Bahria University

Islamabad campus
Department of Management And Computer Sciences

FINANCIAL MANAGEMENT

ASSIGNMENT #1
Submitted to: MAAM TALAT REHMAN Submitted by: Tayyaba Khan Anum shahzad Qanita Hashmi Irum yusaf Huma baseer Mansoor farooq
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Date: 15 SEP 09
Question # 1 List the major financial institutions and describe the function of each briefly? Answer: Financial institutions: are actually specialized financial firms that facilitate the transfer of funds from savers/ investors to the demanders/users. Important institutions of international finance are the International Bank for Reconstruction and Development and International monetary fund Below are some of the major classes financial institutions / intermediaries:MUTUAL SAVING BANKS: MSB accepts savings from individuals and lend on Long term basis to the consumers. They take savings in form of ANNUAL PREMIUM Invest these funds in stocks, bonds, real estate and mortgages And make final payments to insured parties. Offerings: - variety of tax-deferred saving plan for the benefit of the customers when they retire. CREDIT UNIONS:Are cooperative associations whose member are supposed to have a COMMON bond like being the employee of same firm. Members savings are then offered to the other members for different purpose like loans for :1. Auto purchase 2. Home improvement 3. Home mortgage etc
LIFE INSURANCE COMPANIES :

Benefit:- CU are often the cheapest source of funds available to the borrowers . FINANCE serves variety of savers and borrowers as they were the MAJOR INSTITUTIONS that handled Checking accounts facilitating the Federal Reserve System to expand /contract the money supply . Benefit:- they are providing an ever widening range of SERVICES which includes insurances etc . PENSION FUNDS :these are basically the retirement plans funded by government agencies for their workers and commercials banks or any life insurance companies manage them . Investments:- investments are made in Bonds, Real estate {property}, mortgage etc. the corporations that accept funds from savers and use it to buy stock on short term /long term basis issued by business units . Main function : 1. to reduce risk by diversification 2. achieve economies of scale in analyzing securities 3. different funds are made to meet different objectives 4. there are bonds funds for safety purpose 5. stock funds are there for higher returns with risk factor
SAVINGS AND LOAN ASSOCIATION: MUTUAL FUNDS: COMMERCIAL BANKS -- THE DEPARTMENT STORES OF

takes the money from small investors and then lend it to home buyers and borrowers as it serves the residential and commercial savers , mortgage borrowers etc. QUESTION#2

What is stock market? Explain. Write about the stock market of Pakistan. Answer: STOCK MARKET Stock market is the most active secondary market, where outstanding, previously issued securities are traded A stock market is a public market for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately It is very important to financial managers because the primary goal of financial management is to maximize the firms stock price and prices of firms stocks are established in stock markets. MARKETS There are two basic types o stock markets, which include 1-Physical location exchanges 2-Electronic dealer based markets PHYSICAL LOCATION EXCHANGES: Physical location exchanges are the formal organizations having tangible physical locations that conduct autionsin listed securities. It includes 1- New York stock exchange(NYSE) 2- American stock exchange(AMEX) Each has limited number of members and has an elected governing body i.e. board of governors Security exchanges facilitate communication between buyers and sellers.
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TYPES OF STOCK

EXAMPLE The Merrill Lynch might have customer who wants to buy shares of AT&T stock. Simultaneously Morgan Stanley Dean Witters Denver might receive an order from a customer wishing to sell shares of AT&T. Each broker communicates electronically with the firms representative on the New York stock exchange. The exchange members with sell orders offer the shares for sale, and they are bid for by the members with buy orders. Thus the exchanges operate as auction market. 2- ELECTRONIC DEALER BASED MARKETS It includes NASDAQ stock market, the less formal over the counter market, and the recently developed electronic communications networks (ECNs). NASDAQ STOCK MARKET AND OVER THE COUNTER MARKET While the stocks of most large companies trade on the NYSE, a large number of stocks trade off the exchange in what has traditionally been referred to as the counter market (OTC) The dealers buy when individual investors want to sell, and then sell part of their inventory when investors want to buy. Dealer Market A dealer market is defined to include all facilities that are needed to conduct security transactions not made on the physical location exchanges. These facilities include 1- The relatively few dealers who hold inventories for these securities and who are said to make a market in these securities.

2- The thousand of brokers who act as agents in bringing the dealers together with investors. 3- The computers, terminals and electronic networks that provide a communication link between dealers and brokers. Bid Price and Share Price The dealers who make a market in the particular stock quote the price at which thy will pay for the stock. This is called Bid Price. The price at which they will sell shares is called Ask Price. Bid-Ask Spread It is the difference between the bids and asks prices. It represents the dealers mark up or profit.

PAKISTAN STOCK MARKETS The stock market capitalisation of listed companies in Pakistan was valued at $5,937 million in 2005 by the World Bank.. But in 2008, after the General Elections, uncertain political environment, rising militancy , inflation and current account deficits resulted in the steep decline of the Karachi Stock Exchange. As a result, the corporate sector of Pakistan has declined dramatically in significance in recent times. In the first four years of the twenty-first century, Pakistan's KSE 100 Index was the best-performing stock market index in the world as declared by the international magazine Business Week.

There are three basic stock markets in Pakistan, which are as follows: 1KARACHI STOCK EXCHANGE

Karachi Stock Exchange is the biggest and most liquid exchange in Pakistan. It was declared the Best Performing Stock Market of the World for the year 2002 . As of May 30, 2008, 654 companies were listed with a market capitalization. On December 26, 2007, the KSE 100 Index reached its highest value ever and closed at 14,814.85 points. Foreign buying interest had been very active on the KSE in 2006 and continued in 2007. KSE has seen some fluctuations since the start of 2008. One reason could be that it is the election year in Pakistan, and stocks are expected to remain dull.

Disputes between investors and members of the Exchange are resolved through deliberations of the Arbitration Committee of the Exchange. KSE began with a 50 shares index. As the market grew a representative index was needed. On November 1st, 91 the KSE-100 was introduced and remains to this day the most generally accepted measure of the Exchange. Karachi Stock Exchange 100 Index (KSE-100 Index) is a benchmark used to compare prices overtime, companies with the highest market capitalization are selected. To ensure full market representation, the company with the highest market capitalization from each sector is also included

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LAHORE STOCK EXCHANGE

The Lahore Stock Exchange (Guarantee) Limited came into existence in October 1970, under the Securities and Exchange Ordinance of 1969 by the Government of Pakistan in response to the needs of the provincial metropolis of the province of Punjab. It initially had 83 members The number of listed companies has increased to 519 since its inception. With 37 sectors of the economy and 519 listed companies with total capital of Rs. 555.67 billion having market capitalization of around Rs. 3.64 trillion . The LSE has 152 members of which 81 are corporate, and 54 are individual members. The LSE was the first stock exchange in Pakistan to use the internet and currently 50% of its transactions are via the internet. The Lahore Stock Exchange has opened branches in the industrial cities of Faisalabad and Sialkot for trading.

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ISLAMABAD STOCK EXCHANGE

Islamabad Stock Exchange is one of the three stock exchanges of Pakistan and is located in the capital of Islamabad. It was incorporated on October 25, 1989 and it became fully operational on August 10, 1992. At present there are 119 members out of which 93 are corporate bodies including commercial and investment banks, DFIs and brokerage houses. The other 26 Members are individual persons who are well educated, enterprising and progressive minded. The affairs of the Exchange are governed by the Board of Directors. The Board of Directors consists of five elected member directors and four are non-member directors nominated by the SECP while the managing director by virtue In order to protect the interest of the investing

public, an Investors Protection fund has been established by the Exchange. Since the inception of automated trading system (ISECTS), the trade volume has been multiplying day by day and the average daily turnover has now crossed the figure of 1 million shares. The system of physical handling of shares and securities has been phased out and majority of the scrips are settled through Central Depository Company of Pakistan Limited. At the moment there are 241 companies/securities listed on the Exchange with an aggregate capital of Rs. 389.512 billion. The market capitalization stood at Rs. 2,275.00 billion as on 04-04-2007 . The pace of listing has remained slow as the economy of the Country is under consistent pressure due to internal as well as external factors.

Question#3 Explain in detail what is agency relationship?

Answer
In order to understand the concept of agency relationship, we must need to know what agency theory is.

Agency Theory

It is the branch of Economics relating

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to the behavior of principals (such as owners) and their agents (such as managers). Let us look in detail what agents actually are.

Agents
Individuals authorized by another person, called the principal, to act on latters behalf. It has long being recognized that managers may have personal goals that compete with shareholder wealth maximization. Managers are empowered by the owners of the firm that is the shareholders to make decisions, and that creates a potential conflict of interest known as agency theory.

Agency Problem
A potential conflict of interest between the agent (manager) and the outside stockholders. Principals must provide incentives so that management acts in principles best interest and then monitor the results. An agency relationship arises whenever one or more individuals, called principles, hire another individual or organization, called and agent, to perform some services and delegate decision making authority to that agent. In financial management, the primary agency relationships are those between stockholders and managers and managers and debt hold

a) Stock holders vs managers

The objectives of management may differ from those of the firm's stockholders. Often ownership and control are separate, a situation that allows management to act in its own best interests rather than those of the stockholders.
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 Stockholders, hoping that the agents will act in the stockholders' best interests, delegate decision making authority to them Managers can be encouraged to act in stockholders best interest through incentives that reward them for good performance and punish for bad. Managerial compensation Different companies follow different compensation practices but a typical senior executive compensation is structured in three parts 1. Specified annual salary which is necessary to meet living expenses 2. A bonus paid at the end of the year- which depends on the companies profitability during the year 3. Options to buy stock or actual shares of stock which reward the executive for long term performance Direct intervention by shareholders Today the majority of stock is owned by institutional investors such as insurance companies, pension funds and mutual funds therefore the institutional investors have the right to exercise considerable influence, over most firm operations. They can talk with the firms management and make suggestions how the business should be run. Institutional investors acts as lobbyists for the body of stockholders

The threat of firing The threat of hostile take over

The primary monitoring of managers comes not from the owners but from the managerial labor market.' If the managerial labor market is competitive , it will tend to discipline the manager.! b) Stockholders vs creditors
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 There is also a conflict between creditors and

stockholders, creditors have the claim for payment of interest and principal on debt and they have the claim on the firms assets in event of bankruptcy. Creditors lend funds at rates that are based on the riskiness of the firms existing assets, expectations concerning the riskiness of future asset decisions, the firms existing capital structure and expectations concerning the future capital structure decisions. First creditors protect themselves from adverse action by including restrictive covenants in debt agreements.:-- Dividend policy decision The decisions as how much of current earnings to pay out as dividends rather than retain for the reinvestment in the firm. Profit maximization The maximization of the firms net income Earnings per share Net income available to the common dividend by the number of shares of common stock outstanding.

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References:www.google.com www.wikipedia.com & the Notes provided

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