a.
Finance
Finance is the source through which you provide resource. Suppose you need cash to buy
a car. Cash is the resource but from where it has come it is the source. You can buy it from your
own pocket or you can borrow from someone. Your own pocket means investment in business
by owner borrowing means liabilities. Both owner’s equity and liabilities are the source of
finance. Owner’s investment and profit reinvested i.e. retained earnings are the long term
source of finance and liabilities may be divided into long term as well as short term finance. It
you borrow for more than one year it is long term finance and if you borrow for less than a year
it is short term finance.
b.
Efficient Market
It is a hypothesis that the prices prevail in the market is always fair. It means that market price
has incorporated and reflects all related information. According to EMH no one can make high
return without buying riskier investment as market prices are always fair.
c.
Primary Market
Primary market is the place where the securities are issued first time on exchange. Debt
or equity based securities are issued by companies, government and other groups to raise finance.
It means that the company issue or sell securities directly to the investor at a specified price. The
price may be at par or more than or less than par. If they are issued for more than par it is called
premium or if it is issued at less than par, it is called discount. In primary market investor does
not buy from another investor. The issue price is same for all the buyers.
d.
Secondary Market
A place where investor can buy securities from another investor rather than issuing companies.
The price in the market is almost different than the issue price. It may be more or less. The
price in secondary market is affected by market sentiments. Due to change in price the issuer of
the security is not affected. The difference in price is gain or loss to be borne by the investor.
.
e.
Risk
The actual return earned on investment may be different from expected. The chance of the
difference is known as risk. In simple words, it may be defined as uncertainty involved in any
transaction. For example, you have supplied goods to the customer. Will the customer pay or
not, this certainty is known as risk.
The risk may be divided into different categories, they are: market risk, credit risk and
operational risk.
Return on investment is associated with risk attach to that investment. There is a trade off
between risk and return. If risk is high the return is high if risk is low the return is low.
f.
Security
Stock which represent right of ownership and bond which represent a debt agreement are known
as securities.
It means the instrument which represents right on the profit which is generated by the use of
assets of business is called security. Some securities are interest based and some are dividend
based securities.
Some of the securities are common stock, preferred stock, bonds, notes, debenture, option,
future, swap, right, warrant or any other financial assets.
Security is the source of finance who issued it and source of investment who buys it.
g.
Stock
Stock represents ownership in the business and a claim on part of the company’s assets and
earnings. It is an instrument normally having a face value. Normally the stocks do not have any
maturity date, it means they are irredeemable. Stocks may be classified into two categories;
they are common stock and preferred stock. Both are dividend based. Rate of dividend is fixed
for preferred stock and not fixed for common stock. Normally, preferred stocks do not have
voting rights whereas common stocks do have voting rights. Preferred stock holder do have
higher claim on the assets and earnings as compare to common stocks
h.
Bond
It is a debt instrument, which describes the amount loaned, the rate of interest, maturity date and
mode of payment of interest and principal. It is interest based security, therefore falls into the
categories of fixed income securities. Company has to pay interest either company makes profit
or loss. It is issued for longer period than one year; therefore it falls into the category of long
term liability and one of the sources of long term finance. Company may attach different option
with their bonds, e.g. convertible, callable etc.
i.
Capital
Capital is known as amount invested by the owner of the business. If it is sole proprietor and
partnerships the amount invested by owner or owners of the business. In case of corporation
amount invested by stockholder i.e. owner of the business in the form of common stock and
preferred stock.
j.
Debt
It is an obligation to be paid by the business. It is also knows as liabilities. It shows the money
borrowed. If it has been borrowed for more than a year it is called long term debt otherwise it is
called short term debt. It also represents one of the sources of finance available. Interest is to be
paid on debt, which may be treated as expenses for tax purpose. It means tax shield is available
on all kinds of debt. Loans, notes payable, bonds and capital lease are some of the example of
debt.
k.
Yield
Rate of returned based on market price is called yield. For example, if an investor has bought
shares of $10 par and company declares dividend of 10% in cash and still the market value is at
par. IT means that yield earned on share is equal to dividend declared. Now if market price is
different from par, say it is $20, now dividend declared is same but dividend yield is 5% (1/20)
.
l.
Rate of Return
Any profit or loss has been made for a specified period on investment is called the profit
or loss in $ on your investment and when it is converted into percentage it is called rate of return.
For example, you have made an investment of $10,000 at the start of the year and at the end of
the year it becomes $12000. Your return in terms of $ for one year is $2000 and in terms of
percentage it is (2000/10000) x 100 = 20% per annum is your rate of return.
m.
Return on Investment
Generally speaking any profit or loss made on investment is called return on investment. It is
just like rate of return.
Technically speaking, it is a kind of ratio which describes how the profitability of the company is
measured. Normally, net income is divided by total assets. For example, ABC Company has
profit after tax for year equal to $150 million and total assets are $1500 million, it means return
on investment is 10%.
Sometime it has been calculated like this net income + interest expenses/long term debt +
shareholders’ equity.
n.
Cash Flow
When revenues or cost are received or paid in cash it is called cash flow. Normally, income
statement is based on revenue earned and expenses incurred basis whether they have been paid
or not or received or not. But in cash flow statement they showed as cash inflows and cash
outflows at the time of receipt or payment in real terms. Normally it is divided into three
categories:
i
Cash flows from operating activities. It comprises of revenues received during the period
in cash and expenses incurred during the period in cash related to the operation of the
business.
ii
Cash flows from investing activities. It comprises of buying and selling of fixed assets
and other investment.
iii
Cash flows from financing activities. It describes the sources from where the
organization has generated long term finances. It includes both borrowing in the form of
long term debt and issuance of common stock and preferred stock.