Category: Finance

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Perfect Capital Market

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What is meant by a perfect capital market?

If a capital market has the following characteristics then it would be considered as a perfect capital market. In perfect capital market case, assuming complete markets, perfect rationality of agents and under full information, the equilibrium occurs where the interest rates clear the market, with the supply of funds equal to the demand.

  1. There is no transaction (brokerage) cost.
  2. There are no taxes.
  3. There are large numbers of buyers and sellers, so the actions of no one buyer or seller affect the price of the traded security.
  4. Both individuals and firms have equal access to the market.
  5. There is no cost to obtain information, so everyone has the same information.
  6. Everyone has the same (homogeneous) expectations.
  7. There are no costs associated with financial distress.

What role does the perfect capital market assumption play in financial theory?

perfect capital marketRoles of perfect capital market assumption

Clearly, most of these assumptions do not hold in the real world-taxes and brokerage costs exist, individuals often do not have the same access to markets as corporations, managers often have more information about their firms’ prospects than do outside investors and so on. Still, a theory should not be judged on the reality of its assumption, but rather on how consistent its predictions are with actual behavior. If a theory seems reasonable and is consistent with behavior, then the theory will generally be accepted, regardless of the realism of its assumption. Often the assumptions do not limit the ability of the theory to explain real-world phenomena.

For example, although taxes certainly exist, there may be enough tax-exempt institutions with sufficient capital to produce the results predicted by a theory that assumes zero taxes.

If you have any query about the perfect capital market then please let me know. I will try my best to share my knowledge of the perfect capital market.

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Md. Nahian Mahmud Shaikat

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Standard Deviation is Better Measurement

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Why is standard deviation better measurement for risk?

In finance, the standard deviation is applied to the annual rate of return of an investment to measure the investment’s volatility. Standard deviation is also known as historical volatility and is used by investors as a measure for the amount of expected volatility. Basically, the standard deviation is used to see whether the project has less or high risk. So standard deviation is better measurement.

Standard Deviation is Better Measurement

The formula of standard deviation

Standard Deviation is Better Measurement

A measure of the variation in a distribution, equal to the square root of the arithmetic mean of the squares of the deviations from the arithmetic mean, the square root of the variance.

The reasons behind standard deviation as a better measurement for risk are given below

The most commonly used measure of risk for assets or securities is a measure known as the standard deviation. The larger the standard deviation the greater the dispersion and hence the greater the distribution’s stand-alone risk. On the other hand the lower the standard deviation the lower the risky-ness of the project.

 If you want to know how `risky’ a fund/ a project is, there are other ways of assessing it. For instance, you can compare the annual returns of a fund over the past several years. You can analyze how the fund has done in bull markets and in bear markets. Or you can compare compound returns for several time periods. Using compound returns has one problem though. Compound returns can be affected by one year’s exceptional performance. To correct for this, Fund Counsel suggests dropping the exceptional year and re-computing the compound rate of return.

 But from above-mentioned measures standard deviation is considered as a better measurement of risk because by using standard deviation we can easily identify whether the project is risky or not. If the rate of standard deviation is high then the project is risky and if the rate of standard deviation is low then the project is less risky.

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Asymmetric Information

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In financial market what is meant by asymmetric information?

When a manager knows more about his or her firm’s future than do the analysts and investors who follow the company then a situation of asymmetric information exists. In this situation, a firm’s managers may correctly conclude that its securities are undervalued or overvalued depending on whether the inside information is favorable or unfavorable. Of course, there are degrees of asymmetry management is almost always better informed about a firm’s prospects than are outsiders but in some situations, this informational difference is too small to influence managerial actions. In other circumstances such as prior to a merger announcement or when a drug company has made a major research breakthrough managers may have information that will significantly alter the prices of the firm’s securities when it becomes public. In most situations, the degree of information asymmetry lies between the two extremes.

asymmetric information

The potential impact of asymmetric information on markets was analyzed by George Akerlof in a paper titled “The market for Lemons”

The only convincing way for a seller to convey to potential buyers that the product is good to take some action that buyer can unambiguously interpret as a sign that the product is not defective. Such actions are called signals and the act of providing signals is called signaling.

 Since manager’s primary goal is to maximize shareholders wealth managers are generally motivated to convey favorable inside information to the public as rapidly as possible. The easiest way would be to issue a press release announcing the favorable development. However, an outsider would have no way of knowing whether the announcement was true or how important it really was. Therefore such announcements have limited value. But if managers could signal information concerning favorable prospects in some truly credible way then the information would be taken seriously by investors and reflected in security prices.

 Example: Dividend announcements are the classic example of managers providing information through signaling. If a firm announces a significant increase in cash dividend this is its managers signal that the firm has good future earnings and cash flow prospects. If dividend increase is widely anticipated but then is not forthcoming this is a negative signal.

 The presence of effective management signals plays an important role in financial management.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

Facebook: Ördïnärÿ Böÿ

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Principles of Finance

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Principles of Finance

Principles act as a guideline for the investment and financing decision. Financial managers take operating, investment and financing decisions, some of this related to short term and some long term.

Before discussing principles of finance let’s have some idea about finance, is the process of collecting funds and ensures proper utilization of funds. Many people say that finance is the management of funds and those are responsible for managing this fund are financial managers.

There are six basic principles of finance, these are:

  1. Principles of risk and return
  2. Time value of money
  3. Cash flow principle
  4. Profitability and liquidity
  5. Principles of diversity
  6. Hedging principle
six principles of finance

Principles of Finance

The Principle of Risk & Return

This principle indicates that investors have to conscious both risk and return, because higher the risk higher the rates of return and lower the risk, lower the rates of return. For business financing, we have to compare the return with risk. To ensure optimum rates of return investors need to measure risk and return by both direct measurement and relative measurement.

Time Value of Money

This principle is concerned with the value of money, that value of money is decreased when time pass. The value of dollar 1 of the present time is more than the value of dollar 1 after some time or years. So before investing or taking fund, we have to think about the inflation rate of the economy and required rate of return must be more than the inflation rate so that return can compensate the loss incurred by the inflation.

Cash Flow Principle

This principle mainly talk about the cash inflow and outflow, more cash inflow in the earlier period is preferable than later cash flow by the investors. This principle also follows the time value principle that’s why it prefers earlier more benefit rather than later years benefits.

Profitability & Liquidity Principle

This principle is very important from the investor’s perspective because the investor has to ensure both profitability and liquidity. Liquidity indicates the marketability of the investment i.e. how much easy to get cash by selling the investment. On the other hand, investors have to invest in a way that can ensure the maximization of profit with a moderate or lower level of risk.

Principles of diversity

This principle helps to minimize the risk by building an optimum portfolio. Never put all your eggs in the same basket because if it falls then all of your eggs will break, so put eggs by separating in a different basket so that your risk can be minimized. To ensure this principle investors have to invest in risk-free investment and some risky investment so that ultimately risk can be lower. Diversification of investment ensures minimization of risk.

Hedging Principle

Hedging principle indicates us that we have to take a loan from appropriate sources, for short-term fund requirement we have to finance from short-term sources and for long-term fun requirement we have to manage fund from long-term sources. For fixed asset financing is to be done from long-term sources.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

Facebook: Ördïnärÿ Böÿ

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Individual Investor Life Cycle

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Individual Investor Life Cycle

Individual investor life cycle indicates the investment behavior of investor over the different age of their life. The investment decision is based on the age, financial condition, future plans and risk characteristics of an individual.

Investor mainly invests in getting a return which can compensate the sacrifice of present for more future earnings and security. As a financial plan investor can adopt different insurance policies or reserve cash for future. Although investor has to take risk of reserving cash or investing the cash they are ready to take some risk according to their risk-taking behavior.

Phases of Individual Investor Life Cycle

Four Phases of Individual Investor Life Cycle

An investor passes through four different phases in life

  • Accumulation Phase
  • Consolidation Phase
  • Spending Phase
  • Gifting Phase

Accumulation Phase

Investor early or middle to their career tries to accumulate fund so that individual can have money to spend in the later phase of their life. Some people accumulate the fund to buy house, car or other important assets and some people accumulate for their children’s education cost, life peaceful life after retirement.

Funds invested in the early phase of life gives an investor a huge amount of fund which is compounding over the years

Consolidation Phase

Consolidation phase is the midpoint of their career, in this phase, they earn more, spends more and pay off all their debts. In this phase moderately high risk taken by the investor but for capital reservation some investor prefer lower risk investor. Individual invest in the capital market and investment securities.

Spending Phase

This phase starts when an individual retires from the job. Their overall portfolio is to be less risky than the consolidation phase; they prefer low risky investment or risk-free investment. People prefer fixed income securities like a bond, debenture, treasury bills etc. In this phase, they need some risky investor if they have extra money so that future inflation can be adjusted.

Gifting Phase

If individuals believe that they have enough extra funds to meet their current and future expenses then they go for gifting money to their friends, family members or establish charitable trusts. These can reduce their income taxes and they also keep some fun for future uncertainties.

Over the different phase, investor behaves differently and invest in their preferred sector according to their risk-taking behavior.

Written by

Md. Nahian Mahmud Shaikat

Financial Analyst

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The Portfolio Management Process

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The Portfolio Management Process

Before discussing the portfolio management process lets have some idea of a portfolio, basically, portfolio management process is the set of securities or combination of investment securities.

The process of managing a group of investment or portfolio is never stopping, it is a continuous process. An investor needs to develop plan and policies to form a portfolio, monitor the performance and review portfolio from time to time.

The Portfolio Management Process

The portfolio management process is followed by four common steps, these are:

  1. The first step of portfolio management is the formulation of policy statement either individually or get assistance from others. This policy statement is the roadmap of how much an investor is willing to take a risk.
  2. In the second step, a manager should study the current financial and economic condition to forecast the future economic return or condition. An economy is dynamic which is continuously changing over the time because of the direct or indirect impact of the micro and macroeconomic variables.
  3. The third step of the portfolio management process is the formation of a portfolio according to the policy statement and risk-taking behavior of the investor. The portfolio should be formed by using both a risk-free asset and risky asset so that ultimately risk can be minimized.
  4. The final step of the portfolio management is the continuous monitoring by the portfolio managers so that any investment correction can be done as required. Mainly investment should be concentrated with capital gain and profit via a dividend.

These above four-steps basically used for managing the portfolio by the investor or by the portfolio manager.

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Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

Phone: +8801914262602

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Will Profit Maximization Always Result in Stock Price Maximization

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Will Profit Maximization Always Result in Stock Price Maximization

Some people may ask will profit maximization always result in stock price maximization? Profit maximization does not always result in stock price maximization, because profit maximization can only ensure higher earnings per share not the increased value of a stock. Profit can be manipulated by the managerial actions, like reducing operating costs through hampering the normal flow of actions.

Will Profit Maximization Always Result in Stock Price Maximization

Stock Price Maximization

Example:

Suppose managers want to show a higher profit this year, to do this they reducing operating expenses by not entertaining repair and maintenance of machines. So the cost of repair and maintenance saved. This definitely increases the profit of the organization but in the next year, the company has to spend higher operating cost for repair and maintenance which will ultimately reduce the profit.

Here manager’s action increases the profit of the firm but it will not maximize the price of stock because there is no increase in operating efficiency.

So it is clear that more earning per share does not ensure price maximization of stock in the market.

 Actually, wealth maximization can create a positive effect which helps to maximize the price of the stock.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

Phone: +8801914262602

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Maximize the Value of a Corporation

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Maximize the Value of a Corporation

A question may arise to our mind that What does it mean to maximize the value of a corporation?

To understand and answer this type of question one thing is enough that, maximizing the value of a corporation indicates the value maximization of the wealth of a company. We can say the value of a corporation is maximized when the price of a stock is increased. Value maximization is preferable for the owner because it ensures not only the capital gain by selling stock in the market but also get profit through a dividend. It is management’s responsibility to ensure the value maximization.

Maximize the Value of a Corporation

Maximize the Value

For example:

In 2013 the stock price of a company or corporation was Tk 120 but in 2014 the price increase to Tk 210 in the secondary market. This indicates that company successfully utilizes its resources which actually increased the value or price of the stock.

We know that maximization of the value of a corporation is reflected by the increased value of a stock. Above example shows that there is an increase in the price of the stock, so we can say that value of a corporation is increased.

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Finance

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What is Finance

Finance is concerned with decisions about money i.e. how money or fund will be collected and use in a productive sector properly. Before 1960 it refers only the collection of funds but after that, the idea was changed.

Some People May ask what actually finance is?

Finance is not limited to a collection of funds; it must ensure proper utilization of funds.

finance

What is Finance?

Finance is lifeblood of every corporation because we cannot do any business activity without the help of finance. Some people say that the overall activities related to planning, organizing, raising, conservation, using and controlling funds is known as finance.

According to Harvard & Upton, it is that administrative area which is concerned with the arrangement of cash and credit effectively.

It consists of three interrelated areas.

Areas of Finance

  • Money & Capital Market
  • Investments
  • Financial Market

So concluding with the idea, it is not the only collection of fund where the funding cost is lower and then utilizes it to ensure the maximum rate of return for the investors. Managing funds is not an easy task but it is management’s responsibility to manage the funds which can ensure the substantial growth of a company.