Finance for Viva

Definition of Finance:
Finance is the art and science of managing money.

The term finance can be defined as the management of flows of money through an organization,
whether it be a corporation, school, bank or government agency.

Definition of Business Finance:

Business finance can be defined as the activity concerned with planning, raising, controlling,
administering of the funds used in the business.

Goals of Finance:
a. Profit Maximization: Profit maximization refers to the earning per share of a company.
Earnings per share equal to earnings available for common stockholder divided by
number of outstanding share.
b. Wealth Maximization: Wealth maximization refers to the maximization of share price
of a company. Another word, wealth maximization means maximizing the net present
value of a course of action to shareholders.

Financial Market:
A financial market is a market in which financial assets such as stocks and bonds can be
purchased.

Money Market and Capital Market:

Money Market:

Money market is the financial market for short term debt instruments.

Money market is the market for short term, highly liquid, low-risk assets such as Treasury bill
and other negotiable instruments.

Participants/Players of money market:Central bank, Government, commercial banks, financial

institution, Discount houses, Micro Finance Institutions, Corporates, investors,and dealers, etc.

Capital Market:
Capital market is the market for long term security as bonds and stocks.

Capital market is the financial market for equity instrument and for debt instruments with a
maturity greater than one year.

Capital market can be divided into Bond Market and Stock Market. In Bond Market, buying and
selling of newly issued and existing bonds takes place. In stock Market, exchange of newly
issued and existing shares or stocks is carried out.

Players of capital Market:

i. Investment Banks,
ii. Mutual Funds- a guide,
iii. Commercial banks,
iv. Savings and loan associations,
v. Mutual saving Banks,
vi. Credit Unions,
vii. Pension Funds,
viii. Insurance Companies.

The participants of capital market are mainly those who have a surplus of funds and those who
have deficit funds. The persons having surplus money want to invest in capital market in hope of
getting high returns on their investments. On the other hand, people with fund deficit try to get
financing from the capital market by selling stocks and bonds. These two kinds of activities keep
the capital market going.

Primary Market:

Primary market is that market where new issued securities are traded.

Secondary Market:

Secondary markets are those markets in which existing, already outstanding securities are traded
among investors.

Microcredit Regulatory Authority:

The Microcredit Regulatory Authority (MRA) has been established by the Government of the
People’s Republic of Bangladesh under the “Microcredit Regulatory Authority Act 2006” to
promote and foster sustainable development of microfinance sector through creating an enabling
environment foe NGO-MFIs in Bangladesh. License from the authority is mandatory to operate
microfinance operations in Bangladesh as an NGO.

Microcredit Regulatory Authority is the central body to monitor and supervise microfinance
operations of NGO-MFIs in Bangladesh.
Time Value of Money:
A dollar today is worth more than a dollar tomorrow.

A taka received a year hence is not equivalent of a taka received today because the use of money
has a value. The difference represents the time value.

Money that the firm has in its possession today is more valuable than money in the future
because the money it now has can be invested and earn positive returns.

Importance of Time Value of Money:

i. Taking investment decision,

ii. Project selection,
iii. Facing risk and uncertainty,
iv. Determine the loan and lease installment,
v. Fund management, etc.

Present Value:

Present Value, also known as present discounted value, is the value of an expected income
stream determined as of the date of valuation.The present value is always less than or equal to
the future value because money has interest earning potential, a characteristic referred to as the
time value of money.

Future Value:

The value of an asset or cash at a specified date in the future that is equivalent in value to a
specified sum today.

Annuity:

An annuity is a series of equal dollar payment for a specified number of years.

An annuity is a stream of equal periodic cash flow, over a specified time period.

Ordinary Annuity: Ordinary annuity is an annuity for which the cash flow occurs at the end of
each period.

Annuity Due: Annuity due is an annuity for which the cash flow occurs at the beginning of each
period.

Interest:
Money paid regularly at a particular rate for the use of money lent, or for delaying the repayment
of a debt.

Interest is money paid by a borrower to a lender for a credit or a similar liability.

Interest Rates:

Simple Interest: Simple interest is the interest that is earned only on the initial principal amount
and once in a year.

Compound Interest: Interest paid on any previous interest earned as well as on the principal
borrowed is called compound interest.

Nominal Interest Rate: Nominal rate of interest is a rate of interest quoted for a year that has
not been adjusted for frequency of compounding.

Effective Interest Rate: Effective interestis the actual rate of interest earned after adjusting the
nominal rate for factors such as the number of compounding periods of year.

Cash Flow Statement:

Statement of cash flows reports the effect of operating, investing and financing activities on cash
over an accounting period.

A statement of changes in financial position of a firm on cash basis, commonly known as the
cash flow statement.

Operating Cash Flow: A firm’s operating cash flow is the cash flow it generates from its
normal operations-producing and selling its goods or services.

Free Cash Flow: The firm’s free cash flow represents the amount of cash flow available to
investor (creditors and owners) after the firm has met all operating needs and paid for
investments in net fixed assets and net current assets.

Break-even Point:
The firm’s break-even point is defined as the level of sales at which all operating costs are
covered or alternatively the EBIT is zero.

Break-even point refers to a point of no profit, no loss. It is the level of sales where firm’s
revenues are equal to its total cost.

Objective of BEP analysis: The break-even analysis lets you determine what you need to sell,
monthly or annually, to cover your cost of doing business.
The break-even analysis table calculates a break-even point based on fixed cost, variable cost per
unit of sales, and revenue per unit of sales.

Contribution Margin:
In accounting contribution margin is defined as revenues minus variable expenses. In other
words, the contribution margin reveals how much of a company’s revenues will be contributing
(after covering the variable expenses) to the company’s fixed expenses and net income. The
contribution margin can be presented as-

i. The total amount for the company,

ii. The amount for each product line,
iii. The amount for a single unit of product, and
iv. As a ratio or percentage of net sales.

Contribution Margin Ratio:

When the value of leverage is equal to zero?

Answer: When EBIT is zero.

Margin of Safety:

Margin of safety is the excess of budgeted or actual sales over the break-even sales.

Margin of Safety Ratio:

Short Term Financing:

A fund available for a period of one year or less is called short-term finance.
Sources of Short Term Finance:

i. Trade credit,
ii. Advances from customers,
iii. Commercial Paper,
iv. Bankers Acceptance,
v. Bank loan.

Mid-term Financing:
Intermediate financing ordinarily refers to loan that more than one year often for up to five years
and sometimes up to ten years.

Sources of Mid-term Finance:

i. Commercial Bank,
ii. Insurance Company,
iii. Finance Company,
iv. Development Bank,
v. Leasing Company,
vi. Private organization, etc.

Long Term Financing:

Long term financing is a form of financing that is provided for a period of more than five years
to twenty years or more.

Purpose of long term finance:

i. To finance fixed assets.

ii. To finance the permanent part of working capital.
iii. Expansion of companies.
iv. Increasing facilities.
v. Construction projects on a big scale.
vi. Provide capital for funding the operations.

Sources of Long Term Financing:

Internal Source: Owner’s Equity/Share Capital.

External Source: Bond, Debenture.

Bond: A bond is long-term debt instruments representing the issuer’s contractual obligation.

A corporate bond is a long-term debt instrument indicating that a corporation has borrowed a
certain amount of money and promises to repay in the future under clearly defined terms.
Types of Bond: Treasury bond, corporate bond, Municipal bond, foreign bond, unsecured bond,
Secured bond, Coupon bond, Zero coupon bond, call bond, etc.

Zero Coupon Bond: A zero coupon bond makes no periodic interest payments and it is sold at a
deep discount from its face value.

Bond Indenture: A legal document that specifies both the rights of the bond holders and the
duties of the issuing corporation is called bond indenture.

Debenture:
In corporate finance, a debenture is a medium-to long-term debt instrument used by large
companies to borrow money, at a fixed rate of interest. The legal term “debenture” originally
referred to a document that either creates a debt or acknowledges it, but in some countries the
term is now used interchangeably with bond, loan stock or note. A debenture is thus like a
certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified
amount with interest and although the money raised by the debentures becomes a part of the
company’s capital structure, it does not become share capital.

Cost of Capital:
The cost of capital is the rate of return a firm must earn on its investments in project in order to
maintain the market value of its.

Cost of capital is the required rate of return on the various types of financing.

Capital Asset Pricing Model:

The Capital Asset Pricing Model (CAPM) helps us to calculate investment risk and what return
on investment we should expect.

The capital asset pricing model provides a formula that calculates the expected return on a
security based on its level of risk.

Weighted Average Cost of Capital:

The Weighted Average Cost of Capital (WACC) is a calculation of a firm’s cost of capital in
which each category of capital is proportionately weighted. All sources of capital, including
common stock, preferred stock, bonds and any other long term debt, are included in this
calculation.

Flotation Cost:
The cost incurred by a publicly traded company when it issues new securities. Flotation costs are
paid by the company that issues the new securities and includes expenses such as underwriting
fees, legal fees and registration fees.

Investment Opportunity Schedule:

The Investment Opportunity Schedule (IOS) is a representation of the returns on investments.

An investment opportunity schedule is a chart or graph that relates the internal rate of return on
individual projects to cumulative capital spending. To set up an investment opportunity schedule,
the analyst first computes each projects internal rate of return (or modified internal rate of
return). If mutually exclusive projects are part of the analysis, only the highest ranked projects go
on the next step. After computing the individual IRR or MIRR, the projects are ranked from
highest to lowest by MIRR, keeping a tally of cumulative project spending.

Marginal Cost of Capital (MCC):

The Marginal Cost of Capital is the cost of the last dollar of capital raised, essentially the cost of
another unit of capital raised.

Optimum Capital Structure:

The best debt-to-equity ratio for a firm that maximizes its value.

The optimum capital structure for a company is one which offers a balance between the ideal
debt-to-equity range and minimizes the firm’s cost of capital.

Risk Free Rate of Return:

Risk free rate of return is the theoretical rate of return of an investment with no risk of financial
loss.

An interest rate that assumes no inflation and no uncertainty about future cash flows or
repayments. Treasury bills are one examples of an investment with a risk-free rate of return.

Rate of Return:

The gain or loss on an investment over a specified period, expressed as a percentage increase
over the initial investment cost.

Capital Budgeting:
Capital budgeting may be defined as the decision making process by which firms evaluates the
purchase of major fixed assets, including building, machinery and equipment.

The process in which a business determines whether projects such as building a new plant or
investing in a long-term venture are worth pursuing is called capital budgeting.

Average Rate of Return (ARR):

Average Rate Return, also known as accounting rate of return, is the ratio of estimated
accounting profit of a project to the average investment made in the project. ARR is used in
investment appraisal.

Pay Back Period (PBP):

Payback Period in capital budgeting refers to the period of time required to recoup the funds
expended in an investment. In this method, the time value of money is not taken into account.

Discounted Payback Period:

The discounted payback period is defined as the number of years required to recover the initial
investment from discounted cash flows.

Net Present Value (NPV):

The difference between the present value of cash inflows and the present value of cash outflows.

The Net Present Value is defined as the sum of the present values of all cash inflows (positive
and negative) minus the present value of cash outflows over a specified period of time.

Internal Rate of Return (IRR):

Internal Rate of Return is the interest rate at which the net present value of all the cash flows
(both positive and negative) from a project or investment equal to zero.

Project:
Planned set of interrelated tasks to be executed over a fixed period and within certain cost and
other limitations.
Independent Project:

A project whose acceptance or rejection is independent of the acceptance or rejection of other

projects.

A project that is not part of or dependent on any other project.

Mutually Exclusive Project:

Mutually exclusive projects are projects in which the acceptance of one project excludes the
others from consideration, although the NPV and IRR of those projects are positive.

Capital Rationing:
Capital rationing is the act of placing restrictions on the amount of new investments or projects
undertaken by a company. This is accomplished by imposing a higher cost of capital for
investment consideration or by setting a ceiling on the specific sections of the budget.

Capital rationing is a technique of selecting the projects that maximizes the firm’s value when
the capital infusion is restricted.

Capital rationing is the strategy of picking up the most profitable projects to invest the available
funds.

Definition of Risk:
Risk is the chance that some unfavorable events will occur.

Risk is defined as the chance that the actual outcome from an investment will differ from the
expected outcome.

Business Risk:

Business risk is defined as the chance that the firm will not have the ability to meet its operating
expenses from its operating income.

Financial Risk:

Financial risk is that part of total risk that management introduces through debt financing.

Liquidity Risk:

Liquidity risk is the risk that a given security or asset cannot be traded quickly enough in the
market to prevent loss.
Market Risk:

Market risk is the risk that the value of an investment will decrease due to moves in market
factors.

The possibility for an investor to experience losses due to factors that affect the overall
performance of the financial markets.

Interest Rate risk:

Interest rate risk is the chance that an unexpected change in interest rates will negatively affect
the value of an investment.

Interest rate risk is the risk that arises for bond owners from fluctuating interest rates.

Exchange rate Risk:

Exchange rate risk is defined as the variability of a firm’s value due to uncertain changes in the
rate of exchange.

The risk that a business operations or an investment’s value will be affected by changes in
exchange rates. It is also known as foreign exchange risk.

Purchasing Power Risk or Inflation Risk:

The chances of an adverse effect on the value of money as a result of inflationary pressures
within an economy.

Purchasing power risk, also known as inflation risk, is the chance that the cash flows from an
investment won’t be worth as much in the future because of changes in purchasing power due to
inflation.

Political Risk:

Political risk is the risk that an investment’s returns could suffer as a result of political changes
or instability in a country.

Risk Premium: Risk premium is the increase rate over the nominal risk-free rate that investors
demand as compensation for an investment’s uncertainty.

Dividends:

A sum of money paid regularly (typically annually) by a company to its shareholders out of its
profits.
A dividend is a payment made by a corporation to its shareholders, usually as a distribution of
profits. When a corporation earns a profit or surplus, it can re-invest in the business (called
retained earnings), and pay a fraction of this reinvestment as a dividend to shareholders.

Realized Return:

The return that is actually earned over a given time period.

Realized return is the amount that an investor actually realizes from an asset.

Non-diversifiable/Systematic Risk/ Market Risk:

Systematic risk is the fluctuations of return caused by the macroeconomic factors that affect all
risky assets.

Systematic risk is the risk of collapse of an entire financial system or entire market, as opposed
to risk associated with any one individual entity, group or component of a system.

Diversifiable/Unsystematic Risk:

Unsystematic risk is the risk that something with go wrong on the company or industry level,
such as mismanagement, labor strikes, production of undesirable products, etc.

Total Risk:

Systematic risk + unsystematic risk.

Beta-coefficient:

Beta coefficient is a measure of sensitivity of a share price to movement in the market price. It
measures systematic risk inherent in the whole financial system. Beta coefficient is an important
input in capital asset pricing model to calculate required rate of return on a stock. It is the slope
security market line.

Security Market Line (SML):

Security market line is the graphical representation of the capital asset pricing model. It displays
the expected rate of return of an individual security as a function of systematic, non-diversifiable
risk.

The security market line is a useful tool in determining whether an asset being considered for a
portfolio offers a reasonable expected return for risk.

Portfolio:
In finance, a portfolio is a collection of investments held by an investment company, hedge fund,
financial institution or individual.
Efficient Portfolio:

An efficient portfolio is either a portfolio that offers the highest expected return for a given level
of risk, or one with the lowest level of risk for a given expected return. The line that connects all
these efficient portfolios is called efficient frontier.

Market Portfolio:

Market Portfolio is a theoretical bundle of investments that includes every type of asset available
in the world financial market, with each asset weighted in proportion to its total presence in the
market.

Uncertainty:

Uncertainty is that occurrence when we have no idea of what the possible outcome might be.

Risk Vs uncertainty:

i. Risk is measureable while uncertainty is non-measureable.

ii. Risk is when we don’t know what the outcome is, but we do know the distribution of
the outcomes, while uncertainty is when we don’t know what the outcome, and we
don’t know the distribution.

Speculative Risk:

Speculative risk is a category of risk that can be taken on voluntarily and will either result in a
profit or loss. All speculative risks are undertaken as a result of conscious choice.

Return:

Return is the total gain or loss experienced on an investment over a given period.

Leverage:
Leverage is defined as the ability of a firm to use fixed cost assets to magnify the returns to the
shareholders.

Leverage means the tendency to change profit at a faster rate than sales.

Higher the degree of leverage higher the degree of risk and higher the rate of return.

Operating Leverage:
Operating leverage may be defined as the firm’s ability to use the fixed operating cost to magnify
the effects of changes in sales on earnings before interest and taxes.
Where, DOL= Degree of Operating Leverage

EBIT= Earnings before Interest and Taxes.

Financial Leverage:
Financial leverage is the amount of debt that an entity uses to buy more assets.

The degree to which an investor or business is utilizing borrowed money. Companies that are
highly leveraged may be at risk of bankruptcy if they are unable to make payments on their debt,
they may also be unable to find new lenders in the future. Financial leverage is not always bad,
however, it can increase the shareholder’s return on investment and often there is tax advantage
associated with borrowing.

Details about Financial Analyst

Financial Analyst:

Financial analyst is one of the most coveted roles in the financial services industry.
Financial analysts can work in both junior and senior positions within a firm and it is a
position that often leads to other career opportunities in the financial services industry. A
financial analyst researches macroeconomic and microeconomic conditions, gathers
financial information along with company fundamentals in order to make business, sector
and industry recommendations to the company.

Financial analysts provide guidance to businesses and individuals making investment

decisions. They assess the performance of stocks, bonds, and other types of investments.

Important Qualities

Analytical skills: Financial analysts must process a range of information in finding

profitable investments.

Communication skills: Financial analysts must explain their recommendations to clients

in clear language that clients can easily understand.
Computer skill: Financial analysts must be adept at using software packages to analyze
financial data, see trends, create portfolios, and make forecasts.

Decision making skills: Financial analysts must provide a recommendation to buy, hold,
or sell a security. Fund managers must make split-second trading decisions.

Detail oriented: Financial analysts must pay attention to details when reviewing possible
investments, as small issues may have large implications for the health of an investment.

Math skills: Financial analysts use mathematical skills when estimating the value of
financial securities.

To be successful, financial analysts must be motivated to seek out obscure information

that may be important to the investment. Many work independently and must have self-
confidence in their judgment.

Assessment for the ‘Right’ Financial Analyst

Financial Analyst P r o f i l eA M C A T M a p p i n g

A n a l y t i c a l A b i l i t yL o g i c a l A b i l i t y – H i g h

N u m b e r S k i l l sNumerical Ability – Mid to High

E n g l i s h C o m m u n i c a t i o nE n g l i s h – M i d t o H i g h

F i n a n c e B a s i c sA M C A T Finance* – High

T r a i n a b i l i t yLogical Ability – Mid to High

* There are multiple AMCAT modules within finance domain and can be mapped
depending on type of enterprise and the role.

Job Duties
Financial analysts typically do the following:

i. Recommend individual investments and collections of investments, which are

known as portfolios.
ii. Evaluate current and historical data.
iii. Study economic and business trends.
iv. Study a company's financial statements and analyze commodity prices, sales,
costs, expenses, and tax rates to determine a company's value by projecting the
company's future earnings.
v. Meet with company officials to gain better insight into the company's prospects
and management.
vi. Prepare written reports.
vii.Meet with investors to explain recommendations.

More Qualities:

i. Analyze financial information to produce forecasts of business, industry, and

economic conditions for use in making investment decisions.
ii. Assemble spreadsheets and draw charts and graphs used to illustrate technical
reports, using computer.
iii. Evaluate and compare the relative quality of various securities in a given industry.
iv. Interpret data affecting investment programs, such as price, yield, stability, future
trends in investment risks, and economic influences.
v. Maintain knowledge and stay abreast of developments in the fields of industrial
technology, business, finance, and economic theory.
vi. Monitor fundamental economic, industrial, and corporate developments through
the analysis of information obtained from financial publications and services,
investment banking firms, government agencies, trade publications, company
sources, and personal interviews.
vii.Prepare plans of action for investment based on financial analyses.

viii. Present oral and written reports on general economic trends, individual
corporations, and entire industries.
ix. Recommend investments and investment timing to companies, investment firm
staff, or the investing public.
x. Collaborate with investment bankers to attract new corporate clients to securities
firms.
 xi. Contact brokers and purchase investments for companies, according to company
policy.
xii.Determine the prices at which securities should be syndicated and offered to the
public.

Tips for Success:

The most successful junior analysts are ones that develop proficiency in the use of
spreadsheets, databases, PowerPoint presentations and learn other software applications.
Most successful senior analysts, however, are those who not only put in long hours, but
also develop interpersonal relationships with superiors and mentor other junior analysts.
Analysts that are promoted also learn to develop communication and people skills by
crafting written and oral presentations that impress senior management.

Bank and Banking Industry Analysis

Review and analysis of clients’ financial statements/reporting, to assess/present

performance and positioning. Quantitative and qualitative analyses of clients to identify
forces at work, client challenges, and opportunities – across various business segments
include the holding company, bank, broker-dealer, wealth manager, and asset manager.
Understanding, and finding ways to apply, the current and future trends within the
financial industry, including regulatory requirements and economic environment.
Develop dynamic models to support discussions on many of the items referenced above.