Shareholders wealth can be maximized by:

 Increasing the value of the company

 Providing cash flow to shareholders via dividend

A financial manager must take three types of decisions:

 Investment decisions: Identifying the best investment opportunities.

 Financing decisions: Deciding how to finance them.
 Dividend decision: Deciding how much dividend shall be paid.

Advantages and Disadvantages of MIRR over IRR

 An advantage of MIRR compared to IRR is that MIRR assumes the reinvestment rate is the
company’s cost of capital. IRR assumes that the reinvestment rate is the IRR itself, which is
usually untrue
 A disadvantage of MIRR is that it may lead an investor to reject a project which has a lower rate
of return but because of its size generates a larger increase in wealth. In the same way, a high-
return project with a short life may be preferred over a lower-return project with a longer life

Reasons for Hard capital rationing

 Limited access to capital from external sources

 Restrictions in bank lending
 Lending to the company is perceived to be too risky
 Costs associated with making small issues of capital may be too great

Reasons for Soft capital rationing

 Limits set by the management on capital available for each department

 Management wants to avoid dilution of control by issuing new shares
 Management may be unwilling to issue additional capital if it will lead to a dilution of earnings
per share.

Benefits of Capital Investment Monitoring System

It tries to ensure as much as possible that:

 The project meets what is expected of it in terms of revenues and expenses.

 The project is completed on time
  The departments undertaking the projects will be proactive, rather than reactive, towards the
management of risk, and therefore possibly be able to reduce costs by having a better plan.
 Acts as a communication device between managers charged with managing the project and the
monitoring team.
 It helps reassess and change the assumptions made of the project, if changes in external
environment warrant it.

Acquisitions and mergers versus other growth strategies

Acquisitions and Mergers Organic Growth

Quicker, a company immediately gets bigger Takes a long time
Gives rise to integration problem, as each company There are no integration problems
has its own culture, history and ways of operation
Preferred when a company wishes to expand Organic growth into a new area would need
operations into new products, markets and managers to gain knowledge and expertise of an
technologies area or function, with which they are not currently
familiar with
Horizontal acquisitions may help eliminate The growth is internal and hence competitors may
competitors keep operating
There may exist aspects about target company There is no such issue
which are kept hidden from acquiring company
during acquisition process
If the acquired company does not perform as well Less risky
as it was envisaged, then the effect on the
acquiring company may be catastrophic

Acquisitions and Mergers Joint venture

High cost Low cost as it is shared with joint venture
partner
Acquirer obtains management control Control is shared with other partners
There is no such issue May lead to conflicts of interest and
disagreements between joint venture partners
Criteria for choosing an appropriate target for acquisition

Strategic aims and objectives of the acquirer For example, a company might be seeking to grow the
business by expanding its product range or move into
new geographical markets. Acquiring a suitable
business would enable a company to expand its
product range or move into new geographic market
Diversification The target operates in a line of business which is
different from the acquiring firm’s business in order
to diversify its operations
Opportunity and availability An opportunity to acquire a particular company might
arise, and the acquiring company might decide to
take the opportunity whilst it is available
Access to key technology Acquirer may decide to acquire a target company
which has access to better technology
Tax savings The target company may have excess carried forward
tax losses and the acquirer may be interested in
acquiring such company in order to enjoy the tax
savings by reduction in tax liability due to tax losses.

Revenue synergy

 They are increases in total sales revenue following a merger or acquisition, by increasing total
combined market share.
 It may arise in circumstances where the enlarged company is able to promote its brand more
effectively or when the company is able to bid for large contracts, such as to supply goods to
government, which the two smaller companies were previously unable to do so due to their
small size.

Cost synergy

 They are reductions in total costs following a merger or acquisition.

 Prime reason is economies of scale.
 Also, duplicate departments may be dissolved. As one department is now able to fulfil the needs
for entire company.

Financial synergy

 They are reductions in expenses such as finance cost.

 Larger company may be able to borrow funds at a lower rate as it may be seen as a lower credit
risk company.
 It may also arise when a firm with significant excess cash acquires a firm with great projects but
insufficient capital. The combination may create value.
  Combined company may be able to enjoy the tax benefit which was previously not possible with
individual companies.

Different forms of consideration to acquire a target company

Cash

 Target company shareholders certainty about the bid’s value, unlike the shares offer in which
their bid value depends upon what the market value of share prices will be.
 It helps acquirer to maintain full control in the new company, since Target Company shareholders
will not be part of the new company in terms of share ownership.

Share exchange

 Acquirer does not have to raise cash.

 Target company shareholders become shareholders in the new company as well.
 Overall share capital increases.
 Gearing level decreases

Convertible loan stock

 This method of consideration is not used commonly.

 Convertible loan stock is a loan which gives the holder, a right but not an obligation, to convert
its loan stock into ordinary shares of the company, at a predetermined price and time.
 This will benefit the target company shareholders in a sense that after the agreed time period
they may exercise the option to convert into ordinary shares if the share prices are in their favor.
 The target shareholders will receive a fixed/agreed interest each year until the
conversion/redemption date.

Defenses against hostile takeover bid

GOLDEN PARACHUTE

A large payment or other financial compensation guaranteed to a company executive if they should be
dismissed as a result of a merger or takeover.

POISON PILL

An attempt to make company unattractive for the bidding company, normally by giving right to existing
shareholders to buy shares at a very low price.
WHITE KNIGHTS

Inviting a company making an acceptable counter-offer for a company facing a hostile takeover bid.

CROWN JEWELS

The crown jewel defense is a strategy in which the target company sells off its most attractive assets to a
friendly third party or spin off the valuable assets in a separate entity. Consequently, the unfriendly
bidder is less attracted to the company assets.

PACMAN DEFENCE

It is an aggressive strategy. The company threatened with a hostile takeover “turns the tables” by
attempting to acquire its would-be buyer.

LITIGATION OR REGULATORY DEFENCE

The target company seeks government intervention. In order for this strategy to be effective, it would
have to prove that the takeover was against the public interest.

Explanations for the high failure rate of acquisitions in enhancing shareholder value

 Difference in cultures of two companies may lead to integration problem.

 Insufficient time being given by senior management to the acquired company in order to make
the acquisition operationally successful.
 Competitors might react to an acquisition with a new competitive strategy of their own.
Increased competition might drive down the profits for all the participants in the market.
 The expected synergies do not occur.
 The target firm may be valued incorrectly and hence acquirer may result in paying a high
purchase price

Factors to consider when determining which sources of finance are chosen to finance a possible cash bid

AVAILABILITY

 Although there are various sources of finance such as rights issue, bank loan, mezzanine finance
or convertible loan notes there is no guarantee that they will necessarily be available.
 The success of rights issue will depend on the willingness and ability of the director-shareholders
to subscribe.
 Obtaining bank loan or mezzanine finance may be difficult if a company is highly geared.
  Convertible debt issue may depend on the terms and how possible subscribers view the future
prospects of the company.

COST

 Cost of equity is generally higher than cost of debt.

 Issue cost of equity is also likely to be higher than cost of debt.
 Fixed interest cost on bank loan may become a burden if interest rates fall.

DIRECTORS PREFERENCE

 The choice will also be determined by board’s attitude to gearing, the board may feel that it has
reached, or exceeded, the gearing level which it would regard as desirable. If this is the case, the
board would have to use equity finance.

CONTROL

 Implications of the different sources of finance for control of the company may also be
considered.
 An issue of shares arising from the convertible debt would change the balance of shareholdings,
so the directors would have to decide how significant this would be.
 Mezzanine finance may also offer conversion rights, but possibly under certain circumstances.
 Bank loan will have no impact on share capital, but the bank may impose certain restrictions,
including restriction on the sale of assets, limitations of dividends, or requiring accounting
figures, liquidity and solvency ratios, not to go beyond certain levels.

Methods of obtaining Public Listing

Aspect Advantages Disadvantages

IPO  Allows access to broad pool of
capital to fund growth
 High visibility and publicity can
attract new investors
 Underwriting provides a level of risk
protection for the company
DUTCH  Can result in a premium being paid
AUCTION to issuing company
 Incentivizes aggressive bids,
benefitting company being listed
 Lower transaction fees as
underwriters are less involved
 Underwriting fees can be high
 Time consuming (1 to 2 years)
 Economic uncertainties can lead to
unsuccessful IPO, waste of time and
money
 Share pricing determined by
investors – loss of control for
company
 Can be unsuccessful if demand is
weaker than anticipated
 Retail investors may pay excessively
high prices without due diligence,
and may seek to sell their shares as
soon as trading commences –
leading to share price plummeting
 SPAC  Takes less time compared to
traditional methods (3-6 months)
 Avoids underwriting and legal costs
associated with IPOs
 Provides certainty about share
pricing through negotiation before
execution
DIRECT  Bypasses underwriter fees, making it
LISTING a more cost-effective option.
 Existing shareholders can sell their
shares immediately.
 Access to institutional and retail
investors without trading restrictions
– broader shareholder base.
 Negotiations may lead to changes
in the target company's
management team. Changes could
lead to cultural or strategic
dissonance which can lead to a fail.
 SPAC transactions may
underperform relative to initial
expectations
 Shorter timeline for meeting
regulatory requirements compared
to traditional IPOs.
 Not suitable for companies
needing capital for future growth
as no additional capital is raised.
 Success depends on sufficient
investor appetite, without
underwriter guarantee.
 Without underwriters, it can be
challenging to protect against
volatility in the early days of trading

IPO VS Reverse Takeover

Aspect IPO Reverse Takeover

Cost
Time
Expertise Needed
Market Attraction
Regulatory Compliance
Success Guarantee
Investor Attention
Potential Liabilities
Transparency and Due
Diligence
3% to 5% of capital raised,
significant expenses
1-2 years to complete process
Investment banks, lawyers,
experts
Marketing campaign,
prospectus issuance
Extensive compliance needed
No guarantee of success
Potential investor following
Fewer unknown liabilities
upfront
Transparent process
Generally cheaper
Takes less time
Due diligence on listed company
Less marketing effort involved
Less stringent regulatory
requirements
Ensures listing on stock
exchange
May lack immediate investor
interest
May have hidden liabilities from
shell company
Requires thorough due diligence
Key points from takeover directives

The principle of equal treatment

 It stipulates that all shareholders must be offered equal terms.

 Minority shareholders must be offered same terms as those offered to earlier shareholders from
whom the controlling block was acquired.

Squeeze-out rights

 This condition allows the bidder to force minority shareholders to sell their stake, at a fair price,
once the bidder has acquired a specified percentage of the target company’s equity.
 The percentage varies from country to country.
 The main purpose of this condition is to enable the acquirer to gain 100% stake of the target
company and prevent problems arising from minority shareholders at a later date.

Mandatory-bid condition through sell out rights

 It allows remaining shareholders to exit the company at a fair price once the bidder has
accumulated a certain number of shares.
 The number of shares accumulated before the rule applies varies between countries.
 The bidder must offer the shares at the highest share price, as a minimum, which had been paid
by the bidder previously.
 The main purpose for this condition is to ensure that the acquirer does not exploit their position
of power at the expense of minority shareholders.

Management buy-out Management buy-in

Purchase of all or part of the business by its own Purchase of all or part of the business by a team of
managers outside managers
Existing management is likely to have detailed External management will need to gain knowledge
knowledge of the business and its operations of the business and its operations
It will cause less disruption and resistance from the It may face resistance from existing employees
employees
Existing management may lack new ideas New ideas may pour in from the experience
acquired by the external management team
elsewhere
In both cases, it is usually the case that the management team do not have sufficient capital of their own
to afford the business they are trying to buy, and they have to rely on the support of venture capital
finance
PORTFOLIO RESTRUCTURING

Involves the acquisition of companies, or disposals of assets, business units and/or subsidiary companies
through divestment, demergers, spin-offs, MBOs and MBIs.

ORGANISATIONAL RESTRUCTURING

Involves changing the way a company is organized. This may involve changing the structure of divisions
in a business, business processes and other changes such as corporate governance.

The aim of either type of restructuring is to increase the performance and value of the business.

STEPS IN REVERSE TAKEOVER:

 Private company buys enough shares in a public company to control the public company.
 The private company’s shareholders then exchange its shares in the private company for shares
in the public company.

POTENTIAL BENEFITS:

 Route to obtain a stock market listing much quickly and at comparatively lower cost in
comparison to IPO.
 Company obtains benefits of the public trading of its securities including: easier access to capital
markets, higher company valuation and enhanced ability to carry out further takeovers.

POTENTIAL DRAWACKS:

 Lack of expertise to understand and deal with all the regulations and procedures that listed
companies must comply with.
 There is a risk that the listed company being used to facilitate reverse takeover may have some
liabilities and problems that are revealed after the transaction. This risk is comparatively lower in
IPO, which involves a higher level of scrutiny in comparison to reverse takeover.

Competitive advantages a company may gain over its competitors for investing in overseas projects

 Market Expansion: Opens up new markets and cultivates demand in previously untapped
locations.
 Customer Insight: Operating in foreign markets provides a deeper understanding of customer
needs compared to just exporting products.
 Raw Material Access: Easier and cost-effective access to necessary raw materials.
 Labor and Expertise: Access to cheaper labor and specialized expertise, potentially reducing
costs and enhancing competitiveness.
 Proximity Benefits: Being closer to markets, resources, and labor helps cut costs, like reducing
transportation expenses by manufacturing close to sales markets.
  Risk Mitigation: Matching costs and revenues internationally can naturally hedge risks, like long-
term currency fluctuations, minimizing economic risks.

Market price system of transfer pricing

 Simple market price provides an objective measure over which the divisions should agree.
 The buying division may prefer buying from selling division rather than an external supplier
because of better service from, and greater dependability of, dealing within the group.
 The market price may be difficult to determine or may fluctuate wildly making it difficult to
establish a market price system of transfer pricing.
 Internal sales could distort performance by appearing lower in cost compared to external sales,
neglecting shared expenses like administration costs and bad debt. These costs should be shared
between the two divisions to give a fair picture.
 If the selling division has spare capacity, selling at incremental cost rather than market price may
provide greater certainty that the buying division will use the selling division.

Criteria that a credit rating agency considers when assessing a company’s credit rating

Criteria Considerations
Country - Credit rating cannot exceed the credit rating of the country in which it
operates or originates
- Rating depends on relative standing among local companies
Industry - Strength of the industry within the country
- Company's position compared to competitors within the industry
Management - Overall management assessment and succession planning
Evaluation - Track record in delivering financial results
Financial - Assessment of financial position (gearing, working capital management)
- Company’s relationship with its bankers and debt covenants

Impact of the fall in credit rating on a company’s ability to raise financial capital and on its shareholders’
return

 Banks may be less willing to provide loans and investors less willing to subscribe for bonds.
 Even if debt finance is available, it may come with covenants restricting further debt or gearing
levels.
 Debt holders will demand higher coupon rate on debt.
 Additional debt may have other restrictive covenants, restricting company to buy or sell assets.
 It may also result in a company’s cost of equity and cost of debt rising. In turn company’s
weighted average cost of capital will rise as well.

Mezzanine facility
  Most risky type of debt from the lender’s point of view.
 Low in the priority list of repayment in the event of liquidation.
 High interest rate is paid for this high risk.
 Lender typically has a warrant (legal right in writing) enabling him or her to convert the security
into equity at a predetermined price per share if the loan is not paid on time or in full.

Advantages and drawbacks of exchange traded option contracts compared with over-the-counter
options

Advantages

 Readily available on the financial markets, their price and contract details are transparent, and
there is no need to negotiate these.
 Greater transparency and tight regulations can make exchange traded options less risky.
 Transaction costs can be lower.
 The option buyer can sell (close) the options before expiry.
 American style options can be exercised any time before expiry and most traded options are
American style options, whereas over-the-counter options tend to be European style options.

Disadvantages

 The maturity date and contract sizes for exchange traded options are fixed, whereas over-the-
counter options can be tailored to the needs of parties buying and selling the options.
 Exchange traded options tend to be of shorter terms, so if longer term options are needed, then
they would probably need to be over-the-counter.
 A wide range of products (for example, a greater choice of currencies) is normally available in
over-the-counter options markets.

Advantages and drawbacks of currency swaps

It allows the two counterparties to swap interest rate commitments on borrowings in different
currencies.

It has two elements:

 An exchange of principals in different currencies

 An exchange of interest rates

Advantages

 Ideal for companies investing abroad, because it involves payment of interest in the currency in
which company will receive income abroad.
  Company will be able to obtain swap for the amount it requires and may be able to reverse the
swap by exchanging with the other counterparty. Other methods of hedging risk may be less
certain.
 Swaps may cost less than options, etc.

Disadvantages

 The counterparty may default. Although the risk of default can be reduced by obtaining a bank
guarantee for the counterparty.

Advantages of multilateral netting by a central treasury function

 Lower commission and transaction costs due to a smaller number of transactions

 Less loss of interest through money being in transit.
 Foreign exchange rates available may be more advantageous as a result of large transaction sizes
resulting from consolidation.
 The netting arrangements should make cash flow forecasting easier in the group.

BENEFITS OF A CENTRALISED TREASURY DEPARTMENT

 Avoids the need to have many bank accounts.

 Reduces transaction costs and high bank charges.
 Large cash deposits may give company access to a larger, diverse range of investment
opportunities
 If bulk borrowings are required, it may be possible for a company to negotiate lower interest
rates
 Can quickly give funds to other depts and subsidiaries that need it without borrowing

BENEFITS OF A DECENTRALISED TREASURY DEPARTMENT

 They are better able to match and judge the funding required with the need for asset purchases
for investment purposes on a local level.
 They may be able to respond quicker when opportunities arise and so could be more effective
and efficient.
 Decentralized treasury departments may make the subsidiary companies’ senior management
and directors, more empowered and have greater autonomy. This in turn may increase their
level of motivation, as they are more in control of their own future, resulting in better decisions
being made.
FORWARD CONTRACTS OVER THE COUNTER OPTIONS
No payment of premium upfront Involves payment of premium
Gives a certain receipt/payment value for the Receipt/payment depends upon whether option
purpose of budgeting will be exercised or not
Contract has to be fulfilled, even if the transaction It can be allowed to lapse
which led to the forward contract being purchased
is cancelled
Does not allow the holder to take advantage of It need not be exercised if the exchange rate
favorable exchange rate movements moves in the holder’s favor

Interest rate swap advantages and disadvantages

ADVANTAGES

 Transaction costs are generally low.

 Swapping a variable interest rate commitment with a guaranteed fixed rate of interest, allows a
company to forecast finance costs on the loan.
 Swaps are over-the-counter arrangements. They can be arranged in any size and for whatever
time period is required, unlike traded derivatives.

DISADVANTAGES

 Subject to counterparty risk, the risk that the other party to the arrangement may default on the
arrangement. If it is arranged through a bank, the bank can provide a guarantee that the swap
will be honored.
 If a company swaps into a fixed rate commitment, it cannot then change to commitment. This
means it cannot take advantage of favorable interest rate changes as it could if it used options.
 As swaps are over-the-counter instruments, they cannot be easily traded or allowed to lapse if
they are not needed or become no longer advantageous. It is possible that a bank may allow a
reswapping arrangement to reverse a swap which is not required, but this will incur further
costs.

Staff in treasury department

Experienced

 Experienced staff is needed to establish overall guidelines and policies for treasury activities.
  They will also have greater knowledge of law, accounting standards, and tax regulations which
can help the business avoid penalties and perhaps structure its dealings so that it can, for
example, minimize the level of tax paid.
 If a company is planning a major acquisition, the treasury function can provide advice on the
structure of consideration and financing implications.
 Senior staffs are also needed to manage the work of less experienced staff to prevent or mitigate
the effect of mistakes which may be costly.

Inexperienced

 May be able to arrange borrowing if the lender has already been chosen or, for example, arrange
forward rate agreements to be used if they are prescribed.
 May lead to sub-optimal decision making if judgement is required.
 Poor decisions may result in opportunity costs, for example, not using the lender who gives the
best deal or being committed to a fixed forward rate agreement when an option would have
allowed the business to take advantage of favorable rate movements.

Principles that are followed in Islamic finance

 Interest cannot be charged.

 Engaging in speculation is not allowed.
 Finance cannot be provided to products detrimental to society such as alcohol, gambling etc.
 Based on the principle of sharing profits and losses.
 Stresses on the need for ethical behavior and for honesty and integrity.

Murabaha

 Trade credit or loan.

 The bank will purchase the asset and then sell it to the business or individual at a ‘profit’ in
recognition of the convenience of paying later.
 Bank buys asset at $100 and sells it to customer at $125 making a profit of $25.
 Customer can pay $125 in instalments.

Ijara

 Leasing.
 The bank makes available to the customer the use of assets for a fixed period and price.
 The bank remains the owner of the asset and incurs the risk of ownership.
 This means that the bank is responsible for the major maintenance of the asset.
 Customer pays lease rentals.
 Ownership is transferred to the customer at the end of the term either by way of a gift deed or
selling the asset for nominal amount.
Mudaraba

 Equity finance.
 There are two parties in Mudaraba, the provider of capital is called Rab-ul-mal while the
management and work is responsibility of the other who is called mudarib.
 Profits are shared according to a pre-agreed contract whereas the losses are solely attributable
to the provider of capital.
 Rab-ul-mal is not involved in management and execution of decisions.

Musharaka

 Venture capital.
 Both the parties contribute capital to the business and participate in managing the business.
 Profits are shared according to a pre-agreed contract whereas losses are shared according to
capital contribution ratio.
 Organization = mudareb. Finance provide = Rab-ul-maal.
 Under diminishing Musharaka, mudareb keeps paying greater amount to rub ul maal so that he
eventually becomes the owner of the venture capital.

Sukuk

 They are debt finance linked to an underlying asset.

 The sukuk holder is the partial owner in the underlying asset.
 Profit is linked to the performance of the underlying asset.
 There is no guaranteed income.

Salam

 Forward contract.
 Prohibited for certain assets.
 Commodity is sold today for future delivery.
 Cash is received immediately (today) from the financial institution.
 Delivery arrangements such as quantity, quality and time of delivery are decided immediately.
 The sale is generally at a discount so that financial institution can earn profit.
 The financial institution may sell the contract to another buyer for profit.
 Salam arrangements are prohibited for gold, silver and other money-type assets.

Istisna

 Phased payments.
  These are used for long term construction projects.
 Subject matter is raw material which has the characteristics of being transformed.
 The bank finances the project with the client paying an initial deposit, followed by installments
during the course of construction.
 At the completion of the project, the asset is delivered to the client.

Ads of Islamic Finance

 Encourages ethical business partnerships and fair dealings

 Stable financial environment with a long-term view
 Access to global Muslim funds, estimated at over $1,600 billion

Disads of Islamic Finance

 Slower reaction to market demand due to prohibitions on speculation

 Higher costs and slower innovation due to Sharia compliance requirements
 Potential incompatibility with international financial regulations
 Challenges in interpretation of Sharia rulings leading to different outcomes
 Agency-related issues and increased due diligence costs for IFIs

Behavioral factors:

INVESTORS

Maximization of utility

 Preferences for companies that investors consider are acting with social responsibility.
 Avoid “sin stocks”.
 Some investors hold on to shares with prices that have fallen over time and are unlikely to
recover. They may do this because it will cause them psychological hurt to admit, that their
decision to invest was wrong. This is known as cognitive dissonance.

Analysis of relevant information

 Anchoring, Investors may use information that is not relevant but is readily available, possibly to
simplify the decision-making process. For example, investors may buy shares that in the past
have had high values, on the grounds that these represent their true potential values, even
though rational analysis suggests that the prices of these shares will remain low in the future.
 Gambler’s fallacy, selling shares on the ground that the shares have gained in value for “long
enough” and their price must therefore soon start to fall, even if the rational analysis suggests
that the rise in price will continue.
  Herd behavior, Investors buy or sell shares in a company or sector because many other investors
have already done so.

Rational, objective and risk-neutral analysis

 Confirmation bias, paying attention to evidence that confirms investors’ current belief about
their investments and ignoring evidence that casts doubt on their beliefs.

FINANCIAL MANAGERS

Maximization of utility

 Loss aversion bias, acquiring managers are unwilling to let someone else have what they have
been trying to acquire. Studies have looked at contested takeovers, where different companies
bidding against each other have forced the acquisition price up to a level that was significantly
greater than reasonable.

Analysis of relevant information

 Managers may pay more for a target company than rational, having an unrealistic opinion as to
their skills.

Rational, objective and risk-neutral analysis

 Just as previously explained in respect of investors, there may be confirmation bias, paying
attention to information that suggests that an acquisition will enhance value and ignoring
evidence that indicates that the target will not be a good buy.

Introduction to dark pool trading systems

 They are off-exchange facilities that allow trading of large blocks of shares between anonymous
parties.
 It can skip market forces and get a price that is better suited to both buyer and seller.
 The trade is only announced once it is completed.
 They prevent signals reaching the market in order to minimize large fluctuations in the share
price. This is done because when significant volume of shares is involved in trading, even a small
change in share price can translate into a lot of money.
 Dark pools and their lack of transparency defeat the purpose of fair and regulated markets with
large numbers of participants and threaten the healthy and transparent development of these
markets.
International Monetary Fund

 International monetary fund was set up in 1944.

 Its role is to oversee the global financial systems, in particular to stabilize international exchange
rates, help countries to achieve balance of payments and facilitate in the country’s development
through influencing the economic policies of the country in question.
 Where necessary, it offers temporary loans, from member states’ deposits, to countries facing
severe financial and economic difficulties. These temporary loans are often offered with different
levels of conditions.
 IMF believes that in order to regain control of the balance of payments, the country should take
action to reduce the level of demand for goods and services. To achieve this, the IMF often
requires countries to adopt strict austerity measures such as reducing public spending and
increased taxation, as condition of the loan.
 These measures may cause standards of living to fall and unemployment to rise. The IMF regards
these as short-term hardships necessary to help countries sort out their balance of payment
difficulties and international debt problems.
 The IMF has faced a number of criticisms for the conditions it imposes.

Summary of Greeks

Types of Real Options

OPTION TO DELAY/DEFER  Option to delay an investment until new

information is available.
 This happens when a company has exclusive
rights to a project or product, it can delay
taking this project or product until a later
date.
 It creates a call option.
OPTION TO SWITCH/REDEPLOY  It exists when the company can use its
productive assets for activities other than
the original one.
 This may occur when the forecasts of the
activity that was initially started may turn
out to be wrong and it could be beneficial to
stop the project and use resources
 somewhere else.
 It creates a put option.
OPTION TO EXPAND/FOLLOW-ON  It exists when firms invest in projects which
allow them to make further investments in
the future or to enter new markets.
 The initial investment may be considered as
a premium payment.
 Further investment is undertaken only if the
present value from the expansion will be
higher than the additional investment.
 It creates a call option.
OPTIONS TO ABANDON  It is the option to abandon a project during
its life.
 This option might be used if the forecast
initially prepared turn out to be incorrect or
new information changes the expected
payback.
 It creates a put option

Why to incorporate real options value into net present value

 Net present value method of investment appraisal assumes that a decision must be made
immediately or not at all, and once made, it cannot be changed.
 Real options, on the other hand, recognize that many investment appraisal decisions have some
flexibility:
 For example, decisions may not have to be made immediately and can be delayed to assess the
impact of any uncertainties or risks attached to the projects.
 Alternatively, once a decision on a project has been made, to change it, if circumstances
surrounding the project change.
 To recognize the potential future opportunities, if the initial project is undertaken.
 Real options help estimate the value of this flexibility or choice and recognizes the fact that the
additional value created from this flexibility can be attributed to the project.
 By incorporating the value of any real options available into an investment appraisal decision, a
company will be able to assess the full value of a project.

Limitations of BSOP Model

 Assumes real options are European style. Most options in reality would be American style.
Option to exercise early maybe more valuable, so BSOP will undervalue option.
 Assumes accurate volatility, however unlike financial assets, historical data is not available for
real options for large, one-off projects. Volatility will need to be estimated using simulations
which may not be as accurate.
 Assumes that the underlying project or asset is traded within a perfect market. Further it
assumes that a market exists to trade the underlying project or asset without restrictions
  Assumes that interest rates and the asset volatility remain constant until the expiry time ends.
Further, it assumes that the time to expiry can be estimated accurately
 Assumes that the project and the asset’s cash flows follow a lognormal distribution, similar to
equity markets
 Does not take account of behavioral anomalies which may be displayed by managers when
making decisions
 Assumes that future commitments made between parties, which are then used in constructing
the option, will be binding and will be fulfilled

Value of bond

Coupon Rate: 5%

Required Rate: 4%

Repayment: 4 years

Value = 103.62

If required rate is 6%

Value = 96.53

There is an inverse relationship between the yield of a bond and its price or value. Higher the rate of
return (Yield), lower the price of the bond.
 TECHNICAL ARTICLES
BEHAVIORAL FINANCE

Investors:

Maximization of Utility

 Rational decision-making by investors aims to maximize long-term wealth and utility.

 However, behavioral factors, such as emotional preferences or cognitive dissonance, may lead
investors to make suboptimal decisions.

Analysis of Relevant Information

 Investors may not always base decisions on relevant financial information.

 Behavioral biases like anchoring, gambler's fallacy, and herd instinct can impact decision-making,
leading to market bubbles or crashes.

Rational, Objective, and Risk-Neutral Analysis

 Despite the availability of information, behavioral biases like confirmation bias and risk attitudes
may affect how investors analyze and interpret data, influencing their investment choices.

Managers:

Maximization of Utility

 While companies aim to maximize shareholder wealth, behavioral finance suggests that
managers may have different, possibly irrational, objectives, such as short-term rewards or
personal reputation enhancement.

Analysis of Relevant Information

 Managerial decisions, especially in mergers and acquisitions, may not always be based on
rational assessments. Factors like loss aversion bias and overestimation of managerial abilities
can impact decision-making.
Rational, Objective, and Risk-Neutral Analysis

 Managers may exhibit subjective analysis, confirmation bias, and reliance on flawed information
when evaluating potential strategies or acquisitions.

Limitations of Behavioral Finance:

 Critics say despite individual irrationalities, participation in financial markets can discipline
decision-makers. Short-term anomalies resulting from irrational decisions may not negate long-
term general theories, such as the efficient market hypothesis (that stocks trade at their actual
values)

RISK MANAGEMENT

Risk Management in Small vs. Large Companies

 While large companies may not benefit significantly from risk management due to diverse equity
holdings, smaller companies with concentrated equity holdings can enhance value by reducing
risks.

Advantages of Risk Management

 can offer opportunities to reduce cash flow volatility, leading to potential cost savings
 can help corporations save taxes by stabilizing earnings, particularly in situations with
progressive tax functions or multinational operations.
 Can reduce the likelihood of financial distress, minimizing direct and indirect costs associated
with stakeholders, thus enhancing the ability to contract at lower costs.
 Aids in maintaining an optimal mix of debt and equity, reducing agency costs related to external
debt, and ensuring more favorable terms for external funding.
 Can enable corporations to plan internal funding accurately, minimizing the impact of
information asymmetry in external funding.

Manager Behavior

 Those with concentrated equity positions may seek to reduce unsystematic risk
 Those with equity options might prefer riskier projects to maximize future profits, potentially
conflicting with the corporation's best interests.

Value of Risk Management

Generally believed that risk management adds value, but no evidence on a direct link between risk
management activities and increased corporate value.

RULES

Borrowers and Buyers BUY (Calls)

 Buy the product = make a gain if it rises in price and sell

Savers and Sellers SELL (Puts)

 Sell the product = make a gain if it falls in price

** Except for Interest Rate Futures (IRF) which are reverse

CALL = PROFIT WHEN RATES RISE / PROTECT AGAINST FALL IN RATE

PUT = PROFIT WHEN RATES FALL / PROTECT AGAINST RISE IN RATE