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The Financial The Financial EnvironmentEnvironment

DefinitionsDefinitions

• Investment means the sacrifice of current amount (taka) for future amount.

• The Investment Environment encompasses the kind of marketable securities that exist and where and how they are bought and sold.

• The Investment Process is concerned with how an investor should proceed in making decisions about what marketable securities to invest in, how extensive the investment should be, and when the investments should be made.

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Financial System Clients and Their Needs

• Household Sector

– Primary Need: Invest Funds

• Business Sector

– Primary Need: Raise Funds

• Government Sector

– Primary Need: Raise Funds

The Investment ProcessThe Investment Process

• A five step procedure for making investment decision:

Set investment policyPerform security analysisConstruct a portfolioRevise the portfolioEvaluate the performance of the portfolio.

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Three Areas of FinanceThree Areas of Finance

• Corporate Financial ManagementCorporate Financial Management

– Viewpoint of an individual firmViewpoint of an individual firm

• InvestmentsInvestments

– Viewpoint of individual investorsViewpoint of individual investors

• Financial Markets and IntermediariesFinancial Markets and Intermediaries

– Viewpoint of a third party facilitating Viewpoint of a third party facilitating investor-firm interactionsinvestor-firm interactions

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• How do we use corporate resources How do we use corporate resources efficiently to further the goals of the firm?efficiently to further the goals of the firm?

• Decisions are based on Decisions are based on The Principles of The Principles of FinanceFinance

Corporate Financial ManagementCorporate Financial Management

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InvestmentsInvestments• The study of financial transactions from the The study of financial transactions from the

viewpoint of investors outside the firm.viewpoint of investors outside the firm.

• Examples include:Examples include: How do we place a taka/dollar value on a share How do we place a taka/dollar value on a share

of stock or a bond issued by the corporation?of stock or a bond issued by the corporation? How do we assess the risk of these financial How do we assess the risk of these financial

securities?securities? How do we manage a ‘portfolio’ of financial How do we manage a ‘portfolio’ of financial

securities to achieve a stated objective of the securities to achieve a stated objective of the investor?investor?

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Financial Markets and Financial Markets and IntermediariesIntermediaries

• The study of markets where financial The study of markets where financial securities (such as stocks and bonds) are securities (such as stocks and bonds) are bought and sold.bought and sold.

• The study of financial institutions (such The study of financial institutions (such as commercial banks, investment banking as commercial banks, investment banking firms, and insurance companies) that help firms, and insurance companies) that help the flow of money from savers to the flow of money from savers to demanders of money.demanders of money.

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Security MarketsSecurity Markets

• Firms make direct transactions in Firms make direct transactions in financial markets.financial markets.

• The concepts and principles that apply to The concepts and principles that apply to financial markets also apply to the financial markets also apply to the management of real assets.management of real assets.

• Security markets provide information and Security markets provide information and signals that help managers make signals that help managers make decisions.decisions.

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Why Security Markets ExistWhy Security Markets Exist

• Security markets facilitate the transfer of Security markets facilitate the transfer of capital (i.e financial) assets from one owner to capital (i.e financial) assets from one owner to another.another.

• They provide liquidity.They provide liquidity.

– Liquidity refers to how easily an asset can Liquidity refers to how easily an asset can be transferred without loss of value.be transferred without loss of value.

• A side benefit of security markets is that the A side benefit of security markets is that the transaction price provides a measure of the transaction price provides a measure of the value of the asset.value of the asset.

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Security MarketsSecurity Markets

• Money versus Capital MarketsMoney versus Capital Markets

• Primary versus Secondary MarketsPrimary versus Secondary Markets

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Money MarketsMoney Markets

• Market for short-term claims with original Market for short-term claims with original maturity of one year or less.maturity of one year or less.

• High-grade securities with little or no risk of High-grade securities with little or no risk of default.default.

• Examples:Examples: Treasury Bills (T-Bills & Repos)Treasury Bills (T-Bills & Repos) Commercial PaperCommercial Paper Certificates of DepositCertificates of Deposit

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Securities Market Securities Market Description Maturity

Money Market Securities:

Certificates of Depositinterest bearing fixed deposit accounts 1 week to 12 mths (or more)

Commercial Paperunsecured promissory note issued by large, well-known corporation 1 month to 6 mths

Treasury Billsdiscounted short-term debt instrument issued by government 1 month to 12 mths

Repurchase Agreements

contractual agreement between the seller and the client in which the client buys securities from the seller, who agree to buy them back from the client at an agreed time and rate 1 week to 12 mths

Bank Guarantees

debt instrument issued by a frim as part of a commercial transaction where payment is guaranteed by a commercial bank 1 week to 6 mths (or more)

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Capital MarketsCapital Markets

• Market for long-term securities with original Market for long-term securities with original maturity of more than one year.maturity of more than one year.

• Securities may be of considerable risk.Securities may be of considerable risk.

• Examples:Examples: StocksStocks Corporate bondsCorporate bonds Government bonds Government bonds

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StocksStocks

• Shares of a stock represent equity (or Shares of a stock represent equity (or ownership) in a corporation.ownership) in a corporation.

• Stockholders have the right to vote and the Stockholders have the right to vote and the right to dividends.right to dividends.

• Common stock shares represent residual Common stock shares represent residual ownership in the firm.ownership in the firm.

• Dividends on preferred stock shares are Dividends on preferred stock shares are usually fixed, and generally must be paid usually fixed, and generally must be paid before dividends are paid to common before dividends are paid to common stockholders.stockholders.

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BondsBonds

• Represent long-term debt securities - a Represent long-term debt securities - a promise to pay interest and repay the promise to pay interest and repay the borrowed money (principal) on pre-specified borrowed money (principal) on pre-specified terms.terms.

• Issued by corporations as well as Issued by corporations as well as governments.governments.

• Bonds are also referred to as fixed income Bonds are also referred to as fixed income securities.securities.

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OptionsOptions

• Grants the holder the right to buy (or sell) Grants the holder the right to buy (or sell) the underlying security at a fixed price, the underlying security at a fixed price, within a fixed time period.within a fixed time period.

• A A callcall option gives the holder the right to option gives the holder the right to buybuy the underlying security. the underlying security.

• A A putput option gives the holder the right to option gives the holder the right to sellsell the underlying security. the underlying security.

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Forward and Futures ContractsForward and Futures Contracts

• An agreement to buy (or sell) something at An agreement to buy (or sell) something at a fixed price at a fixed point in the future.a fixed price at a fixed point in the future.

• Unlike options, this entails an obligation - Unlike options, this entails an obligation - bothboth parties to the transaction parties to the transaction mustmust fulfill fulfill their obligations.their obligations.

• You can lock in a buying (selling) price for You can lock in a buying (selling) price for the underlying asset.the underlying asset.

• FuturesFutures contracts are similar to forward contracts are similar to forward contracts, but are usually standardized and contracts, but are usually standardized and are traded in the markets.are traded in the markets.

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Primary MarketsPrimary Markets

• A primary market is a market for newly A primary market is a market for newly created securities.created securities.

• The proceeds from the sale of securities in The proceeds from the sale of securities in primary markets go to the issuing entity (IPO).primary markets go to the issuing entity (IPO).

• A security can trade only once in the primary A security can trade only once in the primary market.market.

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Secondary MarketsSecondary Markets

• A secondary market is a market for previously A secondary market is a market for previously issued securities.issued securities.

• The issuing firm is not directly affected by The issuing firm is not directly affected by transactions in the secondary markets.transactions in the secondary markets.

• A security can trade an unlimited number of A security can trade an unlimited number of times in secondary markets.times in secondary markets.

• The volume of trade in secondary markets is The volume of trade in secondary markets is much higher than in primary markets.much higher than in primary markets.

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Investment BankersInvestment Bankers

• An investment banker specializes in marketing An investment banker specializes in marketing new securities in the primary market.new securities in the primary market.

• Examples of investment bankers:Examples of investment bankers: Merrill LynchMerrill Lynch– Dehring, Bunting & Golding Ltd.Dehring, Bunting & Golding Ltd.– Sigma Manufacturers Merchant BankSigma Manufacturers Merchant Bank– etc. etc.

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Brokers and DealersBrokers and Dealers

• These generally participate in the secondary These generally participate in the secondary markets.markets.

• A broker helps investors in buying or selling A broker helps investors in buying or selling securities.securities.

• A broker charges commissions, but never A broker charges commissions, but never takes title to the security.takes title to the security.

• A dealer buys securities from sellers, and sells A dealer buys securities from sellers, and sells them to buyers (hopefully at a higher price!)them to buyers (hopefully at a higher price!)

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Financial IntermediariesFinancial Intermediaries

• These are institutions that assist in the These are institutions that assist in the financing of firms.financing of firms.

• Examples include: commercial banks and Examples include: commercial banks and pension funds.pension funds.

• These institutions invest in securities of other These institutions invest in securities of other firms, but they are themselves financed by firms, but they are themselves financed by other financial claims.other financial claims.

Investment as a Career• Insurance Company (Investment Analyst)• Bank • Credit Rating Firm• Securities Services Company• Brokerage House• Investment Consultant• Finance Company• Other Financial Institutions• Corporations