Financial Economics II 1 Learning in this course • How do firms finance? • Internal Source • External Sources • Capital budgeting and Cost of Capital • Investment Decisions such that value for the company's shareholders is maximised • How do we value? • Capital structure Choice • Does financing decision matter for the value of the firm? • What determines capital structure choice? Learning in this course • Derivative Securities • Why do derivative securities exist? • Forward, Futures and Swaps • Options and Option Pricing Models Why do firms need financial capital? 1. Fixed capital requirement • Funds that are to be used to purchase fixed or durable assets like land & building, plant and machinery, and furniture and fixtures, are known as fixed capital or long term capital. 2. Working capital requirement • Day to day expenses of business or for short term assets or current assets like stock of material, and for meeting current expenses Classification of sources of funds 1. On the basis of period 2. On the basis of ownership 3. On the basis of source of fund generation Sources of finance on the basis of period • Long-Term Capital: Funds requirements for five or more than five years. • Short-Term Capital: Requirement is for a shorter period i.e. less than a year • Medium-Term Capital: Funds required for a period of 2 to 5 years Long-Term Capital • • • • • Issue of equity & preference shares Issue of debentures Loans from financial institutions Loan from banks Reinvestment of profits Short-Term Capital • • • • • Banks Trade credit Factoring Instalment credit Commercial paper Medium-Term Capital • • • • • • Issue of shares Issue of debentures Borrowing from banks and other financial institutions Reinvestment of profits Public deposits Lease financing Classification on the basis of ownership • Owners’ Capital: Capital invested in a business by its owners who by investing the money become entitled to the profits of the business. • Borrowed Capital: Funds raised through loans or borrowings. Borrowed money involves a fixed obligation to pay interest and repay the principal amount as and when due. Classification on the basis of source of fund generation • Internal sources: Funds are raised from within the organisation • • • • • Capital invested by owners Retained earnings Sales of unwanted assets Sales of stock Debt collection • External Sources: Money raised from outside the business • • • • • • Adding more partners Bank overdraft Commercial bills Mortgage Trade credit Government grants Internal sources • Capital invested by owners • Retained earnings • Sales of unwanted assets • Sales of stock • Debt collection External Sources • Adding more partners • Bank overdraft • Commercial bills • Mortgage • Trade credit • Government grants • Venture capital • Lease • Debenture • Bonds • Equity • Hire purchase • Friends and relatives
