managerial finance basic terms

8/6/2019 Managerial Finance Basic Terms

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Project

Managerial Finance

Submitted To:

Sir Iftikhar Ahmed

Submitted BY:

Adnan Sajid 100645-011

Ahmad Fawwad khan 100645-025

Mubashar-ul-haq 080345-001

Programme:

M.Com

University of Management & Technology.


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1. Arbitrage:

Arbitrage can be loosely defined as capitalizing on discrepancy in quoted prices by making

a riskless profit.

The opportunity to buy an asset at a low price then immediately selling it on a different

market for a higher price." If I can buy an asset for $5, turn around and sell it for $20 and

make $15 for my trouble that is arbitrage. The $15 I gain represents an arbitrage profit

Exampl

:

Employee of a bank get a loan from his bank on 1 percentage interest rate. And invested in

other bank & get interest of 8 percentage . and make a profit of 7 % . this difference is

arbitrage.

2 , 3: Ask Price and Bid Price:

The term "ask" refers to the lowest price at which a market maker or Currency exchanger will sella specified number of shares of a stock or specified units of currency at any given time. The term

"bid" refers to the highest price a market maker or currency exchanger will pay to purchase the

stock or currency.

The ask price, also known as the "offer" price, will almost always be higher than the bid price.

Market makers make money on the difference between the bid price and the ask price. That

difference is called the "spread."

4.Asset Allocation:

Asset allocation involves dividing an investment portfolio among different asset categories, such as

stocks, bonds, and cash. The process of determining which mix of assets to hold in your portfolio is a

very personal one. The asset allocation that works best for you at any given point in your life will

depend largely on your time horizon and your ability to tolerate risk.

Asset Allocation is the process of determining optimal allocations for the broad categories of assets

that suit your investment time horizon and risk tolerance.

Example:

The three main asset classes - equities, fixed-income, and cash and equivalents - have different

levels of risk and return, so each will behave differently over time.


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5. Asset under Management:

The market value of assets that an investment company manages on behalf of investors.

Assets under management (AUM) are looked at as a measure of success against the

competition and consists of growth/decline due to both capital appreciation/losses and new

money inflow/outflow.

6.Amortization:

1. The paying off of debt in regular installments over a period of time.

2. The deduction of capital expenses over a specific period of time (usually over the asset's

life). More specifically, this method measures the consumption of the value of intangible

assets, such as a pat nto a copyri

ht. While amortization and depreciation are often used

interchangeably, technically this is an incorrect practice because amortization refers to intangible

assets and depreciation refers to tangible assets.

Amortization can be calculated easily using most modern financial calculators, spreadsheet software

packages such as Microsoft Excel, or amortization charts and tables.

Exampl

:

Suppose XYZ Biotech spent $30 million dollars on a piece of medical equipment and that the patent

on the equipment lasts 15 years, this would mean that $2 million would be recorded each year as an

amortization expense.

7.Bear market

A bear market when the stock market falls for a prolonged period of time, usually by twenty percent

or more. It is the opposite of a bull market. This sharp decline in stock prices is normally due to adecrease in corporate profits.

Bear markets usually occur when the economy is in a recession and unemployment is high, or when

inflation is rising quickly.

y A bear market is only bad if you plan on selling your stock or need your money immediately.

Exampl :

Adnan who is scared by lower earnings due to economic recession sells his stock, causing the price

to drop. This causes other investors (mubasshar, fawwad) to worry about losing the money they've

invested, so they sell as well; the vicious cycle begins.

8.Bull market:

A bull market is a stock market or other financial market where prices rise by 20% or more. A bull

market is the opposite of a bear market. Bull markets can happen as a result of an economic

recovery, an economic boom, or investor psychology.

Exampl

:

Ali is investing in stock market is to take advantage of rising prices by buying early in the trend and

selling his stock shares when they have reached their peak. Because on the whole, Ali has a tendency

to believe that the market will rise (thus bullish), Ali are more likely to make profits in a bull market.


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9.Blue Chip:A nationally recognized well-established and financially sound company. Blue chips

generally sell high-quality, widely accepted products and services. Blue chip companies are

known to weather downturns and operate profitably in the face of adverse economic

conditions which help to contribute to their long record of stable and reliable growth.

y A stock that sells at a high price because of public confidence in its long record ofsteady earnings.

y Blue chip shares are often regarded as less risky that those of smaller companies.

Exampl

:

Blue chip stocks of nestle are seen as a less volatile investment than owning shares in

companies without blue chip status because blue chip (nestle) has an institutional status in

the economy. Investors may buy shares of nestle (blue chip) toprovide steady growth in their

portfolios.

10.Brokerage function:

Brokerage house is basically a company which has been licensed to perform the same functions as

that of a broker. The firm or house serves as an intermediary between the buyer and seller.

A brokerage house is composed of brokers who manage the investments of clients. The level of

involvement of a broker depends on the preference of the investor.

Brokers offer a wide range of services, which includes providing financial advice and information on

various stocks and securities. Brokerage houses may provide information on market research and

strategies.

This arrangement is best-suited to investors who do not wish to spend their time researching on

stocks.

Brokerage houses may specialize in certain types of investments, whereas others may offer a greater

variety. Brokerage houses also have a variety of methods for executing trades. For certain firms, it

may be possible to conduct transactions over the phone or with the use of the Internet.

Exampl :

Iftikhar is a business man and currently he is interested in stock exchange for selling and buying of

shares to increase the earnings, he has no time for selling and buying of shares but he has

investment so he decided to contact with brokerage house for shares business in stock exchange.

Now brokerage house providing services to iftikhar.

11. Open Ended Mutual Fund:

Investors purchase most investment company shares directly from the company itself and sell their

shares back to the company. Such investment companies are called open-ended investment

companies. The company sell as many shares as investors demand, investing the proceeds inadditional securities in accordance with that companys investment objectives.

All sales and purchases of open ended investment companies are made at net asset value per share.


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Exampl :

y NIT ( National Investment Trust)

y ATLAS INCOME FUND

y UTP( Unit Trust Pakistan)

y

UTP IS

LA

MIC FUND

11(ii). Closed Ended Investment Companies

The alternative form of investment companies, the closed End Investment Company. Companys

shares are traded on exchange exactly like any other shares of stock. Closed ended companies have

a fixed number of shares of their stock outstanding, investors use their brokers to buy and sell these

shares paying regular brokerage fees. These companies can sell their shares for less or more than

their net asset values because the prices of these shares are determined by investors in an open

market.

Exampl :

y ICP MUTUAL FUND-04

y PAKISTAN CAPITAL MARKET FUND

y PICIC GROWTH FUND

y ABAMCO CAPITAL FUND

y ABAMCO STOCKMARKET FUND

12. Cash Cow

1. One of the four categories (quadrants) in the BCG growth-share matrix that represents

the division within a company that has a large market share within a mature industry.

2. A business, product or asset that, once acquired and paid off, will produce consistent cash

flow over its lifespan.

Exampl

:

A firm is said to be acting as a cash cow when its earnings per share ( EPS) is equal to its

dividends per share (DPS), or in other words, when a firm pays out 100% of its free cash flow

(FCF) to its shareholders as dividends at the end of each accounting term.

13. Collateral

Assets pledged as security for a loan. In the event that a borrower defaults on the terms of a

loan, the collateral may be sold, with the proceeds used to satisfy any remaining obligations.

High-quality collateral reduces risk to the lender and results in a lower rate of interest on

the loan.


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Exampl

:

For example, if you borrow money to buy a car, the car is the collateral. If you default, the

lender can repossess the car and sell it to recover the amount you borrowed.

Loans guaranteed by collateral are also known as secured loans.

Another example, if you get a mortgage, your collateral would be your house.

14. Collar

In finance, a collar is an option strategy that limits the range of possible positive or negative returns

on an underlying to a specific range.

Exampl

:

Consider an investor who owns one hundred shares of a stock with a current share price of $5. An

investor could construct a collar by buying one put with a strike price of $3 and selling one call with a

strike price of $7. The collar would ensure that the gain on the portfolio will be no higher than $2

and the loss will be no worse than $2 (before deducting the net cost of the put option, i.e., the cost

of the put option less what is received for selling the call option).

Another example is a circuit breaker which is meant to prevent extreme losses (or gains) once an

index reaches a certain level.

15. Defensive Securities:

Defensive securities tend to remain more stable in value than the overall market, especially whenprices in general are falling.

Defensive securities include stocks in companies whose products or services are always in demand

and are not as price-sensitive to changes in the economy as other stocks.

Exampl s:

Some defensive securities could be stock in food, pharmaceuticals, and utilities companies.

16. Financial Assets:

Financial Assets include cash and bank accounts plus securities and investment accounts that can

be readily converted into cash. Excluded are illiquid physical assets such as real estate,

automobiles, art, jewelry, furniture, collectibles, etc., which are included in calculations of Net

Worth.

Exampl s:

An asset that derives value because of a contractual claim. Stocks, bonds, bank deposits, and the like

are all examples of financial assets.


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17. Discount Rate:

1. The interest rate that an eligible depository institution is charged to borrow short-term funds

directly from a Federal Reserve Bank. Different types of loans are available from Federal Reserve

Banks and each corresponding type of credit has its own discount rate.

2. The interest rate used in discounted cash flow analysis to determine the present value of future

cash flows. The discount rate takes into account the time value of money (the idea that money

available now is worth more than the same amount of money available in the future because it

could be earning interest) and the risk or uncertainty of the anticipated future cash flows (which

might be less than expected).

Exampl :

The official interest rate or discount rate inP

akistan in current year is 14%.

Suppose the future value of cash flows of a project is Rs 100,000 number of years are 5 and

discount rate is 12%.so the present value of this cash flow can be calculated by using 12%

discount rate.

18. Eurobond:

Usually, a Eurobond is issued by an international syndicate and categorized according to thecurrency in which it is denominated. A Eurodollar/ bond that is denominated in U.S. dollars

and issued in Japan by an Australian company would be an example of a Eurobond. The

Australian company in this example could issue the Eurobond in any country other than the

U.S. OR

A bond issued in a currency other than the currency of the country or market in which it is

issued.

Exampl

:

A Eurodollar bond that is denominated in U.S. dollars and issued in Japan by an Australian

company would be an example of a Eurobond. The Australian company in this example

could issue the Eurodollar bond in any country other than the U.S.

Eurobonds are issued by multinational corporations; for example, a British company mayissue a Eurobond in Germany, denominating it in U.S. dollars. It is important to note that the

term has nothing to do with the euro, and the prefix "euro-" is used more generally to refer

to deposits outside the jurisdiction of the domestic central bank.


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19. Global Depository Receipts (GDR)

1. A bank certificate issued in more than one country for shares in a foreign company. The shares are

held by a foreign branch of an international bank. The shares trade as domestic shares, but are

offered for sale globally through the various bank branches.

2. A financial instrument used by private markets to raise capital denominated in either U.S. dollars

or Euros.

Example:

A Mexican company might offer GDRs priced in pounds in London and in yen in Tokyo.

Individual investors in the countries where the GDRs are issued buy them to diversify into

international markets. However, since GDRs are frequently offered by newer or less -known

companies, the prices are often volatile and the stocks may be thinly traded. That makes

buying GDRs riskier than buying domestic stocks.

20. Leveraged Buyout:

The acquisition of another company using a significant amount of borrowed money (bonds or loans)

to meet the cost of acquisition. Often, the assets of the company being acquired are used as

collateral for the loans in addition to the assets of the acquiring company. The purpose of leveraged

buyouts is to allow companies to make large acquisitions without having to commit a lot of capital.

Exampl

:

XYZ is a leveraged buyout firm. XYZ wants to buy ABC Inc. using a LBO.

XYZ determines that it will cost $20 billion to purchase ABC Inc. XYZ is attracted by ABC's

positive cash flow and number of profitable subsidiaries that could be sold. XYZ also feels as

though ABC is being mismanaged, and could benefit from a change in management and

different operational processes.

XYZ is not putting up $20 billion dollars in cash to finance the purchase. Instead, they will

put up $2 billion in cash and borrow the rest.

The $18 billion in debt will be secured against the assets in ABC.

If the purchase goes through, then XYZ will use the positive cash flow from ABC to pay thedebt payments, and will most likely look at slashing expenses and possibly selling off assets

to pay down the debt.


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21.Off Balance Sheet Financing:

A form of financing in which large capital expenditures are kept off of a company's balance sheet

through various classification methods. Companies will often use off-balance-sheet financing to keep

their debt to equity (D/E) and leverage ratios low, especially if the inclusion of a large expenditure

would break negative debt covenants.

Exampl

:

Fixed assets purchased on operating lease is an example of this financing. Operating leases are one

of the most common forms of off-balance-sheet financing. In these cases, the asset itself is kept on

the lessor's balance sheet, and the lessee reports only the required rental expense for use of the

asset.

22.Private Placement:

The sale of securities to a relatively small number of select investors as a way of raising capital.

Investors involved in private placements are usually large banks, mutual funds, insurance companies

and pension funds. Private placement is the opposite of a public issue, in which securities are made

available for sale on the open market.

23.Reinvestment Risk:

Reinvestment risk occurs when you have money from a maturing fixed-income investment,

such as a certificate of deposit (CD) or a bond, and want to make a new investment of the

same type.

The risk is that you will not be able to find the same rate of return on your new investment

as you were realizing on the old one. In fact, the return could be significantly lower, based

on what's happening in the economy at large, though it could also be higher.

Exampl

:

For example, if a bond paying 6% interest matures when the current rate is 4%, you must settle for a

lower return if you buy a new bond unless you're willing to buy one of lower quality.

Suppose one invested in a bond with coupon payment of 4%. However, the issuer calls the bond and

pays the par value. The investor has made a profit, but interest rates have fallen and now he/she

may only purchase a bond with coupons of 2.5%.

24.Treasury Stock:

Treasury stock is stock repurchased by the issuer and intended for retirement or resale to the public.

It represents the difference between the number of shares issued and the number of shares

outstanding.

Treasury stock consists of shares issued but not outstanding. Thus, treasury shares are not included

in earnings per share or dividend calculations, and they do not have voting rights.


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Exampl

:

Let's assume Company XYZ decides to buy back some of its shares because it feels that

Company XYZ shares are undervalued in the market right now. When Company XYZ acquires

those shares, they become treasury stock.

25. Yield to Maturity:

Yield to maturity is the most commonly used measure of value of a bond. This yield includes

the compounding of interest and assumes that the bond is held until maturity.

For example, say you own a Company XYZ bond with a $1,000 par value and 5% zero -

coupon bonds that mature in three years. Also suppose this bond is callable in two years at105% of par. To calculate the yield to call, you simply pretend that the bond matures in twoyears rather than three, and calculate the yield accordingly. You should also consider thecall price (105% of $1,000, or $1,050) as the principal at maturity (F). Thus, if this CompanyXYZ bond is selling for $980 today, using the formula above we can calcul ate that the yieldto call is 4.23%.

26. Syndicate:

An association of persons officially authorized to undertake some duty or to negotiate some

business. Syndicate is a general term describing any group that is formed to conduct some type of

business.

Exampl

:

A syndicate may be formed by a group of investment bankers who underwrite and distribute new

issues of Securities or blocks of outstanding issues. Syndicates can be organized as corporations or

partnerships.

27. Consortium:

A group of separate businesses or business people joining together and cooperating to complete a

project, work together to perform a contract or conduct an on-going business.

Exampl!

:

Six companies, including Bechtel and Kaiser joined together in a consortium to build Boulder (now

Hoover) Dam, with each providing different expertise or components.

28. Structured finance:

Structured finance is a broad term used to describe a sector of finance that was created to help

transfer risk using complex legal and corporate entities. This risk transfer as applied to securitization

of various financial assets (e.g. mortgages, credit card receivables, auto loans, etc.) has helped to

open up new sources of financing to consumers.


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Exampl"

:

Bank alfalah providing the structured finance to the customers like credit cards, auto loans etc.

29.Restricted Fund:

A reserve of money that can only be used for specific purposes. Restricted funds providereassurance to donors that their contributions will be used in a manner they have chosen. When a

donor gives money to a nonprofit organization, he or she may specify whether the gift is

unrestricted and can be used for any purpose the organization sees fit, temporarily restricted to be

used for a certain purpose, or permanently restricted so that the donation acts as principal on which

interest can be earned (and only the interest is to be spent).

Exampl#

:

Bank in a housing finance providing a loan under restriction like specific percentage

of amount should be spent for specific purpose just like construction work.

30(i).Accounting Profits:The revenue a company derives from its operations, less all explicit costs.

Exampl $ :

If a company's revenue is $1 million and its total overhead is $750,000; its accounting profit is

$250,000. Unlike economic profits, accounting profits do not consider an activity's opportunity cost.

30(ii).Economic profit:A company's total revenue less its operating expenses, interest paid, depreciation, and taxes.

Exampl % :

Suppose a widget manufacturer earns $1,000,000 in total revenue. The widgets cost $200,000 to

make and his administrative and payroll expenses total $250,000. He also must subtract $50,000 in

depreciation on his widget manufacturing equipment and pay $200,000 in taxes. His net income is

stated as: $1,000,000 - $200,000 - $250,000 - $50,000 - $200,000 = $300,000.

managerial finance basic terms

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