.

Dealing with the Financial Market:

1. Financial Market:
○ Money Market: Deals with the transfer of funds with a maturity period of less
than 1 year. Instruments include short-term deposits, short-term loans, treasury
bills, and commercial papers.
○ Capital Market: Facilitates the transactions of long-term funds, e.g., long-term
deposits, loans, shares, bonds, and debentures.
○ Securities Segment: Involves the collection of funds through corporations by
issuing financial claims or instruments to investors.
2. Primary Market: Collection of funds from investors when a corporation issues financial
instruments for the first time (IPO).
○ Secondary Market: Facilitates the transaction of already issued and outstanding
securities.
○ Seasoned Equity Offering (SEO): When a company issues additional shares
after its IPO.
3. Non-Securities Segment: Facilitates the arrangement of funds through loans to
different economic units.
4. Surplus Unit: Risk-averse individuals or entities who put money in the bank.
○ Deficit Unit: Risk-takers who take loans from banks.

Financial Intermediation: This process involves collecting funds from the surplus unit and
making them available to the deficit unit through financial intermediaries.

Money Market Instruments:

● Treasury Bill: A short-term financial security issued and guaranteed by the government,
sold through auctions, and considered risk-free.
● Commercial Paper: A short-term unsecured financial instrument issued by financially
sound corporations. It is discounted and not guaranteed.

Capital Market:

● Focuses on long-term funds through various instruments like loans, shares, and bonds.
Agency Conflict:

● Arises between shareholders, debt holders, and managers when interests diverge.
Managers may maximize their own benefits at the cost of shareholders or debt holders,
leading to conflicts.
○ Examples of Conflict:
■ Managers taking additional financial benefits for themselves.
■ Shareholders benefiting at the expense of debt holders by taking riskier
projects or paying higher dividends.

Agency Costs:

● Monitoring Costs: Costs incurred to supervise the agent's activities.

● Bonding Costs: Costs to ensure the agent performs in the owner’s interest.
● Residual Loss: The cost due to divergence in the agent's actions from the owner’s
instructions.

Managing Agency Conflict:

● Threat of Firing
● Hostile Takeovers
● Increased Managerial Compensation
● Employee Ownership Programs

Forward Market:

● Forward Contract: An agreement between a corporation and a commercial bank to

exchange a specific amount of currency at a specific rate on a future date.

Option Market:

● Call Option: The right to buy a security at a specific price (strike price) within a specific
period.
● Put Option: The right to sell a security at a specific price.
○ American Option: Can be exercised anytime during the option period.
○ European Option: Can be exercised only at maturity.
Mutual Fund: Collects funds from investors to invest in a diversified portfolio, giving
proportional ownership to investors.

Types of Risks:

● Credit Risk
● Interest Rate Risk
● Liquidity Risk
● Exchange Rate Risk
● Inflation Risk
● Business Risk
● Financial Risk

Interest Rate Formula:

● Nominal Interest Rate = Real Interest Rate + Inflation Rate

● Yield Curve: Represents the relationship between interest rates and different maturity
periods. It can be:
○ Upward Sloping: Normal, higher long-term rates.
○ Downward Sloping: Inverted, higher short-term rates.

Financial Management Responsibilities:

1. Forecasting:
○ Involves predicting short-term and long-term financial needs.
○ Time periods:
■ Short term: Less than 1 year.
■ Medium term: 3 to 5 years.
■ Long term: Over 5 years.
2. Perpetuity: A financial product that lasts indefinitely, often used for bonds or annuities
with no maturity date.

Market Segmentation:

1. Foreign Market:
○ Companies may establish subsidiaries in foreign countries to reduce costs and
maximize profits.
○ Differentiating products and introducing new ones helps maintain competitive
advantage.
 2. Investment and Financing Decisions:
○ B: Balancing – Adjustments to capital markets.
○ M: Modernization – Improving existing operations.
○ I: Replacement – Replacing outdated equipment or systems.

Financial Markets:

1. Money Market:
○ Deals with short-term funds with maturity periods of less than 1 year.
○ Instruments include Treasury bills (guaranteed by the government and sold
through auctions) and commercial papers (unsecured, short-term instruments
issued by financially sound corporations).
2. Capital Market:
○ Facilitates the collection of long-term funds, such as through shares, bonds, or
debentures.
3. Security Segment:
○ Deals with raising funds by issuing financial claims (securities) to investors, such
as through an Initial Public Offering (IPO).
○ Primary Market: Where new securities are issued for the first time.
○ Secondary Market: Facilitates the trading of already-issued securities.
4. Non-Security Segment:
○ Involves funding from loans issued by banks or financial institutions to various
economic units.

Regulatory Bodies:

● Bangladesh Bank (BB): Central bank of Bangladesh.

● Bangladesh Securities and Exchange Commission (BSEC): Regulates the securities
market.

Agency Conflict:

● Occurs when managers prioritize personal gains over shareholders' interests, leading to
a conflict of interest.
● Examples:
○ Shareholders vs. Managers: Managers might take actions that benefit
themselves at the expense of shareholders.
○ Shareholders vs. Debt Holders: Shareholders might prefer riskier projects,
which could jeopardize debt holders' interests.

Expansion Strategy:

● A firm may create products to accommodate local or foreign demand.

● Establishing foreign subsidiaries can reduce costs.
 ● Differentiating products from competitors helps sustain a competitive edge.
● Over time, foreign advantages may diminish as competitors catch up.

Time Value of Money

Time Value of Money (TVM) is the concept that money available today is worth more than the
same amount in the future due to its earning potential. It is the foundation of finance and forms
the basis for the valuation of cash flows in investment analysis, lending, and savings.

Cash Flow Time Lines

A cash flow time line is a graphical representation showing the timing of cash inflows (receipts)
and outflows (payments) over different periods.

● Outflow: Payment or disbursement of cash for expenses or investment.

● Inflow: Receipt of cash from an investment or other sources.

Future Value (FV)

Future Value (FV) is the value to which a present cash flow or series of cash flows grows over
time, compounded at a specific interest rate.
Formula:
FVn=PV×(1+i)nFVn​=PV×(1+i)n

Where:

● PVPV = Present Value

● ii = Interest rate
● nn = Number of periods

Example:

● For PV=100PV=100, i=5%i=5%, and n=1n=1,

FV1=100(1+0.05)=105FV1​=100(1+0.05)=105.

Compound Interest

● Compound Interest: Interest earned on both the initial principal and the interest that has
been added to it.
● Compounding: The process of calculating future value by applying compound interest.

For example, semiannual compounding means interest is calculated twice a year.

Example:
For Tk. 100 at 6% interest for 3 years:
 ● Annual Compounding:
FV3=100×(1+0.06)3=119.10FV3​=100×(1+0.06)3=119.10
● Semiannual Compounding:
FV6=100×(1+0.03)6=119.41FV6​=100×(1+0.03)6=119.41

Present Value (PV)

Present Value (PV) is the current value of future cash flows discounted at a specific interest
rate. Formula:
PV=FVn(1+i)nPV=(1+i)nFVn​​

Example:
For FVn=127.63FVn​=127.63, i=5%i=5%, and n=5n=5,
PV=127.63(1+0.05)5=100PV=(1+0.05)5127.63​=100

Annuities

Annuity: A series of equal payments made at regular intervals for a specified number of
periods.

● Ordinary Annuity: Payments occur at the end of each period.

FVAn=PMT×(1+i)n−1iFVAn=PMT×i(1+i)n−1​
● Annuity Due: Payments occur at the beginning of each period.
FVA(Due)n=PMT×[(1+i)n−1i×(1+i)]FVA(Due)n​=PMT×[i(1+i)n−1​×(1+i)]

Present Value of an Annuity

Present Value of an Ordinary Annuity (PVAn):

PVAn=PMT×1−(1+i)−niPVAn=PMT×i1−(1+i)−n​

Perpetuities

Perpetuity: A stream of equal payments expected to continue indefinitely. Formula:

PV(Perpetuity)=PMTiPV(Perpetuity)=iPMT​

Uneven Cash Flow Streams

In some cases, cash flows vary from one period to another. The present and future values for
these uneven streams are calculated by summing the individual cash flows.

● Present Value of Uneven Cash Flow Stream:

PV=∑[CFt(1+i)t]PV=∑[(1+i)tCFt​​]

Effective Annual Rate (EAR)

EAR is the actual interest rate earned or paid annually, considering compounding periods.
Formula:
EAR=(1+iSIMPLEm)m−1EAR=(1+miSIMPLE​​)m−1

Where:

● iSIMPLEiSIMPLE​= Simple (Quoted) Interest Rate

● mm = Number of compounding periods per year

Amortized Loans

Amortized Loan: A loan that is repaid in equal payments over its life. Each payment covers
interest and principal repayment.

Summary

Understanding the Time Value of Money helps in making informed financial decisions
regarding investments, savings, loans, and any other financial transaction involving cash flows
across different periods.

This document provides an overview of key concepts related to risk and return in finance,
focusing on how investors measure and respond to risk:

1. Risk: The chance of outcomes differing from what is expected, either for a stand-alone
investment or a portfolio.
○ Stand-alone Risk: The risk of an individual investment in isolation.
○ Portfolio Risk: Risk when investments are combined in a portfolio.
2. Probability Distribution: Lists possible outcomes of an investment, with the probability
for each outcome. It helps calculate the Expected Rate of Return, which is the average
of possible returns weighted by their probability.
3. Standard Deviation: A measure of how spread out the returns are, used to assess
stand-alone risk. The Coefficient of Variation standardizes risk by return, comparing
investments with different returns.
4. Risk Aversion: Investors prefer less risk, demanding higher returns for higher risk. This
extra return is called the Risk Premium.
5. Portfolio Risk: Diversifying investments reduces risk. The correlation coefficient (r)
measures the relationship between assets. Perfect negative correlation (r = -1)
eliminates risk, while perfect positive correlation (r = +1) maintains it.
6. Firm-Specific vs. Market Risk:
○ Firm-specific Risk (diversifiable) can be eliminated through diversification.
○ Market Risk (non-diversifiable) affects all investments and cannot be diversified.
7. Capital Asset Pricing Model (CAPM): Helps determine the required return for an asset
based on its market risk (measured by beta). A higher beta indicates more volatility
compared to the market, affecting the required return.
 8. Security Market Line (SML): Represents the relationship between risk and return for
individual assets. Higher beta implies a higher required return.

These concepts are foundational in understanding how investors balance risk with potential
return when making investment decisions.

Time Value of Money (TVM)

The Time Value of Money (TVM) is a financial concept that states a dollar today is worth more
than a dollar in the future due to its potential earning capacity. This concept allows for the
comparison of money flows at different points in time.

Future Value (FV)

The Future Value (FV) of a sum of money is the value at a specified date in the future, based
on its present value and the interest rate.

Formula:

FV=PV×(1+r)nFV=PV×(1+r)n

Where:

● FV = Future Value
● PV = Present Value
● r = Interest rate per period
● n = Number of periods

Example:
If you invest $1,000 at an interest rate of 5% per year for 3 years, the future value will be:

FV=1000×(1+0.05)3=1000×1.157625=1157.63FV=1000×(1+0.05)3=1000×1.157625=1157.63

Present Value (PV)

The Present Value (PV) is the current value of a sum that will be received in the future,
discounted at the interest rate.

Formula:

PV=FV(1+r)nPV=(1+r)nFV​

Where:

● PV = Present Value
 ● FV = Future Value
● r = Interest rate per period
● n = Number of periods

Example:
If you are to receive $1,157.63 in 3 years and the interest rate is 5%, the present value is:

PV=1157.63(1+0.05)3=1157.631.157625=1000PV=(1+0.05)31157.63​=1.1576251157.63​=1000

Annuity

An Annuity is a series of equal payments made at regular intervals. The Future Value of an
Annuity is the total value of these payments, accumulated over time at a given interest rate.

Formula for Future Value of an Ordinary Annuity:

FVannuity=P×(1+r)n−1rFVannuity​=P×r(1+r)n−1​

Where:

● FV = Future Value of the Annuity

● P = Payment per period
● r = Interest rate per period
● n = Number of periods

Example:
If you invest $500 annually at 5% interest for 5 years, the future value will be:

FVannuity=500×(1+0.05)5−10.05=500×1.276281−10.05=500×5.5256=2762.80FVannuity​=500×
0.05(1+0.05)5−1​=500×0.051.276281−1​=500×5.5256=2762.80

Perpetuity

A Perpetuity is an infinite series of equal payments made at regular intervals. The present
value of a perpetuity is given by:

Formula:

PVperpetuity=PrPVperpetuity​=rP​

Where:

● PV = Present Value of the perpetuity

● P = Payment per period
● r = Interest rate per period
Example:
If a perpetuity pays $100 annually and the interest rate is 5%, the present value is:

PVperpetuity=1000.05=2000PVperpetuity​=0.05100​=2000

Risk and Return

Expected Return (k^)

The Expected Return of an investment is the weighted average of the possible returns, with
each return being weighted by its probability of occurrence.

Formula:

k=∑i=1nPri×kik=i=1∑n​Pri​×ki​

Where:

● k^ = Expected Return
● Pr_i = Probability of the i-th outcome
● k_i = Return in the i-th scenario

Example:
If there are two possible returns for a stock, 10% with a 40% chance and 5% with a 60%
chance, the expected return is:

k=(0.40×0.10)+(0.60×0.05)=0.04+0.03=0.07=7%k=(0.40×0.10)+(0.60×0.05)=0.04+0.03=0.07=7
%

Variance (σ²) and Standard Deviation (σ)

Variance measures the spread of the possible returns around the expected return. Standard
Deviation is the square root of the variance and represents the risk (volatility) of the investment.

Formula for Variance:

\sigma^2 = \sum_{i=1}^{n} Pr_i \times (k_i - k^)^2

Formula for Standard Deviation:

σ=σ2σ=σ2​

Example:
Continuing the above example, where the expected return (k^) is 7%:
σ2=(0.40×(0.10−0.07)2)+(0.60×(0.05−0.07)2)=(0.40×0.0009)+(0.60×0.0004)=0.00036+0.00024
=0.0006σ2=(0.40×(0.10−0.07)2)+(0.60×(0.05−0.07)2)=(0.40×0.0009)+(0.60×0.0004)=0.00036+
0.00024=0.0006σ=0.0006=0.02449=2.45%σ=0.0006​=0.02449=2.45%

Capital Asset Pricing Model (CAPM)

The CAPM estimates the required return on an asset based on its market risk (beta).

Formula:

kj=kRF+βj(kM−kRF)kj​=kRF​+βj​(kM​−kRF​)

Where:

● k_j = Required return on asset j

● k_{RF} = Risk-free rate
● β_j = Beta of asset j
● k_M = Market return
● (k_M - k_{RF}) = Market risk premium

Example:
If the risk-free rate is 6%, the market return is 14%, and stock j has a beta of 0.5, the required
return on the stock is:

kj=6%+0.5(14%−6%)=6%+0.5×8%=6%+4%=10%kj​=6%+0.5(14%−6%)=6%+0.5×8%=6%+4%=
10%

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Time Value of Money (TVM)

Future Value of an Annuity Due

An Annuity Due is a series of equal payments made at the beginning of each period. The
Future Value of an Annuity Due accounts for the fact that each payment is invested for one
additional period compared to an ordinary annuity.

Formula:
FVannuity due=P×(1+r)n−1r×(1+r)FVannuity due​=P×r(1+r)n−1​×(1+r)

Where:

● FV = Future Value of the annuity due

● P = Payment per period
● r = Interest rate per period
● n = Number of periods

Example:
If you invest $500 at the beginning of each year at a 5% interest rate for 5 years, the future
value will be:

FVannuity due=500×(1+0.05)5−10.05×(1+0.05)=500×5.5256×1.05=2898.94FVannuity
due​=500×0.05(1+0.05)5−1​×(1+0.05)=500×5.5256×1.05=2898.94

Present Value of an Annuity

The Present Value of an Annuity represents the current value of a series of future payments,
discounted at a specific interest rate.

Formula:

PVannuity=P×1−(1+r)−nrPVannuity​=P×r1−(1+r)−n​

Where:

● PV = Present Value of the annuity

● P = Payment per period
● r = Interest rate per period
● n = Number of periods

Example:
If you expect to receive $600 annually for 4 years and the interest rate is 6%, the present value
will be:

PVannuity=600×1−(1+0.06)−40.06=600×3.4651=2079.06PVannuity​=600×0.061−(1+0.06)−4​=60
0×3.4651=2079.06

Risk and Return

Portfolio Expected Return

The Expected Return on a Portfolio is the weighted average of the expected returns of each
individual asset in the portfolio.
Formula:

kp=w1k1+w2k2+⋯+wnknkp=w1​k1​+w2​k2​+⋯+wn​kn​

Where:

● k^p = Expected return on the portfolio

● w_i = Weight of the i-th asset in the portfolio
● k_i = Expected return of the i-th asset

Example:
If a portfolio consists of two stocks with expected returns of 12% and 8%, and their respective
weights are 60% and 40%, the expected return on the portfolio will be:

kp=0.60(12%)+0.40(8%)=7.2%+3.2%=10.4%kp=0.60(12%)+0.40(8%)=7.2%+3.2%=10.4%

Risk Premium and Required Return

A Risk Premium compensates investors for taking on risk. The required return is calculated by
adding the risk premium to the risk-free rate.

Formula:

Required Return=Risk−free Rate+Risk PremiumRequired Return=Risk−free Rate+Risk

Premium

Example:
If the risk-free rate is 4% and an investor requires a 6% risk premium to invest in a stock, the
required return is:

Required Return=4%+6%=10%Required Return=4%+6%=10%

Beta and Required Return using CAPM

Using the Capital Asset Pricing Model (CAPM), the required return can also be calculated
based on an asset's beta, which measures the asset's risk relative to the market.

Formula:

kj=kRF+βj(kM−kRF)kj​=kRF​+βj​(kM​−kRF​)

Example:
If the risk-free rate is 3%, the market return is 11%, and the beta of the stock is 1.2, the required
return is:

kj=3%+1.2(11%−3%)=3%+1.2×8%=3%+9.6%=12.6%kj​=3%+1.2(11%−3%)=3%+1.2×8%=3%+9.
6%=12.6%