Financial Management
Lecture 2 Addendum
Some Definitions
Copyright: M. S. Humayun
Real Assets vs Securities
• Real Assets
– Tangible Assets like land, house, equipment, car,
wheat, fruits, cotton, computers, etc.
• Securities
– Piece of paper representing a claim on an asset
• Direct Securities: Stocks and Bonds
– Value depends on the cash flows generated by the underlying
assets. Use Discounted Cash Flow (DCF) techniques.
• Indirect Securities: Derivatives, Futures, Options
– Value depends on the value (market price) of the underlying
assets
Copyright: M. S. Humayun
Bonds
• Internationally, the most common way for companies to
raise financing and funds.
• A Bond is a long-term debt contract (on paper) issued by
the Borrower (Issuer of the Bond ie. a company that needs
money) to the Lenders (Bond Holder or Investors ie.
Banks, financial institutions, and private investors).
• Bonds Issued represent Liabilities (on the Balance Sheet)
• A Bond requires the Borrower to pay a pre-determined
amount of interest regularly to the Lender. The interest
may be Fixed or Floating.
• Types of Bonds:
– Debentures:
Unsecured – no asset backing
– Mortgage Bond: Secured by real property ie. Land, house
– Others:
Eurobond, Zeros, Junk, etc.
Copyright: M. S. Humayun
Stocks (or Shares)
• Most common source of raising funds under Islamic Shariah.
• Stocks (or Shares) are paper certificates representing ownership in a
business. Therefore, if a company has issued 1 million shares and
even if you own 1 share only, you are a part owner (or Shareholder) !
• Represents Equity (on the Balance Sheet)
• The Stock certificate lasts as long as the company does. Note:
Perpetual Concern
• Shareholders have a Residual Claim on whatever Net Income (or
Profit) and Assets are left over after the Bond Holders have been paid
off.
• Types of Stocks (or Shares):
– Common Stock:
True owners. Shareholders receive Dividends or portion
of the Net Income (which the management decides NOT to reinvest into the
company in the form of Retained Earnings) in proportion to the number of
shares they hold. The Dividend is uncertain. Common Stock holders have
voting rights to elect a Board of Directors.
– Preferred Stock:
A stock with a predetermined or fixed dividend. The
Preferred Dividend is guaranteed and must be paid out before the Common
Stock Dividend.
Copyright: M. S. Humayun
Where Do Bonds & Stocks Appear on
the Balance Sheet?
Own Bonds
Issued by
Company to
Raise Cash
Stocks & Bonds
Purchased as
Investment
Own Stock
Issued by
Company to
Raise Cash
Copyright: M. S. Humayun
Value
• Book Value
– Value as shown on the Balance Sheet based on historical cost
(or purchase price) and accumulated depreciation
• Market Value
– Value of asset as observed in the market. Depends on the
Supply & Demand and negotiations between Buyers & Sellers.
• Liquidation Value
– Value if the company were closed down and its assets were sold
individually.
• Fair Value or Instrinsic Value
– Present Value of the working assets’ future cash flows. Use
Discounted Cash Flow (DCF) technique.
– If the Intrinsic Value is less than the Market Value, then the asset
is “undervalued” in the mind of the investor
Copyright: M. S. Humayun