businesses with
sound financial statements. In exchange for a specified amount of cash, the borrower
agrees to a certain repayment schedule with a fixed or floating interest rate. Term loans
may require substantial down payments to reduce the payment amounts and the total cost
of the loan.
 A term loan provides borrowers with a lump sum of cash upfront in exchange for specific
borrowing terms.
 Borrowers agree to pay their lenders a fixed amount over a certain repayment schedule
with either a fixed or floating interest rate.
 Term loans are commonly used by small businesses to purchase fixed assets, such as
equipment or a new building.
 Borrowers prefer term loans because they offer more flexibility and lower interest rates.
 Short and intermediate-term loans may require balloon payments while long-term facilities
come with fixed payments.

Types of Term Loans

Term loans come in several varieties, usually reflecting the lifespan of the loan. These include:

 Short-term loans: These types of term loans are usually offered to firms that don't qualify
for a line of credit. They generally run less than a year, though they can also refer to a loan
of up to 18 months.
 Intermediate-term loans: These loans generally run between one to three years and are
paid in monthly installments from a company’s cash flow.
  Long-term loans: These loans last anywhere between three to 25 years. They use company
assets as collateral and require monthly or quarterly payments from profits or cash flow.
They limit other financial commitments the company may take on, including other
debts, dividends, or principals' salaries, and can require an amount of profit set aside
specifically for loan repayment.

Leasing and hire purchase:-

 Leasing and hire purchase are low-risk forms of debt finance that can be used to acquire
assets for a business. Such finance options are available directly from specialist providers,
or indirectly through equipment suppliers or finance brokers.
 Leasing and hire purchase could be the perfect solution if your business needs new
equipment which would otherwise be unaffordable because of cash-flow constraints.
 Because leases and hire-purchase agreements are secured wholly or largely on the asset
being financed, the need for additional collateral is much reduced.
 There is more security for the user because the finance cannot be recalled during the life of
the agreement, provided the business keeps up with payments.
 This means leasing and hire purchase can be useful to businesses at any stage. from start-
ups to large, established organisations.
a) Leasing
A leasing company buys and owns the equipment, which the business then rents for a
predetermined period.
Typically, the lease will have a set interest rate, which fixes the outgoings on that asset. The
business also has the option to replace or update the equipment at the end of the lease period.
b) Hire purchase
If a business wants to own the equipment at the end of the agreement, but avoid the cash flow
impact of buying outright, then hire purchase is an option.
A finance company buys the equipment and the business repays the cash price plus interest
through regular repayments. These agreements are also normally at fixed interest rates.
At the end of the agreement, there is usually a nominal fee to acquire title to the equipment.

A commodity market:-

 A commodity market is a marketplace for buying, selling, and trading raw materials or
primary products.

 Commodities are often split into two broad categories: hard and soft commodities. Hard
commodities include natural resources that must be mined or extracted—such as gold,
rubber, and oil, whereas soft commodities are agricultural products or livestock—such as
corn, wheat, coffee, sugar, soybeans, and pork.

Bonds and their Types

 A bond is a financial instrument whereby its issuer raises (borrows) capital or funds at a
certain cost for a certain time period and pays back the principal amount on maturity of the
bond. Interest paid on bonds is usually referred to as coupons. In simple words, a bond is a
loan taken at a certain rate of interest for a definite time period and repaid on maturity.
 From a company’s point of view, the bond or debenture falls under the liabilities section of
the balance sheet under the heading of debt. And are distinguished on the basis of security
(secured and unsecured bonds). A bond is similar to a loan in many aspects; however, it
differs mainly with respect to its tradability. A bond is usually tradable and can change many
hands before it matures, while a loan usually is not traded or transferred freely.
Issuer
 The entities that borrow money by issuing bonds are called issuers. In the US, there are
mainly 4 major bond issuers, including the government, government agencies, municipal
bodies, and corporates.
Face Value
 Every bond issued has a face value, which is usually the principal amount that is borrowed
and returned on maturity. In layman’s terms, it is the value of the bond on its maturity.
Coupon
 The rate of interest paid on the bond is called a coupon. (Read more about it at  Coupon
Rate).
Rating
 Credit rating agencies usually rate every bond; the higher the credit rating, the lower the
coupon required to pay by the issuer and vice versa.
 Coupon Payment Frequency
 The coupon payments on the bond usually have a payment frequency. The coupons are
usually paid annually or semi-annually; however, they may be paid quarterly or monthly.
Yield
 The effective return that the investor makes on the bond is called a return. Assuming a bond
was issued for a face value of $ 1000 and a coupon rate of 10% on initiation. The Price at a
later date may rise or fall, and hence the investor who invests at a rate other than $ 1000
will still receive a coupon payment of $100 (1000 * 10%), but the effective earning shall be
different since the investment amount is not $1000. That effective return, in layman’s terms,
is called the yield. If the holding period is considered for a year, this is referred to as  current
yield, and if it is held to maturity, it is referred to as yield to maturity (YTM).
 Read Bond Indenture to learn about the terms and conditions of a bond contract.
 There are many types of bonds issued that differentiate each other regarding their features.
These features vary depending upon the requirement of the issuer. Let us look at some of
the major types of bonds issued.
  Different Types of Bonds
a. Plain Vanilla Bonds
A plain vanilla bond is a bond without unusual features; it is one of the simplest forms of bond with a
fixed coupon and a defined maturity and is usually issued and redeemed at face value. It is also
known as a straight bond or a bullet bond.

b. Zero-Coupon Bonds
A zero-coupon bond is a type of bond with no coupon payments. It is not that there is no yield; the
zero-coupon bonds are issued at a price lower than the face value (say 950$) and then pay the face
value on maturity ($1000). The difference will be the yield for the investor. These are also
called discount bonds or deep discount bonds if they are for a longer tenor.

c. Deferred Coupon Bonds

The deferred coupon bond is a blend of a coupon-bearing bond and a zero-coupon bond. These
bonds do not pay any coupon in the initial years and, after that, pay a higher coupon to compensate
for no coupon in the initial years. Such bonds are issued by corporates whose business model has a
gestation period before the actual revenues start. Examples of companies that may issue such bonds
include construction companies.

d. Step-Up Bonds
The step-up bonds are where the coupon usually steps up after a certain period. They may also be
designed to step up not once but in a series. Such bonds are usually issued by companies where
revenues/ profits are expected to grow in a phased manner. These are also called dual coupon or
multiple coupon bonds.

e. Step Down Bonds

The step-down bonds are just the opposite of Step-Up Bonds. These are bonds where the coupon
usually steps down after a certain period. They may also be designed to step down not once but in a
series. Such bonds are usually issued by companies where revenues/ profits are expected to decline
in a phased manner; this may be due to wear and tear of the assets or machinery, as in the case of
leasing.

f. Floating Rate Bonds

Floating rate bonds are so-called because they have a coupon that is not fixed but instead linked to a
benchmark. For example, a company may issue a floating-rate bond as Treasury bond rate + 50 bps
(100 bps = 1%). In such cases, on every interest payment date, the payment will be made 0.50%
more than the treasury bill rate prevailing on the fixing date.

g. Inverse Floaters

Inverse floaters are types of bonds that are similar to the floating rate bond in that the coupon is not
fixed and is linked to a benchmark; however, the differentiating thing is that the rate is inversely
related to the benchmark. In simple words, if the benchmark rate goes up, the coupon rate comes
down and vice versa.

h. Participatory Bonds
A participatory bond is a bond whereby the issuer promises a fixed rate. Still, the coupon cash flow
may increase if the profit/ income levels of the company rise to a pre-specified level and may reduce
when income falls below a pre-specified level; thereby, the investor participates in the return
enjoyed based on company revenues/ income.

i. Income Bonds
Income bonds are similar to participatory bonds; however, these types of bonds do not have a
reduction in interest payments if income/ revenue reduces.
 j. Payment in Kind Bonds
Payment in kind bonds are types of bonds that pay interest/coupon, not in terms of cash payouts
but the form of additional bonds.

k. Extendable Bonds
Extendable bonds allow the holder to enjoy the right to extend the maturity if required. The holder
has an additional benefit in this case because if the rate of interest in the market reduces, the holder
may choose to extend the tenor and enjoy the higher rate of interest in terms of coupon payment.
For this benefit, the holder may enjoy coupon rates that are usually lower than a plain vanilla bond.

l. Extendable Reset Bonds

These types of bonds allow the issuer and the bondholders to reset the coupon rate based on the
prevailing market scenario. This is not linked to any benchmark but on the basis of renegotiation
between the issuer and the bondholders. This is usually the case where the bond tenor is very long.

m. Perpetual Bonds
Perpetual bonds are types of bonds that pay a coupon rate on the face value till the life of the
company. Though Perpetuity means forever, bonds with maturity above 100 years are also
considered perpetual bonds.

n. Convertible Bonds
Convertible bonds are a special variety of bonds that have an inbuilt feature of being converted to
equity shares at a specified time at a pre-set conversion price.

o. Foreign currency convertible bonds

Foreign currency convertible bond is a special type of bond issued in a currency other than the home
currency. In other words, companies issue foreign currency convertible bonds to raise money in
foreign currency.

p. Exchangeable Bonds
Exchangeable bonds are similar to convertible bonds but differ in one aspect; they can be exchanged
for equity shares but not the issuer. These can be exchanged for equity shares of another company
in which the issuer may have stakeholding.

q. Callable Bonds
Bonds that are issued with a specific feature where the issuer has the right to call back the bonds at
a pre-agreed price and a pre-fixed date are called callable bonds. Since these bonds allow a benefit
to the issuer to repay the liability before maturity, these bonds usually offer a coupon rate higher
than a normal straight coupon-bearing bond.
 r. Puttable Bonds
Bonds that are issued with a specific feature where the bondholder has the right to return the bonds
at a pre-fixed date before maturity are called puttable bonds. Since these bonds allow a benefit to
the bondholders to ask for the principal repayment before maturity, these bonds usually offer a
coupon rate lower than a normal straight coupon-bearing bond.

s. Treasury Strips
In the US, Government dealer firms usually break down a coupon-bearing bond into a series of zero-
coupon bonds by considering each cash flow as a separate bond. For example, a 5-year semiannual
coupon-bearing bond can be split into 10 zero-coupon bonds with coupon amount as face value and
1 zero-coupon bond with the principal amount as the face value. These are called  treasury strips.
Bond stripping usually is done to increase liquidity and facilitate easy tradability.

t. Yankee Bonds
A dollar-denominated bond issued in the US by an issuer outside the US is called a Yankee bond.

u. Samurai Bonds
A yen-denominated bond issued in Japan by an issuer outside Japan is called a Samurai bond.

Shogun Bonds: A non-Yen denominated bond issued in Japan by an issuer outside Japan is called a
Shogun bond.

Bank Finance:-

What Is a Bank?
A bank is a financial institution that is licensed to accept checking and savings deposits and make
loans. Banks also provide related services such as individual retirement accounts (IRAs), certificates
of deposit (CDs), currency exchange, and safe deposit boxes.

There are several types of banks including retail banks, commercial or corporate banks, and
investment banks.

In the U.S., banks are regulated by the national government and by the individual states.

Understanding Banks
 Banks have existed since at least the 14th century. They provide a safe place for consumers
and business owners to stow their cash and a source of loans for personal purchases and
business ventures. In turn, the banks use the cash that is deposited to make loans and
collect interest on them.

 The basic business plan hasn't changed much since the Medici family started dabbling in
banking during the Renaissance, but the range of products that banks offer has grown.

 Basic Bank Services

  Banks offer various ways to stash your cash and various ways to borrow money.

Checking Accounts

 Checking accounts are deposits used by consumers and businesses to pay their bills and
make cash withdrawals. They pay little or no interest and typically come with monthly fees,
usage fees, or both.

 Today's consumers generally have their paychecks and any other regular payments
automatically deposited in one of these accounts.

Savings Accounts

 Savings accounts pay interest to the depositor. Depending on how long account holders
hope to keep their money in the bank, they can open a regular savings account that pays a
little interest or a certificate of deposit (CD) that pays a little more interest. The CDs can earn
interest for as little as a few months or as long as five years or more.

 It is important to note that the money in checking accounts, savings accounts, and CDs is
insured up to a maximum of $250,000 by the federal government through the Federal
Deposit Insurance Corp. (FDIC).1

Loan Services

 Banks make loans to consumers and businesses. The cash that is deposited by their
customers is lent out to other customers at a higher rate of interest than the depositor is
paid.

 At the highest level, this is the process that keeps the economy humming. People deposit
their money in banks; the bank lends the money out in car loans, credit cards, mortgages,
and business loans. The loan recipients spend the money they borrow, the bank earns
interest on the loans, and the process keeps money moving through the system.

 Just like any other business, the goal of a bank is to earn a profit for its owners. For most
banks, the owners are their shareholders. Banks do this by charging more interest on the
loans and other debt they issue to borrowers than they pay to people who use their savings
vehicles.

 For example, a bank may pay 1% interest on savings accounts and charge 6% interest for its
mortgage loans, earning a gross profit of 5% for its owners.

 Banks make a profit by charging more interest for loans than they pay on savings accounts.

 Brick-and-Mortar and Online Banks

 Banks range in size from small, community-based institutions to global commercial banks.

 According to the FDIC, there were just over 4,200 FDIC-insured commercial banks in the
United States as of 2021.2 This number includes national banks, state-chartered banks,
commercial banks, and other financial institutions.
  Traditional banks now offer both brick-and-mortar branch locations and online services.
Online-only banks began emerging in early 2010s.

 Consumers choose a bank based on its interest rates, the fees it charges, and the
convenience of its locations, among other factors.

How Are Banks Regulated?

 U.S. banks came under intense scrutiny after the global financial crisis of 2008. The
regulatory environment for banks was tightened considerably as a result.

 Depending on their business structures, U.S. banks may be regulated at the state or national
level, or both. State banks are regulated by each state's department of banking or
department of financial institutions. This agency is generally responsible for issues such as
permitted practices, how much interest a bank can charge, and auditing and inspecting
banks.

 National banks are regulated by the Office of the Comptroller of the Currency (OCC). OCC
regulations primarily cover bank capital levels, asset quality, and liquidity. As noted above,
banks with FDIC insurance are also regulated by the FDIC.

 The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in 2010
following the financial crisis with the intention of reducing risks in the U.S. financial system.
Under this act, large banks now have to submit to regular tests that measure whether they
have sufficient capital to continue operating under challenging economic conditions. This
annual assessment is referred to as a stress test.3

Types of Banks
 Most banks can be categorized as retail, commercial or corporate, or investment banks. The
big global banks often operate separate arms for each of these categories.

Retail Banks

 Retail banks offer their services to the general public and usually have branch offices as well
as main offices for the convenience of their customers.

 They provide a range of services such as checking and savings accounts, loan and mortgage
services, financing for automobiles, and short-term loans such as overdraft protection. Many
also offer credit cards.

 They also offer access to investments in CDs, mutual funds, and individual retirement
accounts (IRAs). The larger retail banks also cater to high-net-worth individuals with
specialty services such as private banking and wealth management services.

 Examples of retail banks include TD Bank and Citibank.

 Commercial or Corporate Banks

 Commercial or corporate banks tailor their services to business clients, from small business
owners to large, corporate entities. Along with day-to-day business banking, these banks
 also offer credit services, cash management, commercial real estate services, employer
services, and trade finance,

 JPMorgan Chase and Bank of America are examples of commercial banks, though both have
large retail banking divisions as well.

Investment Banks

 Investment banks focus on providing corporate clients with complex services and financial
transactions such as underwriting and assisting with merger and acquisition (M&A) activity.
They are primarily financial intermediaries in these transactions.

 Their clients include large corporations, other financial institutions, pension funds,
governments, and hedge funds.

 Morgan Stanley and Goldman Sachs are among the biggest U.S. investment banks.

Central Banks

 Unlike the banks above, central banks does not deal directly with the public. A central bank
is an independent institution authorized by a government to oversee the nation's money
supply and its monetary policy.

 As such, central banks are responsible for the stability of the currency and of the economic
system as a whole. They also have a role in regulating the capital and reserve
requirements of the nation's banks.

 The U.S. Federal Reserve Bank is the central bank of the U.S. The European Central Bank, the
Bank of England, the Bank of Japan, the Swiss National Bank, and the People’s Bank of China
are among its counterparts in other nations.

Trade credit:-

 Trade credit is a business-to-business (B2B) agreement in which a customer can purchase

goods without paying cash up front, and paying the supplier at a later scheduled date.
Usually, businesses that operate with trade credits will give buyers 30, 60, or 90 days to
pay, with the transaction recorded through an invoice.

 Trade credit can be thought of as a type of 0% financing, increasing a company’s assets

while deferring payment for a specified value of goods or services to some time in the
future and requiring no interest to be paid in relation to the repayment period.

Understanding Trade Credit

 Trade credit is an advantage for a buyer. In some cases, certain buyers may be able to
negotiate longer trade credit repayment terms, which provides an even greater advantage.
Often, sellers will have specific criteria for qualifying for trade credit.

 A B2B trade credit can help a business to obtain, manufacture, and sell goods before ever
having to pay for them. This allows businesses to receive a revenue stream that can
 retroactively cover costs of goods sold. Walmart is one of the biggest utilizers of trade
credit, seeking to pay retroactively for inventory sold in their stores. International business
deals also involve trade credit terms. In general, if trade credit is offered to a buyer it
typically always provides an advantage for a company’s cash flow.

 The number of days for which a credit is given is determined by the company allowing the
credit and is agreed upon by both the company allowing the credit and the company
receiving it. Trade credit can also be an essential way for businesses to finance short-term
growth. Because trade credit is a form of credit with no interest, it can often be used to
encourage sales.

 Since trade credit puts suppliers at somewhat of a disadvantage, many suppliers use
discounts when trade credits are involved to encourage early payments. A supplier may
give a discount if a customer pays within a certain number of days before the due date. For
example, a 2% discount if payment is received within 10 days of issuing a 30-day credit. This
discount would be referred to as 2%/10 net 30 or simply just 2/10 net 30.

Trade Credit Accounting

 Trade credits are accounted for by both sellers and buyers. Accounting with trade credits
can differ based on whether a company uses cash accounting or accrual accounting. Accrual
accounting is required for all public companies.1 With accrual accounting, a company must
recognize revenues and expenses at the time they are transacted.

 Trade credit invoicing can make accrual accounting more complex. If a public company
offers trade credits it must book the revenue and expenses associated with the sale at the
time of the transaction. When trade credit invoicing is involved, companies do not
immediately receive cash assets to cover expenses. Therefore, companies must account for
the assets as accounts receivable  on their balance sheet.

 With trade credit, there is the possibility of default. Companies offering trade credits also
usually offer discounts, which means they can receive less than the accounts receivable
balance. Both defaults and discounts can require the need for accounts receivable  write-
offs from defaults or write-downs from discounts. These are considered liabilities a
company must expense.

 Alternatively, trade credit is a useful option for businesses on the buying side. A company
can obtain assets but would not need to credit cash or recognize any expenses
immediately. In this way, trade credit can act like a 0% loan on the balance sheet.

 The company’s assets increase but cash does not need to be paid until some time in the
future and no interest is charged during the repayment period. A company only needs to
recognize the expense when cash is paid using the cash method or when revenue is
received using the accrual method. Overall, these activities greatly free up  cash flow for the
buyer.

Trade Credit Trends

 Trade credit is most rewarding for businesses that do not have a lot of financing options. In
financial technology, new types of point of sale financing options are being provided for
businesses to utilize in place of trade credits. Many of these fintech firms partner with
sellers at the point of sale to provide 0% or low-interest financing on purchases. These
 partnerships help to alleviate trade credit risks for sellers while also supporting growth for
buyers.

 Trade credit has also brought about new financing solutions for sellers in the form
of accounts receivable financing . Accounts receivable financing, also known as invoice
financing or factoring, is a type of financing that provides businesses with capital in relation
to their trade credit, accounts receivable balances.

 From an international standpoint, trade credit is encouraged. The World Trade Organization
reports that 80% to 90% of world trade is in some way reliant on trade finance. 2 Trade
finance insurance is also a part of many trade finance discussions globally with many new
innovations. LiquidX for example now offers an electronic marketplace focused on  trade
credit insurance for global participants.

 Research conducted by the U.S. Federal Reserve Banks also highlights some important
insights. The 2022 Small Business Credit Survey finds that trade credit finance is the third
most popular financing tool used by small businesses with 9% of businesses reporting that
they utilize it.3

Bill Discounting :-
In trade, bill discounting is a method through which an entity can sell its unpaid invoices
(receivables) to a 3rd party financier—a bank or any other financial institution which provides the
facility of bill discounting. Against the unpaid bill, the financier provides short-term aid in
the working capital requirement of the entity that sold the unpaid bill and charges a specific
commission and discount rate. This process of selling and getting short-term financial assistance is
bill discounting. It is now the financier that further pursues the payment of the unpaid bill, not the
company.

Factoring and reverse factoring are the other two methods for bill discounting designed to increase
the cash in-flow in the company efficiently. They do so without disturbing the other financial
statement but accomplish the same purpose as bill discounting. 

Bill Discounting Rate of Interest

What exactly is the bill discounting rate of interest? Remember when we talked about a 3rd party
financier providing the seller of the unpaid invoice with short-term finance. The financial institution
that buys the due bill buys it at a discounted rate, which means that the amount that the company
will receive against selling the unpaid bill will be less than the amount due on that invoice or bill.
There is a rational reason behind this. When a company plans to opt for bill discounting to fund its
requirement in the short term, it is a risk to the financial institution if that invoice has defaulted. The
financial institution or any other financier buys that unpaid invoice at a lesser amount than what is
on the document To keep that risk minimum or mitigate that risk.

Factors That Affect the Bill Discounting Rate of Interest

The interest rate that the financier may offer to a specific company or entity depends upon factors
like business stability, financial history, economic stability, business volumes, the applicant's credit
score, of the applicant or credibility of the applicant. In a nutshell, the factors depend on the
company applying for the bill discounting process and with whom they are applying for the bill
discounting.
Bill Discounting Process
The bill discounting process is not as complex as the concept sounds; it is easy to understand. We
will also look at an example, but first, let's know the basic framework of bill discounting.

 The process enables companies to sell their unpaid invoices, which they get when they make
a trade or deal with a certain set of buy or an individual buy.
 They sell these unpaid invoices to a 3rd party financier at a discounted price or a lesser value
than their face value.
 The financier or discounting institution buys that particular invoice from the firm with
agreeableness.
 The company then pays the amount to the company.
 After this, the financier pursues the unpaid invoice, and the buyer is supposed to pay the
financier, not the company. But keep in mind that the financier will receive an amount equal
to the invoice's face value.
 Take a simple example of a seller (Rakesh and sons Ltd) who sold its products to a buyer
(VKS Ltd). As a result, VKS Ltd gives a letter of credit from the bank of 60 days to Rakesh and
sons Ltd.

 If Rakesh and sons Ltd wants to get money from the bank before 60 days, the bank charges
some interest rate from Rakesh and sons Ltd.

 Assume that Rakesh and sons Ltd is supposed to get ₹1,00,000 after 60 days because of the
bank's interest of ₹5000. Rakesh and sons Ltd receives ₹.95,000 in return from the bank. VKS
ltd deposits ₹1,00,000 to the bank on the 60th day only.

 Here Rakesh and sons Ltd sold its products and got paid immediately, VKS Ltd got the goods
by not settling directly, and the bank earned a commission of ₹5000 on bill discounting.

 Here we can see that the discounted rate of interest that the bank charges was 5%.

 Below, there is an illustration of the process.

 Now that we know what bill discounting is, let's understand how you can use it for your
benefit. 

The Criteria Of Eligibility For Bill Discounting

Depending upon the different financier or financial institution, the criteria for being eligible for bill
discounting could vary. Here is a general framework that one can look up to as a guide to applying
for bill discounting.

Factors that affect the eligibility

 Business vintage
 Previous loan defaults should be minimum
 The company involved in the process of bill discounting should be financially stable.
 Repayment history and capability need to be unquestionable.
 Business volume and annual turnover
 Credit rating of the business
 Business positive net worth or profitability
Now that we covered what makes a company eligible for bill discounting, let's look at the essential
documents that a financier may require from the company when applying for bill discounting.

Document Required For Bill Discounting

Some key documents are required and good to have, but depending upon a financier may or may
not ask for additional documents.

 Bill Of Exchange
 Commercial invoice and packing list
 Transport document i.e. (lorry receipt/ rail receipt)
 Delivery challan (fines), if any
 Acceptance from LC issuing bank
 Discounting request letter/ application 

Benefits Of Bill Discounting Includes

 It helps to maintain a good In-flow of cash in the business that may be required to maintain
its stability.
 It works as a quick financial aid to a company with urgent funds requirements.
 It provides instant liquidity to the company.
 No impact on the balance sheet and no debt incurred.
 The process also provides the seller of the invoice hassle-free source of finance at the
expense of a small fee.

Interest rate and their types:-

How does a bond work?

 Bond is a debt security that is one of the popular asset classes known to investors apart from
stocks (equities) and cash and cash equivalents.
 They are issued by corporations or governments to fund a new project or refinance an
existing project. Hence helping them in raising money for future projects or ongoing
projects. This instrument can be issued directly to investors in the market. These are publicly
traded in the market. Alternatively, they can be issued privately and are traded only over-
the-counter (OTC) and are circulated privately.
 When the borrower issues bonds to the lender, an agreement is made between both the
parties. The issuer of the bond promises to pay back the principal on the maturity date. The
issuer also pays interest on the money borrowed (coupon payment) throughout the tenure
of the loan period.
 The bond‘s face value is mostly INR 1,000. The issuer will fix the coupon rate. However, the
market price or issue price will depend on the credit quality of the borrower, holding period
until maturity, and the coupon rate.
 A bond includes details of the amount borrowed, date of maturity on which the money will
be paid back to the investor, and details of coupon payments, including the coupon rate.
Once the bonds are issued, investors or bondholders are entitled to receive interest annually
or semi-annually. And upon maturity, will receive the face value (principal amount).
However, this is only valid when the bondholder holds it until maturity.
  There is no compulsion that one has to hold the bond until maturity. When interest rates
fall, and prices increase, the investor can sell it to earn profits. The bondholder will stop
receiving coupon payments once they sell the bond.
 Moreover, the issuer of the bonds can buy back the bonds in case of a decline in interest
rates or if the credit rating of the borrower has improved. Then the issuer will reissue new
bonds at a lower cost. This is because, the higher the credit quality, lower will be the interest
rate. This way, the bond issuer can reduce their debt obligation.

Features of a Bond

 All bonds share certain characteristics. They include the following:

 Face value: The worth of the bond upon maturity. It is also the base amount on which
interest is calculated.
 Coupon rate: The interest rate on the bond paid by the issuers of the bond to the investors.
Coupon payments are made annually or semi-annually.
 Coupon dates: The dates on which the investors receive the coupon payment.
 Maturity date: The date on which the bond issuer pays back the face value of the bond to
the investor. It indicates repayment of the loan taken.
 Issue price: The price at which the bond is initially sold to the investor by the issuer. In other
words, it is the price at which investors buy them. When the interest rate rises, the issue
price will go down. Similarly, the issue price will go up when the bond rates (interest rates)
fall.
 Bond duration: Duration measures the sensitivity of a bond‘s price to the interest rate
changes. It is not an indicator of the length of time until maturity.
 Credit quality: Credit quality is one of the principal determinants of a coupon rate. If the
issuer of the bond has a low credit rating, the default risk is greater, and as a result, these
bonds pay more interest. The credit rating agencies frequently keep updating the ratings of a
bond. Usually, bonds issued by the governments are very stable and are considered to be
the highest quality. These are called investment-grade bonds. On the other hand, bonds that
are not investment grade, but are not in default, are known as high yield or junk bonds.
These junk bonds have a high risk of default in the future. Also, to compensate for the risk,
investors demand higher coupon payments.
 Time to maturity: Certain bonds have long maturity dates. Hence, they tend to pay higher
interest rates. A high-interest rate is paid because the bondholder is exposed to inflation risk
and interest rate risk for an extended period. As interest rates change the value of bond and
bond portfolio will either rise or fall.

What are Different Bond Categories

Primarily there are four categories of bonds that are sold in the market.

1. Government Bonds

Government bonds are issued by the Central and State Government of India. The Reserve Bank of
India manages and regulates them. These include:

 bills that mature within less than one year

 notes that mature between one to 10 years
 bonds that mature in more than ten years
Since the Government of India issues them, the credit risk or default risk is almost nil. Government
bonds are considered to be the safest type of investment options to earn regular interests and
principal on maturity. However, the long term/ duration bonds are exposed to inflation risk.

2. Municipal Bonds

Municipal bonds are another type of government bonds issued by municipalities or government
bodies. In comparison to government bonds, municipal bonds carry higher risk. However, the
chances of a state government or a municipality going bankrupt or defaulting their payments are
very low. But they suffer from inflation risk. Also, these are tax free bonds.

3. Corporate Bonds

Companies issue corporate bonds. Companies issue them because the bond market offers debt at a
lower interest rate and favourable terms. Hence most companies prefer issuing bonds over bank
loans. The corporate sector represents a large portion of the bond market. They pay higher yields
than government bonds. However, they suffer from inflation risk, interest rate risk and credit risk.

4. Asset Backed Securities

Asset-backed securities ABS are bonds issued by banks and other financial institutions. Banks usually
bundle cash flows from a pool of assets and offer them as asset backed securities to investors. One
of the most common ABS is a mortgage loan pool of a bank. The bank offers mortgage backed
securities.

Types of Bonds

 Following are the types of bonds:

 Traditional bond: A traditional bond allows the bondholder to withdraw the entire principal
amount at one upon the bond’s maturity.
 Callable bond: A callable option is an option exercised by the bond issuer. When an issuer
calls out their right to redeem the bond before its maturity is called a callable bond. An
issuer can convert a high debt bond to a low debt bond through a callable bond.
 Fixed rate bond: Bonds whose coupon rate remains constant through the tenure of the
bond.
 Floating rate bond: Bonds whose coupon rate varies during the tenure of the bond.
 Putable bond: Puttable bonds are those where an investor sells their bonds and gets the
money back before the date of maturity.
 Mortgage bond: Mortgage bonds are ABS bonds. These types of bonds are often backed by
securities. For example, they can be backed by real estate companies and equipment.
 Zero coupon bond: Zero coupon bond is a bond with a zero coupon rate. The bond issuer
pays only the principal amount to the investor on maturity. They do not make any coupon
payments. However, they are issued at a discount to their par value. The bondholder
generates returns once the issuer repays the amount at face value.
 Serial bond: In a serial bond, is the one where the issuer pays back the loan amount to the
investors in small amounts every year. This is to reduce the final debt obligation on the
issuer.
 Extendable bond: An extendable bond allows the investor to extend the maturity period.
 Convertible bond: A convertible bond allows the bondholder to convert their debt into
equity (stock) at some point. However, it depends on conditions like share price. These are
suitable for companies as the interest outflow becomes lower. The investors can benefit
 from this when they can make a profit from the upside in the stock. However, this only
happens when the project is successful.
 Dynamic Bonds: Dynamic bond funds are open-ended debt mutual funds that invest across
duration. They follow a dynamic approach in terms of the maturity of securities in the
portfolio. One of the main objectives of dynamic bond funds is to provide optimal returns in
both falling and rising interest rate scenarios.

Unit-3
WHAT IS CASH FLOW?

 Cash flow refers to the net balance of cash moving into and out of a business at a specific
point in time.
 Cash is constantly moving into and out of a business. For example, when a retailer purchases
inventory, money flows out of the business toward its suppliers. When that same retailer
sells something from its inventory, cash flows into the business from its customers. Paying
workers or utility bills represents cash flowing out of the business toward its debtors. While
collecting a monthly instalment on a customer purchase financed 18 months ago shows cash
flowing into the business. The list goes on.
 Cash flow can be positive or negative. Positive cash flow means a company has more money
moving into it than out of it. Negative cash flow indicates a company has more money
moving out of it than into it.
Types of Cash Flow

 Operating cash flow: This refers to the net cash generated from a company’s normal business
operations. In actively growing and expanding companies, positive cash flow is required to
maintain business growth.
 Investing cash flow: This refers to the net cash generated from a company’s investment-related
activities, such as investments in securities, the purchase of physical assets like equipment or
property, or the sale of assets. In healthy companies that are actively investing in their
businesses, this number will often be in the negative.
 Financing cash flow: This refers specifically to how cash moves between a company and its
investors, owners, or creditors. It’s the net cash generated to finance the company and may
include debt, equity, and dividend payments.

What Is the Time Value of Money (TVM)?

The time value of money (TVM) is the concept that a sum of money is worth more now than the
same sum will be at a future date due to its earnings potential in the interim. The time value of
money is a core principle of finance. A sum of money in the hand has greater value than the same
sum to be paid in the future. The time value of money is also referred to as the present discounted
value.
Understanding the Time Value of Money (TVM)
 Investors prefer to receive money today rather than the same amount of money in the
future because a sum of money, once invested, grows over time. For example, money
deposited into a savings account earns interest. Over time, the interest is added to the
principal, earning more interest. That's the power of compounding interest. 

 If it is not invested, the value of the money erodes over time. If you hide $1,000 in a
mattress for three years, you will lose the additional money it could have earned over that
time if invested. It will have even less buying power when you retrieve it because inflation
reduces its value.

 As another example, say you have the option of receiving $10,000 now or $10,000 two years
from now. Despite the equal face value, $10,000 today has more value and  utility than it will
two years from now due to the opportunity costs associated with the delay. In other words,
a delayed payment is a missed opportunity.

 The time value of money has a negative relationship with inflation. Remember that inflation
is an increase in the prices of goods and services. As such, the value of a single dollar goes
down when prices rise, which means you can't purchase as much as you were able to in the
past.

Time Value of Money Formula

 The most fundamental formula for the time value of money takes into account the
following: the future value of money, the present value of money, the interest rate, the
number of compounding periods per year, and the number of years.

 Based on these variables, the formula for TVM is:

Payback-period:-

https://cleartax.in/s/payback-period

Components of TVM
The key components are as mentioned below –
 1. Interest/Discount Rate (i)– It’s the rate of discounting or compounding that we apply to an
amount of money to calculate its present or future value.
2. Time Periods (n) – It refers to the whole number of time periods for which we want to calculate
the present or future value of a sum. These time periods can be annually, semi-annually, quarterly,
monthly, weekly, etc.
3. Present value (PV)– The amount of money that we obtain by applying a discounting rate on the
future value of any cash flow.
4. Future value (FV)– The amount of money that we obtain by applying a compounding rate on the
present value of any cash flow.
5. Installments (PMT)– Installments represent payments to be paid periodically or received during
each period. The value is positive when payments have been received and become negative when
payments are made.
Time Value of Money Formula
What if you bought a bike and the dealer gives an option to pay Rs 3,00,000, its total cost, now, or 3
installments of Rs 1,00,000 for the next three years at the end of each year.

It’d be wrong if you add the installments and provide a comparison with the current amount that
you’ll have to pay.

Why? Let’s find out by learning about the two main calculations that we encounter in situations of
time value.

1. Present Value (PV)

 The present value is known as the current value of a sum of money that we will receive in
the future.
 We have mentioned that the purchasing power of money reduces over time. The formula of
PV accounts for this reduction by applying a discounting rate to the sum that we will receive
in the future.
 Due to the use of the discounting rate, the process of calculating the present value of a sum
of money is also known as discounting a sum of money.
 The PV of a sum of money can be used to determine the current value of projected cash flow
from a bond, an annuity, a loan, or any such instance where you are supposed to receive
money from a third party in the future and you want to know exactly how much that money
will be worth today.
 It is given by the following formula –
PV = FV / (1 + i)^n
Here, we require three things to calculate the present value –

1. What is the value of the sum we will receive in the future? (FV);
2. What is the rate of discounting at which the purchasing power of the money will fall? (i); and
3. After how many years will we receive the concerned sum of money? (n).
2. Future Value (FV)
As the name goes, the FV denotes the value of a sum of money at some date in the future.

This calculation is useful for investors and businesses who want to know the future value of their
potential investments to make a good investment decision.

The formula for FV is given by –

 FV = PV (1+i)n
This formula requires only three things to give us a future value –

1. What amount of money do we have right now? (PV);

2. What is the assumed interest rate at which it will grow? (i); and
3. After how many years will we need the money? (n)

https://saylordotorg.github.io/text_personal-finance/s08-01-the-time-value-of-money.html

Perpetuity

Perpetuity in the financial system is a situation where a stream of cash flow payments continues
indefinitely or is an annuity that has no end. In valuation analysis, perpetuities are used to find the
present value of a company’s future projected cash flow stream and the company’s terminal value.
Essentially, a perpetuity is a series of cash flows that keep paying out forever.

Finite Present Value of Perpetuity

Although the total value of a perpetuity is infinite, it comes with a limited present value. The present
value of an infinite stream of cash flow is calculated by adding up the discounted values of each
annuity and the decrease of the discounted annuity value in each period until it reaches close to
zero.
An analyst uses the finite present value of perpetuity to determine the exact value of a company if it
continues to perform at the same rate.

Real-life Examples

Although perpetuity is somewhat theoretical (can anything really last forever?), classic examples
include businesses, real estate, and certain types of bonds.

One example of a perpetuity is the UK’s government bond known as a Consol.   Bondholders will
receive annual fixed coupons (interest payments) as long as they hold the amount and the
government does not discontinue the Consol.

The second example is in the real-estate sector when an owner purchases a property and then rents
it out. The owner is entitled to an infinite stream of cash flow from the renter as long as the property
continues to exist (assuming the renter continues to rent).

Another real-life example is preferred stock, where the perpetuity calculation assumes the company
will continue to exist indefinitely in the market and keep paying dividends.

Present Value of Perpetuity Formula

Here is the formula:

PV = C / R

Where:

 PV = Present value

 C = Amount of continuous cash payment
 r = Interest rate or yield

Example – Calculate the PV of a Constant Perpetuity

1. Company “Rich” pays $2 in dividends annually and estimates that they will pay the dividends
indefinitely. How much are investors willing to pay for the dividend with a required rate of
return of 5%?

PV = 2/5% = $40

An investor will consider investing in the company if the stock price is $40 or less.

https://analystprep.com/cfa-level-1-exam/quantitative-methods/annuity-formulas-examples/

2.   stock pays a constant dividend of $8 at the end of each year for 20 years at a 25% required
rate of return. Calculate the present value of the stock dividends.

Solution

The constant dividends of the stock are valued as perpetuity. So from the question,
A=8

r=25%

So that:

PV=Ar=80.25=$32

(Perpetuity and annuity problems)

Perpetuity with Growth Formula

Formula:

PV = C / (r – g)

Where:

 PV = Present value

 C = Amount of continuous cash payment
 r = Interest rate or yield
 g = Growth Rate
What is an Annuity?

 An annuity is a financial product that provides certain cash flows at equal time intervals.
Annuities are created by financial institutions, primarily life insurance companies, to provide
regular income to a client.

 An annuity is a reasonable alternative to some other investments as a source of income

since it provides guaranteed income to an individual. However, annuities are less liquid than
investments in securities because the initially deposited lump sum cannot be withdrawn
without penalties.

 Upon the issuance of an annuity, an individual pays a lump sum to the issuer of the annuity
(financial institution). Then, the issuer holds the amount for a certain period (called an
accumulation period). After the accumulation period, the issuer must make fixed payments
to the individual according to predetermined time intervals.

 Annuities are primarily bought by individuals who want to receive stable retirement income.

Types of Annuities

There are several types of annuities that are classified according to frequency and types of
payments. For example, the cash flows of annuities can be paid at different time intervals. The
payments can be made weekly, biweekly, or monthly. The primary types of annuities are:

1. Fixed annuities

Annuities that provide fixed payments. The payments are guaranteed, but the rate of return is
usually minimal.

2. Variable annuities

Annuities that allow an individual to choose a selection of investments that will pay an income based
on the performance of the selected investments. Variable annuities do not guarantee the amount of
income, but the rate of return is generally higher relative to fixed annuities.

3. Life annuities

Life annuities provide fixed payments to their holders until his/her death.

4. Perpetuity

An annuity that provides perpetual cash flows with no end date. Examples of financial instruments
that grant perpetual cash flows to its holder are extremely rare.

The most notable example is a UK Government bond called consol. The first consols were issued in
the middle of the 18 th century. The bonds did not specify an explicit end date and were redeemable
at the option of the Parliament. However, the UK Government redeemed all consols in 2015.
Valuation of Annuities

Annuities are valued by discounting the future cash flows of the annuities and finding the present
value of the cash flows. The general formula for annuity valuation is:

Where:

 PV = Present value of the annuity

 P = Fixed payment
 r = Interest rate
 n = Total number of periods of annuity payments

The valuation of perpetuity is different because it does not include a specified end date. Therefore,
the value of the perpetuity is found using the following formula:

PV = P / r

Example 4:

An investment of $200,000 is expected to generate the following cash inflows in six years:

Year 1: $70,000
Year 2: $60,000
Year 3: $55,000
Year 4: $40,000
Year 5: $30,000
Year 6: $25,000

Required: Compute payback period of the investment. Should the investment be made if

management wants to recover the initial investment in 3 years or less?
Solution:

(1). Because the cash inflow is uneven, the payback period formula cannot be used to
compute the payback period. We can compute the payback period by computing the
cumulative net cash flow as follows:

Payback period = 3 + (15,000*/40,000)

= 3 + 0.375
= 3.375 Years

*Unrecovered investment at start of 4th year:

= Initial cost – Cumulative cash inflow at the end of 3rd year
= $200,000 – $185,000
= $15,000

The payback period for this project is 3.375 years which is longer than the maximum desired
payback period of the management (3 years). The investment in this project is therefore not
desirable.

Additional notes:-
SCOPE OF FINANCIAL MANAGEMENT:
The main objective of financial management is to arrange sufficient finance for meeting short term
and long term needs. A financial manager will have to concentrate on the following areas of finance
function.

1. Estimating financial requirements:

The first task of a financial manager is to estimate short term and long term financial requirements
of his business. For that, he will prepare a financial plan for present as well as for future. The amount
required for purchasing fixed assets as well as needs for working capital will have to be ascertained.

2. Deciding capital structure:

Capital structure refers to kind and proportion of different securities for raising funds. After deciding
the quantum of funds required it should be decided which type of securities should be raised. It may
be wise to finance fixed assets through long term debts. Even here if gestation period is longer than
share capital may be the most suitable. Long term funds should be employed to finance working
capital also, if not wholly then partially. Entirely depending on overdrafts and cash credits for
meeting working capital needs may not be suitable. A decision about various sources for funds
should be linked to the cost of raising funds.

3. Selecting a source of finance:

An appropriate source of finance is selected after preparing a capital structure which includes share
capital, debentures, financial institutions, public deposits etc. If finance is needed for short term
periods then banks, public deposits and financial institutions may be the appropriate. On the other
hand, if long term finance is required then share capital and debentures may be the useful.

4. Selecting a pattern of investment:

When funds have been procured then a decision about investment pattern is to be taken. The
selection of an investment pattern is related to the use of funds. A decision will have to be taken as
to which assets are to be purchased? The funds will have to be spent first on fixed assets and then
an appropriate portion will be retained for working capital and for other requirements.

5. Proper cash management:

Cash management is an important task of finance manager. He has to assess various cash needs at
different times and then make arrangements for arranging cash. Cash may be required to purchase
of raw materials, make payments to creditors, meet wage bills and meet day to day expenses. The
idle cash with the business will mean that it is not properly used.

6. Implementing financial controls:

An efficient system of financial management necessitates the use of various control devices. They
are ROI, break even analysis, cost control, ratio analysis, cost and internal audit. ROI is the best
control device in order to evaluate the performance of various financial policies.

7. Proper use of surpluses:

The utilization of profits or surpluses is also an important factor in financial management. A judicious
use of surpluses is essential for expansion and diversification plans and also in protecting the
interests of shareholders. The ploughing back of profits is the best policy of further financing but it
clashes with the interests of shareholders. A balance should be struck in using funds for paying
dividend and retaining earnings for financing expansion plans.

 CURRENT ASSETS MANAGEMENT

The Finance Manager should also manage the current assets to have liquidity in the business.
Investment of funds in current assets reduces the profitability of the firm. However the finance
manager should also equally look after the current financial needs of the firm to maintain optimum
production. While investing in current assets, he should see that proper trade off is maintained
between the profitability and liquidity.

Finance and its relation with other Disciplines

Business function means functional activities that an enterprise undertakes in achieving its desired
objectives. These functions may be classified on the basis of its operational activities.

1. Financial Management and Economics

2. Financial Management and Accounting

3. Financial Management or Mathematics

4. Financial Management and Production Management

5. Financial Management and Marketing

6. Financial Management and Human Resource

1. Financial Management and Economics

Economic concepts like micro and macroeconomics are directly applied with the financial
management approaches. Investment decisions, micro and macro environmental factors are closely
associated with the functions of financial manager. Financial management also uses the economic
equations like money value discount factor, economic order quantity etc. Financial economics is one
of the emerging area, which provides immense opportunities to finance, and economical areas.

2. Financial Management and Accounting

Accounting records includes the financial information of the business concern. Hence, we can easily
understand the relationship between the financial management and accounting. In the olden
periods,

both financial management and accounting are treated as a same discipline and then it has been
merged as Management Accounting because this part is very much helpful to finance manager to
take decisions. But nowadays financial management and accounting discipline are separate and
interrelated.

3. Financial Management or Mathematics

Modern approaches of the financial management applied large number of mathematical and
statistical tools and techniques. They are also called as econometrics. Economic order quantity,
discount factor,

time value of money, present value of money, cost of capital, capital structure theories, dividend
theories, ratio analysis and working capital analysis are used as mathematical and statistical tools
and techniques in the field of financial management.

4. Financial Management and Production Management

Production management is the operational part of the business concern, which helps to multiple the
money into profit. Profit of the concern depends upon the production performance. Production
performance needs finance, because production department requires raw material, machinery,
wages, operating expenses etc. These expenditures are decided and estimated by the financial
department and the finance manager allocates the appropriate finance to production department.
The financial manager must be aware of the operational process and finance required for each
process of production activities.

5. Financial Management and Marketing

Produced goods are sold in the market with innovative and modern approaches. For this, the
marketing department needs finance to meet their requirements. The financial manager or finance
department is responsible to allocate the adequate finance to the marketing department. Hence,
marketing and financial management are interrelated and depends on each other.

6. Financial Management and Human Resource

Financial management is also related with human resource department, which provides manpower
to all the functional areas of the management. Financial manager should carefully evaluate the
requirement of manpower to each department and allocate the finance to the human resource
department as wages, salary, remuneration, commission, bonus, pension and other monetary
benefits to the human resource department. Hence, financial management is directly related with
human resource management.

1.6 Functions of Finance Manager

Finance manager is one of the important role players in the field of finance function. He must have
entire knowledge in the area of accounting, finance, economics and management. His position is
highly critical and analytical to solve various problems related to finance. A person who deals finance
related activities may be called finance manager. Finance manager performs the following major
functions:

1. Forecasting Financial Requirements

It is the primary function of the Finance Manager. He is responsible to estimate the financial
requirement of the business concern. He should estimate, how much finances required to acquire
fixed assets and forecast the amount needed to meet the working capital requirements in future.

2. Acquiring Necessary Capital

After deciding the financial requirement, the finance manager should concentrate how the finance is
mobilized and where it will be available. It is also highly critical in nature.

3. Investment Decision

The finance manager must carefully select best investment alternatives and consider the reasonable
and stable return from the investment. He must be well versed in the field of capital budgeting
techniques to determine the effective utilization of investment. The finance manager must
concentrate to principles of safety, liquidity and profitability while investing capital.

4. Cash Management

Present days cash management plays a major role in the area of finance because proper cash
management is not only essential for effective utilization of cash but it also helps to meet the short-
term liquidity position of the concern.

5. Interrelation with Other Departments

Finance manager deals with various functional departments such as marketing, production,
personel, system, research, development, etc. Finance manager should have sound knowledge not
only in finance related area but also well versed in other areas. He must maintain a good relationship
with all the functional departments of the business organization.

What’s Part of a Comprehensive Financial Plan?

The most important thing your financial planner will do for you is right their name: putting together
a financial plan for you and your family.

A financial plan is a complete overview of the steps you’ll have to take to achieve the goals you lay
out for yourself. These objectives could include paying for your children to go to college, giving to
charity, paying for a comfortable retirement or maximizing the amount of money you pass down to
your children.

Your financial planner will help you create a financial plan after talking to you about your goals and
needs. Then they’ll engage in a variety of services, described in the section above, to help you
achieve your goals.

How Much Do Financial Planning Services Cost?

The cost of financial planning depends largely on the advisor you work with and that advisor’s fee
schedule. Many financial advisors who offer financial planning services will do so on either a flat fee
or hourly fee basis.
A flat fee means you’ll pay a single fee for all financial planning services. Your total fee will likely
depend on the value of your assets under the advisor’s management as well as the complexity of the
financial planning services you require. An hourly fee structure means you’ll pay a set fee for each
hour of work that your advisor puts in.

A financial advisor or financial planner who offers both financial planning and investment advisory
services may charge a wrap fee. This means you’ll pay a single rate for the advisor’s services,
transactional fees and custodial fees. Wrap fee rates are generally based on a percentage of the
client’s overall assets under management (AUM).

Bottom Line
Financial planning is about looking at all elements of a person’s financial life and coming up with a
plan to help you as an individual meet your responsibilities and achieve your goals. It can include a
number of services such as tax planning, estate planning, philanthropic planning and college funding
planning. You might pay based on an hourly fee, a flat fee or an asset-based fee.

Basic Principles of Financial Management

Organize Your Finances

Organizing your finances is the first step to creating wealth. Credit cards, bank accounts, personal
loans, brokerage accounts, mortgages, car loans and retirement accounts should to be tracked.
Budgeting software can provide complete solutions to track all such accounts, make on-time
payments and more. Jeff Morris, a certified public accountant in Bethesda, Maryland, points out:
“Once you enter your accounts and balances into budgeting software, you will be able to spend less
time getting organized and more time making sense of your situation.”

Spend Less Than You Earn

Personal financial software provides powerful tools to help you track and budget your spending and
take steps to achieve your long-term goals. If you learn to track your finances and know where you
spend the most, you’ll be able to control your money. “The best way to ensure that you either
overcome debt or avoid it in the first place is to never spend more than you make,” Morris says.

Put Your Money to Work

Take advantage of the time value of money. Morris gives the following example: “A 21-year-old who
invests $17.50 a day until retiring at the age of 65 at a 5 percent average annual investment return
can be a millionaire. At age 30, the required daily savings amount almost doubles. At age 40 the
amount quadruples.” So save early and often, even if the amount is small.

Limit Debt to Income-Producing Assets

With credit cards and car loans, every penny you spend to repay that debt is money flushed down
the drain. All but a few models of cars depreciate to zero and require more in repairs and finance
charges than can be reasonably expected to be returned to the owner upon being sold. Morris
explains, “With their ultra-high interest rates, credit cards utilized to buy household goods and
clothes that quickly wear out are bad bargains. If you have to be in debt, stick to financing items that
retain their value over time, like real estate and education.”
Continuously Educate Yourself

Budgeting software often links to hoards of research that puts the collective knowledge of Wall
Street at your fingertips. “Read every financial periodical, book and blog you can find from well-
regarded financial authors,” Morris recommends. “Understand why you are investing so that you will
stick to your plan. Periodically gather research so you do not miss excellent investment
opportunities.”

Understand Risk

The key to understanding return on investments is that the more you risk, the better the return
should be. This is called a risk-return trade-off. Investments like stock and bonds that have a higher
rate of return often have a higher risk of losing the principal that you invested. Investments like
certificates of deposit and money market accounts with a lower rate of return have a lower risk of
losing principal. Since no one knows the future, you cannot be 100 percent sure any investment will
do well. Morris explains, “If you diversify your investments, one can go sour without severe impact
to your overall portfolio.”

Diversification Is Not Just for Investments

Find creative ways to diversify your income. Everyone has a talent or special skill. “Turn your talents
into a money-making opportunity. Investigate ways to make money from home and launch a home-
based business,” Morris says. The extra income can supplement your full-time income or even result
in an exciting career change. Good financial management software can show you how even a slight
improvement in income can positively change your financial profile.

Maximize Your Employment Benefits

Employment benefits like a 401(k) plan, flexible spending accounts and medical and dental insurance
yield some of the highest rates of return that you have access to. “Make sure you are taking
advantage of all the ways benefits can save you money by reducing taxes or out-of-pocket
expenses,” says Morris.

Pay Attention to Taxes

Financial planning software helps you manage your tax information. For example, Quicken quickly
analyzes taxable investments and provides powerful organizing tools that make year-end tax filings
go much smoother. Morris emphasizes, “We all know that any money you make is going to be taxed.
That is why it is important to consider the related tax implications for every investment.”

Plan for the Unexpected

Despite of your best efforts, you’ll face unforeseen emergencies. Morris urges, “Save enough money
and stock up on insurance to be able to weather extended unemployment, accidents, catastrophic
medical care, large car or house repairs and natural disasters.” Increasing the amount of money you
save when times are good can help you manage the cost impact of hedging against bumps in the
road, making sure unexpected financial exposure does not derail your long-term goals and your
family’s financial security.

One Example:-
Mutual fund calculator: Monthly SIP of ₹10,000 turns ₹1.82 Cr in 20 years

Mutual funds are constructed to make full use of the force of compounding, and if an investor stays
involved for as long as possible, the potential of compounding can be witnessed to the full, resulting
in enormous returns that will enhance your wealth. When it comes to investing in mutual funds, SIP
is frequently favoured since it allows investors to experience the power of compounding by
reinvesting mutual fund earnings, such as dividends and capital gains, back into the same fund. As a
result, you will increase your return through compounding if you continue to invest in the same
fund. And in order to clarify this, we will use the 20-year-old Aditya Birla Sun Life Frontline Equity
Fund as an example.

Aditya Birla Sun Life Frontline Equity Fund Returns

The fund began operations on August 30, 2002, and it has already been in operation for 20 years.
Since its inception, it has generated returns of 19.25% on average annually, and every three years
the invested capital has doubled. Considering that the fund has produced an average annual return
of 19.25% since its inception, a monthly SIP of ₹10,000 initiated 20 years ago would today be equal
to almost ₹1.82 Cr. Since the fund has produced an annualised SIP return of 13.35% over the past
ten years, a monthly SIP of ₹10,000 that was started in this fund ten years ago would currently have
grown to around ₹24.06 lakh.  

A monthly SIP of ₹10,000 that was begun in this fund 5 years ago would have grown to  ₹8.61 Lakh
during the past 5 years, according to the fund's annualised SIP return of 14.45%. The fund has
produced an annualised SIP return of 19.5% over the past three years, which implies that a monthly
SIP of ₹10,000 started in this fund three years ago would currently have grown to almost  ₹4.82
Lakh. 

The fund's annualised return over the past two years has been 24.66% stronger than the category
average of 22.72%, and over the past year, it has been 6.09% better than the category average of
4.95%, but still less than the 7.74% growth in the Nifty 100 TRI Benchmark Index. According to the
statistics above, we can determine how the fund has doubled investors’ money every 3 years, how it
has multiplied investors’ wealth by over 33 times since its inception.
 Example:-

(Key takeaways of Aditya Birla Sun Life Frontline Equity Fund

As of June 30, 2022, Aditya Birla Sun Life Frontline Equity Fund-Growth had assets under
management (AUM) at ₹21534.38 crores, and as of August 26, 2022, the fund's NAV was ₹343.7. The
fund's expense ratio of 1.75% is higher than the majority of other funds in the same category. The
fund has investments in the financial, technology, energy, consumer goods, and automotive
industries. Its top 5 holdings are ICICI Bank Ltd., HDFC Bank Ltd., Infosys Ltd., Reliance Industries Ltd.,
and Larsen & Toubro Ltd. 97% of the fund's holdings are domestic equities, with 85.6% of those
holdings being large-cap companies, 9.31% being mid-cap stocks, and 2.1% being small-cap stocks.

Assets Under Management (AUM) of Indian Mutual Fund Industry as on October 31, 2022 stood at ₹
39,50,323 crore. The AUM of the Indian MF Industry has grown from ₹ 7.68 trillion as on October 31,
2012 to ₹39.50 trillion as on October 31, 2022 more than 5 fold increase in a span of 10 years.

Growth of Mutual Fund Industry Expected in India in the Current Year and the Forthcoming Years. In
2022, it is estimated that there will be around 1.88 crores registered mutual fund investors in India
as against 1.86 crore households with an annual income of more than Rs 10 lakh per annum.)

Understanding the Different Types of Financial Planning

A financial planner may offer a variety of services to you. These services will often be considered in
concert with one another. This helps the planner put together an overall plan that considers all
aspects of your current situation and future aspirations.

Here are eight common services that are generally offered as part of financial planning:

 Tax planning: Financial planners often help clients address certain tax issues. They can also figure
out how to maximize your tax refunds and minimize your tax liability. Certain advisors may also be
able to actually help you with preparing your taxes and filing your annual taxes.
 Estate planning: Estate planning seeks to make things a bit easier for your loved ones after you die.
Preparing a will may be part of a financial planner’s services. Estate planning also helps prepare for
any estate tax you may be subject to.
 Retirement planning: You presumably want to stop working some day. Retirement planning services
help you prepare for that day. They ensure that you’ve saved enough money to live the lifestyle you
want in retirement.
 Philanthropic planning: It’s always nice to give something to people who need it or help a cause
close to your heart. Financial planning can help you ensure you’re doing it efficiently and getting all
the tax benefits you’re eligible for.
 Education funding planning: If you have children or other dependents who wish to pursue a college
degree, you may want to help them to pay for it. Financial planning can help make sure you are able
to do so.
 Investment planning: Though financial planning doesn’t include the actual management of your
assets, it can still help with your investment portfolio by mapping out how much you should be
investing and in which types of investments.
 Insurance planning: A financial planner can help you evaluate your insurance needs. Some financial
planners are also licensed insurance agents and can sell you insurance themselves. However, they’ll
likely earn a commission, which would create a conflict of interest.
 Budgeting: This is perhaps the cornerstone of financial planning. A planner can make sure you are
spending the right amount given your income and can also make sure that you aren’t going into
debt.

The exact services offered by a financial planner will vary based on the individual. Make sure the
financial planner you choose offers the services you need.

Unit 2:-
 Sources of Business Finance
1. Retained Earnings: In most cases, a firm does not pay out all of its profits as dividends to its
shareholders. A part of the net earnings may be kept in the company for future use. This is referred
to as "retained profits." It is a source of internal finance, self-financing, or 'profit plowing.' The
amount of profit available for reinvestment in a company is determined by a variety of factors,
including net profits, dividend policy, and the company's age.

2. Trade Credit: A trade credit account is a line of credit given by one business to another for the
purchase of products and services. Trade credit allows you to buy supplies without having to pay
right away. Such credit shows up in the buyer of goods' records as sundry creditors' or 'accounts
due.'

3. Public Deposit: Public deposits are deposits raised directly from the general public by organizations.
Public deposit interest rates are often greater than those provided on bank deposits. Anyone
interested in making a monetary contribution to an organization might do so by completing a
designated form. In exchange, the organization gives a deposit receipt as proof of payment. While
depositors receive a greater interest rate than banks, the cost of deposits to the firm is lower than
the cost of bank borrowings.

4. Commercial paper: In the early 1990s, commercial paper became a popular form of short-term
financing in our country. Commercial paper is an unsecured promissory note that a company issues
to generate capital for a limited period of time, usually 90 to 364 days. It is distributed to other
businesses, insurance companies, pension funds, and banks by a single company. The sum raised via
CP is usually rather substantial. Because the loan is completely unsecured, only companies with a
solid credit rating may issue a CP. The Reserve Bank of India is responsible for its regulation.

So, we see there are many such fundamentals in the procurement of the business fund thus the
finance team should carefully execute their analyses.

Equity:
The raising funds through issue of shares attract flotation costs. The shareholder expects the return
in the form of dividends and capital appreciation of their investment reflected in the increase in
stock market price.

The dividend payments are made only if the distributable profits are available with the company,
after payment of interest charges and tax payments. Any further issue of shares by the existing
companies may dilute the controlling interest.

The equity is considered as low risk but most expensive way of funding the company’s projects. The
equity funds are not returnable except in the case of liquidation. However, the buy-back of shares is
allowed under the provisions of the Companies Act, 1956.

The equity holders will participate in the policy decisions of the company. In company form of
business, only legal personality exists, hence all decisions are carried through the agents who work
for remuneration. Therefore, agency problems arise with the managers.

Debt:

The debt funds are raised in the form of debentures, bonds, term loans etc. The expectation of the
providers of debt is obtain return in the form of interest payments which should commensurate with
the risk attached to their investment. The debt is repaid as per the agreement. The interest should
be paid irrespective of the profitability of the firm.

The portion of debt component in capital structure will facilitate the trading on equity Le. the
interest on debt is payable at a fixed rate and if the firm’s return on capital employed is more than
the interest payable, the excess return over fixed interest will be added to the profits available to
equity providers.

But the high proportion of gearing i.e., excess reliance on debt funds will increase the financial risk of
the firm. The cost of debt is always lower than cost of equity, since any interest payable will reduce
the tax liability of the firm. The non-repayment of interest and principal amounts in time may
sometimes call for liquidation of the company.

https://efinancemanagement.com/sources-of-finance/types-of-debentures

https://www.youtube.com/watch?v=74Oipb5IAhI
 Advantages and Disadvantages of Financial Markets
Advantages
The benefits of the financial market are as follows.
o It offers a platform for businesses to raise funds for both long and short-term investments.
o Companies may obtain financing at a lesser cost than if they took out a high-interest loan from a
commercial bank. Furthermore, commercial banks do not provide large loans.
o Companies have the freedom to obtain money from the market as needed until their authorized
share capital is depleted.
o Financial market intermediaries, such as banks and financial institutions, give financial and strategic
advice to both corporations and investors. They give information, advice, and professional services
that might otherwise be unavailable.
o It offers a platform for simultaneously trading and dealing with various shares, equities, bonds,
derivatives, and other financial instruments.
o Financial market laws and regulations that are stricter assist to strengthen the economy by instilling
trust in both investors and businesses.
o Provide a platform for worldwide money lending and borrowing in several currencies.

Disadvantages
We can observe some of the financial market's drawbacks here.
o Too many procedures imposed by regulatory organizations might lengthen the process.
o Due to strict laws and restrictions, certain businesses are unable to access the financial sector. They
are unable to establish resources that need constant monitoring and compliance checks.
o Investors may lose money owing to a lack of knowledge or because they are uninformed of the
situation.
o Companies may shift from being investor-driven to being profit-driven. It's critical that the Board of
Directors makes choices that benefit all of the company's stakeholders and avoids manipulating
investors' funds for personal gain.

Asset Classes of Financial Instruments

Beyond the types of financial instruments listed above, financial instruments can also be categorized
into two asset classes. The two asset classes of financial instruments are debt-based financial
instruments and equity-based financial instruments.

1. Debt-Based Financial Instruments

Debt-based financial instruments are categorized as mechanisms that an entity can use to increase
the amount of capital in a business. Examples include bonds, debentures, mortgages, U.S. treasuries,
credit cards, and line of credits (LOC).

They are a critical part of the business environment because they enable corporations to increase
profitability through growth in capital.

2. Equity-Based Financial Instruments

Equity-based financial instruments are categorized as mechanisms that serve as legal ownership of
an entity. Examples include common stock, convertible debentures, preferred stock, and
transferable subscription rights.

They help businesses grow capital over a longer period of time compared to debt-based but benefit
in the fact that the owner is not responsible for paying back any sort of debt.

A business that owns an equity-based financial instrument can choose to either invest further in the
instrument or sell it whenever they deem necessary.

Additional Resources

Thank you for reading CFI’s guide on Financial Instrument. To help you become a world-class
financial analyst and advance your career to your fullest potential, the additional resources below
will be very helpful:
  Debentures
 Interest Rate Swap
 Options: Calls and Puts
 Preferred Shares

Sources of Financing:-

https://www.extension.iastate.edu/agdm/wholefarm/html/c5-92.html

https://efinancemanagement.com/sources-of-finance - very nice site.

Sources of finance for business are equity, debt, debentures, retained earnings, term loans, working
capital loans, letter of credit, euro issue, venture funding, etc. These sources of funds are used in
different situations. They are classified based on time period, ownership and control, and their
source of generation. It is ideal to evaluate each source of capital before opting for it.

Sources of capital are the most explorable area, especially for the entrepreneurs who are about to
start a new business. It is perhaps the most challenging part of all the efforts. There are various
capital sources we can classify on the basis of different parameters.

Knowing that there are many alternatives to finance or capital a company can choose
from. Choosing the right source and the right mix of finance is a crucial challenge for every finance
manager. Selecting the right source of finance involves an in-depth analysis of each source of fund.
For analyzing and comparing the sources, it needs an understanding of all the characteristics of the
financing sources. There are many characteristics on the basis of which sources of finance are
classified.

On the basis of a time period, sources are classified as long-term, medium-term, and short-term.
Ownership and control classify sources of finance into owned and borrowed capital. Internal sources
and external sources are the two sources of generation of capital. All the sources have different
characteristics to suit different types of requirements. Let’s understand them in a bit of depth.

 Trade Credit

Related Concepts and Other Considerations

Trade credit has a significant impact on the financing of businesses and is therefore linked to other
financing terms and concepts. Other important terms that affect business financing are credit
rating, trade line, and buyer’s credit.

A credit rating is an overall assessment of the creditworthiness of a borrower, whether a business

or individual, based on financial history that includes debt repayment timeliness and other factors.
Without a good credit rating, trade credit may not be offered to a business.

If businesses do not pay trade credit balances according to agreed terms, penalties in the form of
fees and interest are usually incurred. Sellers can also report delinquencies on trade credit, which
may affect a buyer’s credit rating. Delinquencies affecting a buyer’s credit rating can also affect
their ability to obtain other types of financing as well.

Trade credit is usually only available for businesses with an established credit history. New
businesses without a credit history may have to look at other means of financing.

A trade line, or tradeline, is a business credit account record provided to a business credit reporting
agency. For large businesses and public companies, trade lines can be followed by rating agencies
such as Standard & Poor’s, Moody’s, or Fitch.

Buyer’s credit is related to international trade and is essentially a loan given to specifically finance
the purchase of capital goods and services. Buyer’s credit involves different agencies across borders
and typically has a minimum loan amount of several million dollars. 

Advantages and Disadvantages of Trade Credit

Buyers

The advantages of trade credit for buyers include simple and easy access to financing. It is also an
affordable type of financing that comes at no extra cost when compared to other means of
financing, such as a loan from a bank.

Because payment is not due till later, trade credits improve the cash flow of businesses; they can
sell the goods they acquired without having to pay for those goods till a later date. Trade credits
also improve your business profile as well as your relationship with your vendors.

The disadvantages of trade credit include high costs if payments are not made on time. Costs
usually appear in the form of late-payment penalty charges or interest charges on the outstanding
debt. If payments are not made, this can also negatively impact the credit profile of your business
as well as the relationship with your supplier.

Sellers

The advantages of trade credits for sellers include building a strong relationship with your clients,
encouraging customer loyalty, and, therefore, repeat business. Trade credits can also lead to higher
sales volumes as buyers are likely to purchase more when there is no cost associated with the
financing.

Sellers have a few more disadvantages than buyers when it comes to trade credits. These include
delayed revenue. If a business is flush with cash, that's not a problem. If budgets are tight then
delayed revenue might be an issue in terms of covering operating costs.

Trade credits also come with bad debts as some buyers will inevitably not be able to pay. This
means a business takes on risks when extending financing. Bad debts can be written off, but having
a customer not pay can always be detrimental to a business.

Pros

 Cost-effective means of financing for buyers

 Improves cash flow for buyers

  Encourages higher sales volumes for sellers

 Leads to strong relationships and customer loyalty for sellers

Cons

 High cost for buyers if payments are not made on time

 Late payments or bad debts can negatively impact a buyer's credit profile and relationship
with suppliers

 Sellers run the risk of buyers not paying their debts

 Delayed payments can be a strain on the balance sheet for sellers

Reference Links:-

1. Investing Decision:- https://www.youtube.com/watch?v=WO_jJge0ZTc :- 7 RULES OF

INVESTING WARREN BUFFETT HINDI | MASTER THE BASICS OF RULES OF
INVESTING | WARREN BUFFETT
2. https://www.youtube.com/watch?v=Smp0zBzpIhA :- RICH DAD POOR DAD BOOK
SUMMARY | 6 RULES OF MONEY
3. https://www.youtube.com/watch?v=SzgwRuKvC0c :- Financial Goal Setting - How to plan
your journey | Ankur Warikoo Hindi Video | WITH CALCULATOR
4. https://www.youtube.com/watch?v=FfVAaFCcZfg :- Want to Retire Before 40? Easy
Retirement Planning with Calculator.
5. https://www.youtube.com/watch?v=WN9Mks1s4tM :- Top 10 Financial Concepts You
Must Know | CA Rachana Ranade
6. Pay back Period Problems:- https://www.accountingformanagement.org/payback-method/
This link refers for four to five problems
7. https://learn.financestrategists.com/explanation/management-accounting/capital-
budgeting-important-problems-and-solutions/ (Problems on capital budgeting).

8. https://youtu.be/2fQNc-k53Ws (Perpetuity)

9. https://www.managementstudyguide.com/functions-of-a-financial-system.htm (unit-2
notes)
10. leasing and hire purchase:-
https://efinancemanagement.com/sources-of-finance/difference-between-lease-
financing-vs-hire-purchase
11. Public Deposit:- https://www.geeksforgeeks.org/public-deposits-advantages-and-
disadvantages/
12. Commodity Market:- https://www.investopedia.com/terms/c/commodity-market.asp
13. Sources of Financing:- https://www.extension.iastate.edu/agdm/wholefarm/html/c5-
92.html and https://efinancemanagement.com/sources-of-finance
14. Bonds and their Types https://efinancemanagement.com/sources-of-finance/bonds-and-
their-types and https://www.moneycontrol.com/fixed-income/bonds/listed-bonds/