Determinants of Time Value of Money

What are the determinants of the time value of money? Time value of money is the most important concept of finance. The main thing of the time value of money is that the value of dollar 100 now is more than the value of dollar 100 after some time. That is the value of money today is more than the value of money after some time. When making any investing or financing decision we have to consider this idea, otherwise, we may incur some loss of benefit. To calculate the present value of any fund this time value concept is used to identify the required rates of return.

The Idea that money available at the present time is worth more than the same amount in the future because of the potentiality of future earnings. This core principle of finance holds that provided money can earn interest, any amount of money is worth more the sooner it is received.

Determinants of the time value of money

There are several determinants which are used to calculate the actual value of the money. Four commonly used determinants are:

  1. Consumption preference of a person
  2. Uncertainty of future
  3. Inflation of the economy
  4. Investment Opportunity

determinants of time value of money

Consumption preference of a person

People prefer current consumption to future consumption if there is the same level of satisfaction. Most of the people are ready to sacrifice the current consumption if they find that in the future they will be able to consume more than the present. A higher rate of return that is more than the required rates of return is mainly leading them to take the decision of sacrifice of current consumption. Some people think that the future is uncertain so it’s better to consume now although they are not concern about the benefit of future.

Uncertainty of future

Future is always uncertain. Nobody knows what will happen in the future. So it is better to consume now rather than consume in the future if current consumption rate is more. People would like to compensate for uncertain future cash flow against certain cash flow.

Inflation of the economy

Inflation is related with the purchasing power of money. With the time the purchasing power of money is decreased. Every economy has inflation but the rate is different from country to country economy. If there is higher inflation then the required rates of return of investor are higher. For a higher inflationary economy, consumers prefer current consumption rather than future consumption.

Investment opportunity

Time value of money considers the idea of reinvestment that is if an investment generates cash inflow periodically then this periodic return can be reinvested which will generate a higher return. If the cash flow comes now, it can be invested and generate additional cash flow, therefore whatever may be the cash flow now. The future cash flow is more than its present cash flow.

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Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

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Call Option

Call Option

A call option is an option to buy financial instruments at a specific price after a certain period. A call option is an option for the buyer to exercise not an obligation to perform. There can be an agreement between the buyer and seller for the purpose of exchange of financial instrument; here buyer gets the right to buy stock/bond or other financial securities if buying is beneficial for him/her.

In a call option basically, a buyer makes an agreement with the seller if he thinks that there is a potentiality of positive change of instrument price in the market. So to get this opportunity a strike price is set for which securities will be exchanged and this contract is valid for a fixed period of time.

A question may arise that why seller of stock/bond or other financial securities want to make contact with the buyer although he knows that this contract will exercise only if the stock price is higher than the strike price. The main reason is that seller assumes that future price of this security will less than the strike price so that he will be the gainer.

For example Call Option

Suppose Mr. Jhon makes a contract with Mr. Sparrows to exercise a call option where they fixed a price (strike price) of an instrument is 80 Dollar i.e. Mr. Jhon will purchase this instrument only if the instrument price is higher than the strike price.

At the maturity of the contract the price of the stock is 100 Dollar, so Mr. Jhon will buy the stock at 80 dollars which will help him to make a profit of 20 dollars.

On the other hand, if this stock price is 79 dollar or less than this then this option will not be exercised.

The process of developing a call option:

  • Buy a call option with the expectation of an increase in market price
  • If market rate appreciates compared with a strike price
  • Call option of yours will create value for you
  • At the expiry date if the market price is higher than strike price then you will exercise the call option which will generate profit for you.
call option

The process of Call Option

Call options is an agreement (a written contract which is enforceable by law) between buyer and seller to buy and sell financial instruments with a fixed price determined earlier if the price of the instrument is higher than the market price then this contract will be exercised.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

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How to Take Share Buy Decision

How to Take Share Buy Decision

Share

Share is the small proportion of the capital of a company. Both private and public limited companies have share capital. But the only public limited company can issue their share in public through IPO (Initial Public Offering) to raise their share capital. Basically, the shares of the public limited company are traded in the stock market. Buyers and sellers are involved with this market through brokers (commission agent). There are thousands of millions of investors investing a large amount of money in the capital market. It is an investor’s responsibility to choose right share of a right company so that they would get a benefit (capital gain and dividend) from investing.

Question is what are the things an investor should consider before investing in the capital market through purchasing share/stock or how to take share buy decision?.

how to take share buy decision

Share/Stock Buy Decision

There are several factors/things that need to consider before investing in the capital market/stock market through purchasing share/stock of a company. These factors are:

  1. Calculate the present value of all future benefit. If the present value is more than the current price then buy the stock/share. On the other hand, if the current market price is more than the calculated present value then definitely sell the stock.
  2. To reduce the risks of investment do not forget to choose a company from a different industry. So that you can diversify your investment also make sure that you pick the right company stock
  3. Check the growth rate of the company in which you want to invest. You can get growth-related data from the annual report or in the stock market/capital market
  4. Choose stock/share which company has a lower price-earnings ratio
  5. You can also choose stock which provides higher EPS (Earnings per Share) compared with other companies
  6. If you have financial knowledge then check the financial statement (cash flow statement, income statement, balance sheet) of the companies over the period of time. Cash flow will help you to check the cash inflow and outflow. And from other financial statements, you will get profit/loss, assets & liabilities related information. It is your responsibility to check ever information that may have an impact on the future earnings of the stock/share
  7. You also need to consider the current market rate and the current economic condition of the country
  8. Never buy share without knowing anything or if anyone influences you to buy a share

These are the some of things that you can consider before investing. If you analyze properly and invest in the capital market then there will be less chance to lose your investment. Never try to gamble in the market, although many people think that buying and selling a stock is one kind of gambling.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: nahia[email protected]

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Job Description of Financial Manager

Simple Job Description of Financial Manager

Financial manager are responsible for managing financial resources of an organization. Basically those who make financial plan for effective use of the fund to ensure organizational wealth maximization are known as financial manager. The success of an organization depends on the right use of the financial resource, although it is very tough job to manage. But financial manager/ finance manager always work for collecting fund from least costly sources and invest in potential sector where maximization of return is insured.

Job Description of Financial Manager

A job description contains a list of responsibilities that have to be performed by a financial manager/ finance manager. It also contains what are the qualities and qualifications are required to be a finance manager. A simple job description may include followings:

  1. Title of the Job: This indicates the position of financial manager that is position can be of assistant manager / manager / senior manager.
  2. Role of the Job or job responsibilities: There are several roles that a manager have to perform, these are
  • Required to formulate financial planning and taking financial decision as per requirement of the company.
  • Preparing monthly/ quarterly/ yearly budget for the company.
  • Monitoring cash inflow and outflow over the period.
  • Preparing reports and financial statements.
  • Ensuring wealth maximization of the company as it is primary goal.
  • Prepare financial report to check the performance of the company, that whether the performance is upward or downward.
  • Make forecast of future demand of the fund and take initiative to manage this fund timely.
  • Maintain good relationship with the creditor.
  • Ensuring balance between long term and short term asset and liabilities.
  • Formulating collection and payment mechanism (collection of accounts receivable, payout the accounts payable)
job description of financial manager

Simple Job Description of Financial Manager

  1. Location of the Job: Location of job or workplace for the manager, current location or probable future location need to be mention clearly.
  2. Remuneration/ Benefit of the Job: The amount of remuneration which will be provided for the financial manager over the period is needed to be mentioned. Because this one is the influential factor that that will create interest of working.

Functions of Financial Manager

Functions of Financial Manager

Finance works as a lifeblood for an organization, without finance, it is not possible to run any business. Every business organization requires managing and ensuring the effective use of funds and financial resources. But the question is who will manage these funds. It is a financial manager’s responsibility to manage funds (collection and proper use of funds). Managing funds is the main functions of financial manager.

Financial Manager

Financial Manager

Financial Managers are those who mainly deal with financial resources and make a decision about financial matters. Every decision taken by financial managers is concerning investing and financing.

Basically, the functions of a financial manager can be categorized into three main functions. These are:

  1. Capital structure decision
  2. Investing and Financing Decision
  3. The decision about dividend policy

Functions of Financial Manager
Capital Structure Decision

The main function of a financial manager is to form an optimal capital structure for the organization. The optimal capital structure depends on the type of company and its financial capability. Capital structure means the ratio of debt and equity. The financial manager set the proportion of debt and equity for a company. It can be 50/50 ratio or 60/40, or 70/30, or 55/45, or others according to the decision of managers.

Investing and Financing Decision

Financial managers always concern about the cost of collecting funds and the return on the invested capital. Where cost is less, the fund should be collected from there. And where the return is maximized with lower or moderate level of risk, funds should be invested there. So it’s a financial manager’s responsibilities to make the right choice which can bring profit for the company.

Dividend Policy

When companies make a profit, a question arises there that whether profit will be distributed or not. If distributed then what proportion of profit will be distributed among the shareholders and what will be kept as a retained earnings. As a function of managing funds, the financial manager makes a decision about dividend policy.

In addition to these, there are many functions/ roles that financial manager does. Some of these functions are given below:

  1. Identifying what amount of funds is required for the company.
  2. Managing working capital which mainly deals with short-term asset and liabilities.
  3. Cash forecasting that is forecasting of cash inflow and outflows.
  4. Provides required fund to every department of the company.
  5. Ensuring optimal use of the financial resources.
  6. Ensuring substantial growth of the company.
  7. Buying and selling of financial assets.
  8. Valuation of a company’s stock.
  9. Maximizing the wealth of the company by increasing the stock price in the market.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

Agency Cost

What is Agency Cost and who bears them?

An agency cost is a cost of reducing agency conflict among the owner/ principal (stockholders) and managers (agent). We can also say the cost which is bears by the company to reduce the agency conflict is basically known as agency cost and this cost must be maintained by the respective parties or by the company. To reduce agency conflict some effective measure can be taken which is cost worthy.

Managers can be encouraged to act in the stockholders best interests through incentives, constraints, and punishments. But these tools are effective only if shareholders can observe all of the actions taken by managers. A moral hazard problem, defined here as a situation in which agents take unobserved actions in their own interests, arises because it is virtually impossible for shareholders to monitor all managerial actions. To reduce agency conflicts and the moral hazard problem, stockholders must incur agency costs, which include all costs designed to encourage managers to maximize shareholder wealth rather than act in their own self-interests.

agency cost

Agency Cost

There are three major categories of agency costs

  1. Expenses to monitor managerial actions, such as audit cost,
  2. Expenditures to structure the organization in a way that will limit undesirable managerial behavior, such as appointing outside investors to the board of directors, and
  3. Opportunity costs which are incurred when restrictions, such as requirements for stockholders to vote on certain issues, limit the ability of managers to take timely actions that would contribute to shareholder wealth.

 Agency costs must bear by shareholders. In the absence of any effort whatever to affect managerial behavior, and hence with zero agency costs, there will almost certainly be some loss of shareholder wealth due to improper managerial actions. Conversely, agency costs would be very high if shareholders attempted to ensure that every single managerial action coincided exactly with shareholder interests. Thus, the optimal amount of agency costs to be borne by shareholders should be viewed like any other investment decision.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

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Conflict Between Shareholders and Creditors

What kind of agency conflict between shareholders and creditors may exist?

A conflict between shareholders and creditors is common for the company which uses debt capital to form an optimum capital structure. Agency relation exists when one party works as an agent of the principal. In an organization, management works as an agent of owner or shareholders. When managers work for the company they can be influenced by the own interest so that they prefer their own interest rather than the interest of the company, on the other hand, creditors interest is to provide credit and get the principal amount and interest timely. For ensuring their credit return creditor always concerned whether the company is doing business in the right manner or not. By monitoring the financial performance of the company creditors actually, want to ensure their interest. So if there is any dispersion then creditors work to resolve the issue by taking necessary steps.

Conflict Between Shareholders and Creditors

The conflict between Shareholders & Creditors

Creditors have a claim on part of the firm’s earnings stream as well as a claim on the firm’s assets in the event of bankruptcy. However, the stockholders have control through the firm’s managers of the decision that affect the profitability and risk of the firm. Creditors lend funds at a specific rate which is based on the several factors. These are:

  1. On the riskiness of the firm’s existing assets,
  2. On expectations concerning the riskiness of future asset additions,
  3. On the firm’s existing capital structure (that is, the amount of debt financing used), and
  4. On expectations concerning future capital structure decision.

These are the primary determinants of the riskiness of a firm’s cash flows and hence its debt, so creditors base their required rates of return on these factors.

 Now suppose the stockholders, acting through management, have the firm take on a large new project that has a greater risk than was anticipated by creditors. This increased risk will cause the required rate of return on the firm’s debt to increase, which in turn will cause the value of the outstanding debt to fall. If the risky capital investment is successful, all of the benefits will go to the firm’s stockholders, because creditors’ returns are fixed at the old, low-risk rate. However, if the project is unsuccessful, the bondholders will have to share in the losses.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

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Agency Conflict

What is Agency Conflict?

Agency conflict is a common problem we face in an organization, this problem arises because of the difference in the interest of management, owner, and other related parties. An agency relationship arises whenever one or more individuals hire other individuals to perform some service and also delegate decision making authority to the agents. Here the hiring parties are principal and hired individuals are the agent. But the question is what is agency conflict?

agency conflict

Agency Conflict

Agency Conflict

A potential agency conflict exists whenever a manager owns less than 100 percent of the firm’s common stock. If the firm is a proprietorship business then the manager is the owner, the owner-manager will take actions to maximize his or her own welfare, or utility. The owner-manager will probably measure utility primarily by personal wealth, but other factors, such as leisure time and perquisites, will be considered. However, if the owner-manager sells some of the firm’s stock to outside investors, a potential conflict of interest, called an agency conflict, arises. For example, the owner-manager may now decide to lead a more relaxed life and not work as strenuously to maximize shareholder wealth because less of this wealth will accrue to him or her. Also, the owner-manager may decide to take more “business trips” to fun locations because some of the cost will now be borne by the outside shareholders.

In most large corporations, potential agency conflicts are quite important, because managers generally own only a small percentage of the firm’s stock. In this situation, shareholder wealth maximization could take a back seat to any number of possible managerial goals. In an organization, an agency conflict may always be there but it is owners responsibility to reduce agency conflict as much lower level as they can.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

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What is a Bond

What is a Bond?

Question may arise in your mind that what is a bond. A bond is a financial instrument used by the government or corporations to collect money from the market. It provides a fixed benefit to the bondholders periodically and also at the time of maturity. Although the use of bond as a financing instrument used in developed countries and is very popular around the world. But in Bangladesh the use of the bond not getting enough popularity yet.

By selling a bond, borrowers make a contract with the buyer to pay interest and principal at the time of maturity. All provisions, terms & conditions are written in the bond indenture. A bond indenture is the written document where all terms are clearly mentioned which actually helps to ensure the right of the bondholders.

Basically, a bond pays interest semi-annually to the bondholders at the specific rate which is mentioned in the bond indenture.

Bonds with the maturity of 10 years or more are considered as long-term bond. The interest of bond is set on the basis of market interest rate. Every bond has coupon rate (except zero coupon bonds), maturity date, and face value (basically Tk 1000). Some may have call provision and convertible features.

There is an inverse relationship between interest rate (market interest) and the price of the bond. Higher the interest rates lower the price of the bond and vice versa. We get the price of the bond by discounting the cash and capital gain received from the bond by the required rates of return. Normally large companies issue a bond for the purpose of collecting long-term funds from the market.

Basic Characteristics of Bond

what is a bond

Characteristics of a Bond

From above-mentioned issues we can draw some basic characteristics of a bond, these are:

  • Bond is a long-term financial instrument issued by the large companies to collect long-term funds.
  • Every bond must have a face value, maturity value, and coupon rate and maturity period.
  • It provides periodical benefit to the holders (basically for an interval of six months).
  • The terms and conditions are written in the bond indenture.
  • Zero coupon bonds do not provide any coupon/interest. It provides benefit at the maturity where the bond is issued at discount.
  • There is an inverse relationship between interest and price of the bond.
  • The callable or convertible feature is common for a bond.

Actually, the characteristics of a bond are depended upon the types of a bond which is being issued and where it is issued. Country to country the type and features of the bond vary.

Basic Types of Risk

What are the Basic Types of Risk?

We know that future is uncertain, because of uncertainty; involvement of risk can be traced to our every part of life. When we talk about any investment we have to think about risk and return, higher the risk higher the rates of return and lower the risk lower the rates of return. Our life is directly related with economic activities where risk is the considerable element that cannot be overlooked.

To minimize the risk people go for savings and some people take the help of insurance companies/ agencies by paying insurance premium. Risk can be categories into different perspective but here we only discuss about the business risk.

Before discussing the types of risk, let’s have some idea of risk. Risk is the deviation between the actual outcome and expected outcome. Some risk can be minimized and some risk cannot be minimized. Some risk arisen from the micro economic factor and some from macro economic factors.

Basic types of risk that we may found are:

Basic Types of Risk

Basic Types of Risk

Unsystematic Risk

Unsystematic risk is that portion of risk which can be minimize through diversification of the investment by forming portfolio. If we form a portfolio using the negatively correlated investment securities then it would be possible to minimize the risk at lower level. This types of risk is known as diversiable risk Theoretically it is possible to eliminate the portion of unsystematic risk but in real sense it is not possible to eliminate the risk through diversification.

Systematic Risk

Systematic risk is that portion of risk which cannot minimize through diversification of the investments. Systematic risk is mainly arisen from the macro economic variables which are beyond our control. Beta is the measure of the systematic risk. Sometimes this risk is also known as systematic market risk. Sources of systematic risk are given below with short explanation.

Business Risk

Business risk is the risk which mainly arise when a firm or business organization unable to generate sufficient revenue to maintain its operating expenditure through providing service or selling products, that is risk is directly related with the operation of the firm.

Financial Risk

When a firm is unable to pay off its fixed financial obligation then this type of risk may arise. This type of risk is involved with the levered firm which uses debt capital for business. In some cases this risk can lead a lead a company to bankruptcy.

Liquidity Risk

This risk is involved with the marketability of a security or investment that is the capacity to generate asset into cash as much quicker as possible. If an investment is takes less time to convert into cash then it is liquid asset or investment.

Country Risk

Unstable political condition of a country is responsible for this type of risk. If this risk is more than an economy definitely fall, so does business. In our Bangladesh this type of risk is higher.

Exchange Rate Risk

Exchange of currency is required when a country is involved with import and export. For importing product or services foreign currency basically dollar is used. So if there is more fluctuation of the exchange rate frequently then a business may incur loss. This probable loss is the risk for the business.

Although every economic activity is involved with risk, we need to be more cautious to minimize the risk. If we can minimize the risk of doing business then it will be possible to generate profit for the company/ business organization.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

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