financial markets and instruments - intro

8/13/2019 Financial Markets and Instruments - Intro

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Financial Management

This is only a summary. Please read the text and readings given

for details. Removal of errors and omissions, if any, in this ppt is

your responsibility.


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Books and Resources

Principles of Corporate Finance by Brealey & MyersGlobal Edition 10e

Also refer to

Corporate Finance by Aswath Damodaran

Corporate Finance by Ross, Westerfield and Jaffe

Financial Management by I.M. Pandey


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Books and Resources

A regular finance daily viz, ET, BS, FE, FT, WSJ

A professional journal like

Journal of Applied Corporate Finance,

Financial Analysts Journal or

McKinsey Quarterly (online edition available)


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Field of Finance

Corporate Finance

Investment Banking

Commercial Banking

Financial Services

Behavioural Finance


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Development of Finance

Economists were long aware of the credit marketsespecially as a way of allocating resources over

time.

Developed into a field of its own over time and

specific applications


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Key Contributors.

Eugene Fama Merton Miller

Robert MertonWilliam Sharpe

Harry Markowitz

Fisher Black


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Key Contributors.

Richard Thaler

Amos TverskyDaniel Kanheman

Al Roth Loyld Shapley

Maurice Allais


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What is Financial Management

Financing decision

choosing where to get funds

Investment decision

choosing how to use funds


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Goals of a Firm

Three major decisions

What projects to undertake (real investment

and capital budgeting)

How do you finance these projects (debt,equity)

How should the firm distribute the cash

generated by these projects (Dividend policy)

All these decisions are to enhance the value of

the firm


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Goals of a Firm

Is shareholder value maximization an appropriatemeasure or goal

What about other constituents or stakeholdersare

they being ignored

Various opinions, ideas, and perspectives.


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Goals of a Firm

Generally

Shareholders are the only stakeholders who

simultaneously maximize everyones claims in

seeking to maximize their own..


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Ownerships Vs. Control

In a corporation ownership and control areseparate leading to the classic Agency Problem

Information asymmetry, especially in a world of

uncertainty and risk


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Specifically, managers may not always act in the

best interest of the shareholders/owners of the

corporation

Insufficient effort by managers

Unnecessary investment or expansion

Entrenchment strategies

Lack of transparency

Self-dealing

Short-term vs. long-term focus

Inflated and unusual compensation package


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Potential solutions, although imperfect are through both

internal and external control and monitoring

Internal Control Mechanism

Monitoring of the Management (e.g., by BoD)

Periodic reporting and transparency Effective and independent Board of Directors

External Control Mechanism

Market Competition External Auditors

Rating Agencies and Analysts

Regulatory bodies


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This Course

Financial Markets

Valuation of Real Assets

Valuation of Financial Assets (including risk-returntradeoff and Cost of Capital)


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Main Principles

Time Value of money

Risk-Return tradeoff

Gains to diversification

No arbitrage


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Financial Markets

Financial markets allows people to easily buy andsell financial securities, and commodities at lowtransaction costs and at market-based prices

Financial markets facilitate raising capital,transferring risk and international trade

Financial markets bring borrowers and lenders

together and improve the market liquidity

With globalization world financial markets areinterlinked and affect each other


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Financial Markets

In India there is financial dualismformal andinformal market

Formal Organized and regulated (Banks, RBI, MoF,

SEBI) Subject to interest rate bands and regulation Usually inflexible credit structure Relatively high transaction cost (not just

monetary, includes intangible search costs)


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Financial Markets

Informal

Unorganized and non-regulated Flexible and need-based Relatively low transaction cost Presumed to have high probability of default

Interest rates are very high Examples: traditional money lender, pawn shop,

storecredit based on knowing each other,usually rural and caters to the credit-deprived

With liberalization, planned growth and regulation,banking services have spread to the rural areas andincreased the scope of the formal sector


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Financial Markets

The financial markets can be divided in severalways

(relies on an underlying security)

Capital markets (providing long-term financing)

Money markets (short-term financing andinvestments)

Forex (Foreign exchange)

Derivatives

Capital markets can be either primary orsecondary

Equity and Debt

Other marketsFutures, Insurance,


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Financial Markets

Primary market (generally for new issues)

Equity offered to exiting shareholders is RightsOffering

When equity is offered to select entities it is aPrivate Placement

When anyone can subscribe to the issue it isPublic Offer


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Financial Markets

Secondary Market Market for previously issued securities

Generally, the issuing firm is not affected by the

trading of the securities

A security can trade any number of times

Much larger than the primary market

Transaction takes place in the listed exchanges


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Financial Instruments

Financial instruments are

Evidence of an ownership interest in an entity

an asset

Marketable and traded in organized markets Can be held by individuals (or firms) in a portfolio

for risk diversification

Links borrowers and lenders


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Firms have a choice of raising capital for financingprimarily using Debt or Equity

Within each there is a variety of offerings and the

choice of a specific instrument (vehicle) is firmspecific and based on economic conditions

Financial innovation has led to the growth of

various hybrid instrumentsi.e. having somefeatures of debt and some of equity. E.g.

Convertible bonds, Preferred stock, Debentures


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Equity - ownership capital, right to controlfirm, risky, residual claimant

Debtborrowing under terms of contract


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Difference between debt and equity lies in the natureof the claims to the firms cash flows

Debt has a claim to a contracted set of cash flows for

both the interest and principal while Equity is the

residual claimant (more risky)

In the event of liquidation, debt has earlier claim to

the cash flows vs. equity

Tax treatment differential

Debt is for a contracted period of time while equity

has infinite life

Equity has control over a firms management


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Debentures

Similar to promissory notes Relationship with firm like a lender-borrower (debt)

Can have various featuresconvertible, non-convertible, partially convertible, oroptionally convertible

Can be secured or unsecured

Can be floating or fixed interest rate

Examples

Shriram Transport Finance Company, one of the largest asset financing NBFCsin India, plans to enter the debt capital market on October 7, 2013 with a publicissue of Secured Redeemable Non-Convertible Debentures (NCDs) of facevalue of Rs.1,000 each.

August 2012 saw back-to-back non-convertible debenture (NCD) issues fromIndia Infoline Investment Services, Shriram City Union Finance, MannapuramFinance and Muthoot Finance, with a fixed interest rate ranging between 11.5%and 12.25%

Religare Finvest issued an NCD in Sep 2012


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Preference shares area hybrid form of instrumentsThey resemble equity share as well as debentures

Resemblances to equity share

Dividend payable from distributable profits No obligation on the firm to preference dividend

Resemblances to a debenture

Rate of dividend fixed Preference shareholders enjoy priority or

preference over equity holders


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Key features of Preference shares Accumulation of dividends

Callability

Convertibility Redeemability

Participation in excess profits


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Market Index

Stock market indices are akinto barometers A picture of how the market as a whole has fared

Is a very directional indicator of the consumer

perception or economic sentiment Stock market indicators like Sensex and Nifty are

nothing but weighted average index numbers

The Dow Jones Industrial Average (DJIA)comprises of a set of firmsa few years ago, it

dropped one of the firmswhich one, why?


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Market Index

Some index have multiple versions depending onthe weighting, how dividends are accounted for

Global index includes companies w/o regard to

the country in which they are traded

Some index are for specialized sectors or

industry

Recently, ethical index, sustainability index,

environment index, CSR index and several such

have cropped up


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Market Index

Various weighting schemes Price weightedNikkei 225, DJIA

Capitalization weightedSensex, Nifty, S&P 500

Equally weighted indicesA version of the RyderS&P (tracks the S&P 500), Kansas Board of

Trade


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IPOBook Building

The cumulative demand for the shares of thecompany at various prices are as shown below:

Cum. Qty. Subscription

(%)500 16.67

1500 50.00

3000 100.00

5000 166.67

7500 250.00


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IPOBook Building

The highest price at which the issuer is able toissue the desired number of shares is the price

at which the book cuts off i.e. Rs 58 in the earlier

example

The issuer in consultation with the BRLMs, willfinalize the issue price at or below the cut off

price, i.e., at or below Rs. 58

All bids at or above this issue price and cut-off

bids are valid bids and are considered for

allocation in the respective categories


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Future Sessions

Time Value of Money

Capital Budgeting Techniques

Investment Decision and Estimating Cash Flow

Valuation of Securities

Risk & Return (CAPM)

Cost of Capital

Options (depending on time available)


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Thank you!

financial markets and instruments - intro

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