FOUNDATIONS OF FINANCE

SESSION 1
Prof. Udayan Sharma

1
What is a Corporation?

■ A corporation is a legal entity. In the view of the law, it is a legal person that is owned by
its shareholders.
– It can make contracts, carry on a business, borrow money and may be sued etc.
■ It is separate from its owners.
■ Corporations enjoy most of the rights and responsibilities that individuals possess.
■ Shareholders have limited liability. How much can they lose?

■ Apple Inc., Walmart Inc., and Microsoft Corporation are all examples of corporations.

■ Closely held and public companies?

2
Corporation and decisions it makes

■ Investment Decision: Generally includes purchase of real assets. Also called capital
budgeting. Takes long term view of the firms goals.
■ E.g. Setting up a manufacturing facility.

■ Financing Decision: Sale/purchase of financial assets in order to raise(capital structure) or

handle money for the firm. Meeting obligations of bond/stock holders.
■ E.g. Pay-out decisions, raising equity, paying debt.

■ Example:
– Facebook Acquires WhatsApp for 22 Billion
– Jio receives Rs 43,574 crore from Facebook for 9.99% stake
– Wallmart spends $1.2 million in advertisement

■ Dividend payment ( a payout decision) is usually dealt separately from financing decision.3
Role of Financial Manager

The goal is to maximizing shareholder value. Must be in constant touch with financial markets.

4
Role of Financial Manager
Objective:

• Increase market value of the firm and current price of its shares.

• Does this mean increase profits as much as you can?

• Not necessarily. Managers may increase short term profits by actions like cutting back on
expenses that are required for long term value maximization.

• Hence, objective is to maximize the shareholder value.

5
What is a Financial market?

■ A platform where securities are issued and traded.

– Example: Stock market

■ Role of financial markets

– Helps corporations to raise money for operations. E.g. Shares and bonds issuance.
– Liquidity: Financial markets are places where supply meets demand.
– Helps to manage risk exposure: E.g. Hedging in futures markets
– Price Discovery

– The most fundamental function is to allow for the efficient allocation of capital and
assets in a financial economy.
6
Imagine a world without financial
markets?
■ Capital could not be allocated efficiently

■ Economic activity such as commerce & trade, investment, and growth opportunities
would be greatly diminished.
Classification of financial markets
(Types)

8
Classification of financial markets
(Basic classification)
■ Primary Market
– Issuance of a security for the first time.
■ IPOs, Issuance of bonds
■ Secondary Markets
– Buying and selling of previously issued securities
BSE
NSE
Bond secondary market

9
Classification of financial markets
(Types)
■ Over the Counter (OTC) Market – Over-the-counter or off-exchange trading is done
directly between two parties, without the supervision of an exchange.
■ 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.
■ 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.
■ Forex Market – It is a financial market where investors trade in currencies. In the
entire world, this is the most liquid financial market.

10
Classification of financial markets
(Forms)
■ By Nature of Claim
Debt Market – It is a market where fixed bonds and debentures or bonds are exchanged between
investors.
Equity Market – It is a place for investors to deal with equity.
■ By Maturity of Claim
Money Market – It deals with monetary assets and short-term funds such as a certificate of deposits,
treasury bills, and commercial paper, etc.
Capital Market – It trades medium and long term financial assets.
■ By Timing of Delivery
Cash Market – It is a market place where trade is completed in real-time.
Futures Market – Here, the delivery or compensation of products are taken in the future specified date.
■ By Organizational Structure
Exchange-Traded Market – It has a centralised system with a patterned procedure.
Over-the-Counter Market – It has a decentralised organisation with customised procedures

11
Money Market

■ Money market instruments are short-term financing instruments aiming to increase the
financial liquidity of businesses.
– Usually traded over the counter
■ Types of instruments:
– Certificate of deposit- A certificate of deposit is a time deposit. The bank expects
CD to be held until Maturity, at which time they can be withdrawn and interest paid.
– Commercial Paper: This type of money market instrument serves as a promissory
note generated by a company to raise short term funds. It is unsecured, and
thereby usually used by large-cap companies with renowned market reputation.
– Treasury Bills -- These are only issued by the central government of a country when
it requires funds to meet its short term obligations.
■ Issued by RBI usually for a period of 91 day, 182 day and 364 day. These are Zero
coupon bonds.
12
Money Market

■ Types of instruments:
– Repurchase Agreements
Commonly known as Repo, is a short term borrowing tool where the issuer availing
the funds guarantees to repay (repurchase) it in the future.

What is Repo rate commonly used with reference to RBI and banks?

– Bankers Acceptance-- A banker's acceptance is an instrument representing a

promised future payment by a bank. The payment is accepted and guaranteed
by the bank as a time draft to be drawn on a deposit.
Useful in international trade.

13
Capital Market

■ A place where buyer and seller come together for trading long term securities.

■ Types of instruments:
– Equity Shares
– Preference shares: Dividend payment takes priority over common shareholders.
– Bonds
– Debentures: Type of bond but without any collateral.

14
Understanding quotes
■ How do you Buy stocks?

Market Typically large banks or financial institutions.

Always ready to buy and sell.
Maker Create liquidity in the market

Brokers facilitates the trade.

■ The market maker creates the market for investors, while the broker buys or sells the shares
from that created market. 15
Understanding quotes

■ Stocks:
A basic quote for a specific stock provides information, such as its
■ bid and ask price,
■ last traded price,
■ and volume traded.
What is Bid Ask spread?

Example: BID/ASK = 10.50/10.55

One may have to pay 10.55 to buy the stock and would receive 10.50 on selling it.
Here, Spread is .05
16
17
Understanding quotes

■ Role of bid-ask spread?

■ Who gains from it?

18
Understanding quotes

■ Currency quotes
■ Direct Quote: The quote is direct when the price of one unit of foreign currency is
expressed in terms of the Domestic currency.
– EUR/USD=1.25
– BASE/QUOTE
– one euro is exchanged for 1.2500 U.S. dollars
– EUR(Foreign)/USD(Domestic)
■ Indirect quotation: The domestic currency is the base and the foreign currency is the
counter.

19
Floating and Fixed exchange rates

■ Floating currencies—Their values change according to how the currency trades on

foreign exchange.
– Depends on demand and supply, and it generally fluctuates constantly.

■ Fixed Currency-- A fixed exchange rate denotes a nominal exchange rate that is set
firmly by the monetary authority with respect to a foreign currency or a basket of
foreign currencies.
– Example : Aruba, Bahamas, Barbados, and Bermuda
– Example: Jordan, Oman, Qatar, Saudi Arabia, and the United Arab Emirates
– What about China? Do they peg Yuan?

20
Exchange rates

■ Bid-Ask spread and pips(.0001 – Change at 4th decimal place)

■ I want to sell 10,000 Euros.

– I would receive 1.2458*10,000= $12458
– Now, there is a change of 10 pips for Sell price.
– I shall only receive $12448
– Currency may move 50 to 70 pips in a day.
21
T-Bill QuotesISSUE BID ASK CHANGE YIELD
02/12/2022 5.08 5.06 -0.03 5.24

■ What is face value?

Face value (par value) is the amount paid to a bondholder at the maturity date, as
long as the bond issuer doesn't default.

■ What is discounted price of a bond?

Discount over its face value and redeemed at par on maturity.

Example: For example, an investor who purchases a bond at a discount for $920
will receive $1,000 at maturity. The $80 return is the investor's earnings or return
for holding the bond. T-Bill is type of a bond.

22
T-Bill Quotes ISSUE BID ASK CHANGE YIELD
02/12/2022 5.08 5.06 -0.03 5.24

■ The first numbers refer to the bill's maturity date, 149 days to go. Let face value of
the bill be $10,000.
■ This is the amount investor receives on maturity of bill.
■ The bid represents the interest rate the buyer wants to be paid for the bond.
– 5.08 % of face value in this case. i.e. Rs. 508
■ The ask, or offer price, represents the interest rate the seller is willing to sell to you
at.
– 5.06% of face value in this case. i.e. Rs. 506
– Ask or purchase price= 10,000- 506 *(149/360)= $9790.57

23