Data Science - Bond Trading - Fixed Income Markets

Peter Simon

Managing Director, Financial Markets Data Science

Peter leads DataRobot’s financial markets data science practice and works closely with fintech, banking, and asset management clients on numerous high-ROI use cases for the DataRobot AI Platform.  

Prior to joining DataRobot, he gained twenty-five years’ experience in senior quantitative research, portfolio management, trading, risk management and data science roles at investment banks and asset managers including Morgan Stanley, Warburg Pincus, Goldman Sachs, Credit Suisse, Lansdowne Partners and Invesco, as well as spending several years as a partner at a start-up global equities hedge fund. Peter has an M.Sc. in Data Science from City, University of London, an MBA from Cranfield University School of Management, and a B.Sc. in Accounting and Financial Analysis from the University of Warwick.  His paper, “Hunting High and Low: Visualising Shifting Correlations in Financial Markets”, was published in the July 2018 issue of Computer Graphics Forum.

When Does Machine Learning Work Well in Financial Markets Blog 

A DATA SCIENTIST EXPLAINS: WHEN DOES MACHINE LEARNING WORK WELL IN FINANCIAL MARKETS?

January 17, 2023

by

Peter Simon

As a data scientist, one of the best things about working with DataRobot customers is the sheer variety of highly interesting questions that come up. Recently, a prospective customer asked me how I reconcile the fact that DataRobot has multiple very successful investment banks using DataRobot to enhance the P&L of their trading businesses with my comments that machine learning models aren’t always great at predicting financial asset prices. Peek into our conversation to learn when machine learning does—and doesn’t—work well in financial markets use cases.

https://www.datarobot.com/blog/a-data-scientist-explains-when-does-machine-learning-work-well-in-financial-markets/

Yield Book Analytics

Empowering financial markets with the best-in-class models, robust analytics, and related services.

Our brand is changing to LSEG Yield Book

As a trusted and authoritative source of fixed income analytics for more than 30 years, Yield Book offers an expanded set of capabilities that include market-leading data and cashflows modelling for in-depth security and portfolio analysis ranging from vanilla bonds to highly structured mortgages and complex derivatives for clients to comprehensively address their requirements. 

Why Yield Book?

Single source solution

Sophisticated analytics

Differentiating insights

Unrivalled flexibility

Regulatory alignment

Single Source Solution

Get access to the “golden source” of fixed income data, prices, indices, and analytics driven by Refinitiv’s Pricing and Reference data that underpins the construction of FTSE Russell indices. 

Industry-wide analytics solutions

Our market-leading models, derived analytics solutions and AI-powered workflows enable buy-side and sell-side customers to stay ahead of the competition. Our clients can access analytical solutions across the breadth of their business requirements, including:

Scenario aligned cashflows

Real-time user-specified parameters, such as curves 

Derived analytics solutions, such as SRI / FRTB analytics

Our solutions are underpinned by comprehensive asset class coverage, sophisticated market leading models, supported by world-class expertise in global financial markets. 

https://solutions.yieldbook.com/en

Machine learning-aided modeling of fixed income instruments

Daniel Martin, Barnabás Póczos

Machine Learning Department

Carnegie Mellon University

Pittsburgh, PA 15213

Burton Hollifield

Tepper School of Business

Carnegie Mellon University

Pittsburgh, PA 15213

https://www.ml.cmu.edu/research/dap-papers/f18/dap-martin-daniel.pdf

Supervised similarity learning for corporate bonds using

Random Forest proximities

Jerinsh Jeyapaulraj

2022

https://arxiv.org/pdf/2207.04368.pdf

BondGPT

2023

https://fortune.com/2023/06/13/bondgpt-artificial-intelligence-finance-bond-kings-bill-gross-jeffrey-gundlach/

PIMCO - UNDERSTANDING INVESTING in BONDS

https://europe.pimco.com/en-eu/resources/education/everything-you-need-to-know-about-bonds

data science in bond trading  - Google search interesting results

Handbook of Artificial Intelligence and Big Data Applications in Investments - CFA

 This book can be found at cfainstitute.org/ai-and-big-data

Download

Handbook of Artificial Intelligence and Big Data Applications in Investments  https://rpc.cfainstitute.org/en/research/foundation/2023/ai-and-big-data-in-investments-handbook

AI Pioneers in Investment Management

https://www.cfainstitute.org/-/media/documents/survey/AI-Pioneers-in-Investment-Management.ashx

Investment Times - 9 January 1986 - Kakinada

 

ICFAI University - Portfolio Management – II

 Portfolio Management II 

Fixed Income Portfolio Management: Fixed Income Portfolio Management Strategies – Use of Derivatives in Fixed Income Portfolio Management – International Fixed Income Portfolio Management.

Managing a Property Portfolio: The Role of Property Portfolio in a Diversified Portfolio – The Property Investment Decisions – Microeconomic Influences on Property Returns – Macroeconomic Influences on Property Returns.

Portfolio Management Using Futures: Features of Index Futures Contracts  – Pricing of Index Futures Contracts – Stock Index Arbitrage – Portfolio Strategies Using Index Futures – Modifying Expectations with Futures and Options  – Portfolio Insurance – Perils of Using Futures to Hedge Portfolio Risk – Trading of Index Futures in India – Hedging with Interest Rate Futures.

Portfolio Management Using Options: Generic Terms Used in Options – Factors Influencing Option Prices – Elementary Investment Strategies – Trading Strategies of Options – Arbitrage with Options – Option Pricing Models – Evaluation of Option Based Investment Strategies.

Alternative Investments: Selection/Advantages of Alternative Investments – Private Equity Investing  – Evolution of Venture Capital Industry in India – Managed Futures – Hedge Funds – Role of Alternative Assets in a Traditional Portfolio.

International Diversification: Diversification Benefits of International Investments – Hedging Foreign Exchange Risk – International Fixed Income – Managing a Portfolio of International Assets.

Management of Investment Institutions: Behavioral Style Analysis – Return Based Style Analysis – Comparison of Investment Style – Strategies for Allocating Funds among Different Styles – Risks, Controls and Prudential Issues – Application of Style Analysis to Different Asset Classes.

Evolution of Mutual Funds: Introduction to Mutual Funds, History of Mutual Funds, Mutual Funds Industry in India, Mutual Funds Industry: Abroad, Advantages and disadvantages of mutual funds Factors Conductive to Growth of Mutual Funds Industry

Mutual Funds in India: The Different Types of Mutual Funds, Difference between the mutual funds and hedge funds, Fund of funds, Exchange traded fund, The Players in the Mutual Funds Industry, The Structure of Mutual Funds, Organization and Management Pattern of UTI,,Legal tax structure in US and UK ,Tax Treatment and Benefits, The Role of Mutual Funds in the Financial Market

Regulation of Mutual Funds: UTI Act, 1963, The Indian Trust Act, 1882, Companies Act, 1956 (for a Trust Company), SEBI (Mutual Funds) Regulation Act, 1996, establishment of mutual funds ,Launching of a Scheme, Winding up,  Investments, Valuation of Investments, financial reporting

Mutual Funds Prospectus and Balance Sheet: How to Read a Prospectus of a Mutual Fund?, How to Read and Analyze a Balance Sheet of a Mutual Fund?

Investment Strategies of Mutual Funds Investors: How to Evaluate a Mutual Fund, How to Select Different Mutual Funds Schemes, Understanding the Nature of Risks Involved in Mutual Funds Investment , Steps to Choose the Right Mutual Funds Scheme

Marketing and Investment Aspects of Mutual Funds: Marketing Aspects of Mutual Funds- Marketing plan, Product planning, Branding , pricing ,distribution , Promotion ,servicing ,market analysis and research , Marketing strategy , Operation ,Investment Aspects of Mutual Funds

Performance of Mutual Funds: Performance of Mutual Funds in the USA, Performance Analysis of Indian Mutual Fund Industry

Ethics in Mutual Funds: The Role of the AMFI, Ethical Aspects Considered in the Mutual Fund Industry

Future Scenario of Mutual Funds Industry: Trends in the Mutual Fund Industry in the US Indian Scenario and the Future Perspective, Overemphasis on Funds under Management.

The Gerald Loeb Award for Business and Finance Journalism

Gerald Martin Loeb was born in 1899 in San Francisco, California. He began his career in 1921, in the bond department of a securities firm. He moved to New York City in 1924 to help establish E.F. Hutton and eventually ascended to vice-chairman of the board. During Gerald Loeb’s career, he was a favorite of business and financial journalists for his willingness to be interviewed and was described as “probably the most quoted man on Wall Street” (Forbes Magazine 1955). He was also an author of two investment strategy books, a guest columnist for Forbes Magazine and widely considered a Wall Street icon. In 1957, he established the G. and R. Loeb Foundation (under stewardship of the University of Connecticut) to present The Gerald Loeb Awards for Distinguished Business and Financial Journalism. In 1973, Mr. Loeb transferred the stewardship of the awards to UCLA Anderson School of Management under the deanship of Harold Williams.

https://www.anderson.ucla.edu/gerald-loeb-awards


Sanjay Jha got the award.

International Finance and Financial Management in Multinational Company

World trade has increased. Companies export a lot and import a lot. Apart from import and export, now multinational, or global, corporations are emerging which operates in an integrated fashion in a number of countries. Also, there are companies that are using number of factories in various countries which are supported by suppliers located in various countries and then different countries are served by different factories.

In managing finance in companies with international trade or multinational operations,  some additional factors need to be considered.  Five of these factors are listed and described here:

1. Different currency denominations. Cash flows occur in  various currencies.  Hence,
exchange rates must be included in all financial analyses.

2. Political risk. Nations are free to place constraints on the transfer or use of corporate resources, and they can change regulations and tax rules at any time. They can even expropriate assets within their boundaries. Therefore, political risks occur in many forms  and they must be addressed explicitly in any financial analysis.

3. Economic and legal ramifications. Each country has its own unique economic and legal systems, and these differences can cause significant problems in operations.  For example, differences in tax laws among countries can cause a given economic transaction to have strikingly different after-tax consequences depending on the country where the transaction occurs. Legal differences
make procedures that are required in one part of the company illegal in others. These differences also make it difficult for executives trained in one country to move easily to another.

4. Role of governments.  Frequently, in many countries, the terms under which companies compete, the actions that must be taken or avoided, and the terms of trade on various transactions are determined not in the marketplace, but by direct negotiation between host governments and multinational enterprises. This is essentially a political process, and it must be treated as such. Thus,
traditional financial models have to be recast to include political and other noneconomic aspects of the decision.

5. Language and cultural differences. Different countries have unique cultural heritages that shape values and influence the conduct of business. Multinational corporations find that matters such as defining the appropriate goals of the firm, attitudes toward risk, performance evaluation and compensation systems, interactions with employees, and the ability to curtail unprofitable
operations vary dramatically from one country to the next.


Those five factors complicate financial management and increase the risks that multinational firms face. However, the prospects for high expected returns make it worthwhile for firms to accept these risks and learn how to manage them.


International Monetary Terminology



1. An exchange rate is the price of one country’s currency in terms of another country’s currency. One U.S. dollar would buy 0.5046 British pound, 0.6340 euro, or 0.9919 Canadian dollar.

2. A spot exchange rate is the quoted price for a unit of foreign currency to be delivered “on the spot” or within a very short period of time.

3. A forward exchange rate is the quoted price for a unit of foreign currency to be
delivered at a specified date in the future say 3 months or 6 months.

4. A fixed exchange rate for a currency is set by the government and is allowed to
fluctuate only slightly (if at all) around the desired rate, which is called the par
value.

5. A floating or flexible exchange rate is not regulated by the government, so
supply and demand in the market determine the currency’s value. The U.S.
dollar and the euro are examples of free-floating currencies.

6. Devaluation or revaluation of a currency is the technical term referring to the
decrease or increase in the stated par value of a currency whose value is
fixed.

7. Depreciation or appreciation of a currency refers to a decrease or increase,
respectively, in the foreign exchange value of a floating currency. These
changes are caused by market forces rather than by governments.

Monetary Arrangements of Countries with respect to Exchange Rates


At the most basic level, currency regimes can be divided into two broad groups:
floating rates and fixed rates.  In the floating-rate category, two main subgroups are there.


1. Freely floating. Here the exchange rate is determined by the supply and demand
for the currency.

2. Managed floating. Here there is significant government intervention to manage
the exchange rate by manipulating the currency’s supply and demand.  Governments rarely reveal their target exchange rate levels when they use a managed-float regime because doing so would
make it too easy for currency speculators to profit.


Types of fixed-exchange-rate regimes include the following:

1. No local currency. The most extreme position is for the country to have no local
currency of its own, using another country’s currency as its legal tender (such
as the U.S. dollar in the Panama Canal Zone).

2. Currency board arrangement. Under a variation of the first subregime, a country
technically has its own currency but commits to exchange it for a specified
foreign money unit at a fixed exchange rate.

3. Fixed-peg arrangement. In a fixed-peg arrangement, the country locks, or
“pegs,” its currency to another currency or basket of currencies at a fixed
exchange rate. This allows the currency to vary only slightly from its desired
rate; and if it moves outside the specified limits (often set at 1% of the target
rate), its central bank intervenes to force the currency back within the limits.

Other variations have been used, and new ones are developed from time to time.


MBA Core Management Knowledge - One Year Revision Schedule

Digital Transformation In Finance Area and Financial Management

Finance Transformation in the Big Data Era
Published on Published onJanuary 27, 2018
Karen (Yan) Wang
EMBA，AAIA，Certified Green Belt, Senior Finance Manager at Honeywell
https://www.linkedin.com/pulse/finance-transformation-big-data-era-karen-yan-wang/


Finance in a digital world: It’s crunch time for CFO’s!
A series on digital transformation in finance
https://www2.deloitte.com/us/en/pages/finance-transformation/articles/finance-digital-transformation-for-cfos.html



________________


________________
EMAGIA CORPORATION
Published on 15 Nov 2016

Liquidity, Solvency and Profitability - The Finance Challenge

Liquidity, Solvency, and Profitability are issues that are presented in the management report to share holders as a part of annual report of the company to shareholders.

Liquidity and solvency are discussed as part of the risk management of the company. The company has to be liquid so that it can pay creditors when the payment is due. Solvency is the condition where assets of the company are more than its liabilities. Top management has to do go through forward plans of the company to make sure its strategy does not create liquidity and solvency risks for the company. Many times low profits made by a company during the financial periods create these problems. Of course solvency risk comes because of losses sustained by a company in one or more new projects or the deterioration of existing business into losses.

Liquidity


Cash is king. Capital is queen. Without liquidity, the ability to pay to creditors, suppliers, employees, government promised payments when they become due, business comes to standstill. Liquidity planning has to be done by the company and top management has to make sure that the plan provides adequate liquidity for the next 12 months. It may be even a rolling plan. Top managers have to   understand  each inflow and outflow of the liquidity plan and have to satisfy themselves that those inflows and outflows are plausible and sufficient for the liquidity needs of the organization.

Solvency is the condition that equity capital is there in the company to support debt. When companies enter loss making phases, the equity may go on reducing and sometimes result in zero equity. The creditors can ask for the winding up of the company. Top managers have to take care of the five year plans of the company to make sure that the company will be solvent.

Profit is the reason why the company is in business. Top managers approve a business investment only there is adequate return. But approval implies complete conviction in the plan and the expected results have to come in the future periods. Top managers when they approve the business plans and budgets carry a burden to check the feasibility of them from all angles.



This article is part of #AtoZChallenge 2017 for Blogging Posts. My Theme for the Challenge is Top Management Challenges - Full List of Articles  http://nraomtr.blogspot.com/2016/12/a-to-z-2017-blogging-challenge-top.html


To Know More About A to Z Blogging Challenge
http://www.a-to-zchallenge.com/

Blog posts visited today

Entrepreneurial Finance

Strategic Entrepreneurial Finance: From Value Creation to Realization

Darek Klonowski
Routledge, 27-Nov-2014 - Business & Economics - 420 pages

Entrepreneurial finance is a discipline that studies financial resource mobilization, resource allocation, risk moderation, optimization in financial contracting, value creation, and value monetization within the context of entrepreneurship. However, without proper strategic consideration the discipline is incomplete. This book examines how the activity of entrepreneurial finance can be enhanced via a concentration on value creation and through improved strategic decision-making.

The most unique feature of the book is its focus on value creation. For entrepreneurs, value creation is not a one-off activity, but rather a continuous cycle of incremental improvements across a wide range of business activities. Entrepreneurial value creation is described in four comprehensive stages: value creation, value measurement, value enhancement, and value realization, referred to as the C-MER model. This book focuses on what creates value rather than merely presenting value creation in a straight accounting framework.

At the same time, deliberate and tactical planning and implementation ensure that the firm does not ignore the components necessary for it to survive and flourish.Vigorous strategic deliberations maximize the entrepreneurial firm’s chances of making the right business decisions for the future, enable the firm to manage its available financial and non-financial resources in the most optimal manner, ensure that the necessary capital is secured to progress the development of the firm to its desired development level, and build value.

While financial considerations are important, the field of strategic entrepreneurial finance represents a fusion of three disciplines: strategic management, financial management, and entrepreneurship. This orientation represents a natural evolution of scholarship to combine specific domains and paradigms of naturally connected business disciplines and reflects the need to simultaneously examine business topics from different perspectives which may better encapsulate actual entrepreneurial practices.

https://books.google.co.in/books?id=IDOcBQAAQBAJ

Financial Management - Subject Update Articles

March 2014

Is Your Budget Stuck on Last Year's Numbers?
McKinsey Article
http://www.mckinsey.com/insights/corporate_finance/is_your_budget_process_stuck_on_last_years_numbers

Finance for Non-Finance Managers

In all MBA programs, financial accounting, cost accounting and management accounting are taught under various names. Financial management is also taught. Many times persons who want to specialize in non-finance subjects neglect finance related subjects. But it is not right. First of all, every subject included in the MBA curriculum has to be learned during the MBA education period with adequate attention. No subject must be neglected. One can create two categories of subjects. If one gives 120 hours per semester for category A subjects and gives only 80 hours to category B subjects it is ok. Total neglect and later on telling, I ignored the subject are not appropriate.

Financial analysis is required in marketing, operations, supply chain management and even human resource management.  Pricing decision is an important decision in marketing and it has relation to financial analysis. In operations and SCM facility decisions require investment and investment analysis is an important finance topic. Human resource accounting is a popular topic now as human resources decisions like training budgets have financial analysis as the basis. Hence in each non-financial management area, finance is involved. Learn finance subject adequately when it is taught to you during MBA. In this blog, I created summaries of chapters of all subjects in MBA curriculum. Do visit and read them to refresh your knowledge at your convenience. 

Long Term Finance for Companies - USA

The corporate lending world can, in its simplest form, be divided into two different
approaches: the asset-based credit market and the cash flow-based credit market.
In ABL transactions, the lender’s interest is secured by the borrower’s assets, which then
forms the basis for determining how much credit the borrower can access. In contrast, the
cash flow method of determining credit capacity is principally based on an analysis of
the borrower’s enterprise value.


Asset-based lenders have generally found that, over time, the valuation of a borrower’s
assets is remarkably stable over a variety of business and economic cycles. This makes
calculating a borrower’s credit capacity based on asset values a highly predictable way
of providing capital to clients.


Cash flow-based loans, while also usually a secured form of financing, often use EBITDA
(or a company’s earnings before interest, taxes, depreciation and amortization) along with
a multiplier to determine credit capacity, rather than the value of the underlying collateral
assets. The level of EBITDA can change and the multiplier applied can change significantly during business and economic cycles. During an economic downturn, most companies will see their EBITDA decline, both on a relative and absolute basis. Often, the multiplier being used by lenders will shrink at the same time; this combination of declining EBITDA and a shrinking multiplier can result in a significant decline in available credit capacity at what could be the exact time a company most needs access to capital.

Typical uses

Frequent uses of ABLs

For higher quality, large-corporate borrowers, ABLs are often used simply for financing working capital. These companies will often access the public or private capital markets for long-term forms of financing for the majority of their overall capitalization. They will then use ABLs to fund seasonal changes in working capital, for shareholder value-creating actions such as share repurchase programs, dividends or distributions, and for opportunistic acquisitions.


For midsized companies, in addition to providing working capital financing, ABLs often incorporate
term loans, which are secured by longer-term assets such as machinery and real estate, to provide incremental credit capacity.

ABLs also tend to play a key role in the financing of companies facing cyclical or operating
performance headwinds that have caused their credit profile to deteriorate. They need
patient capital to attempt to execute on their business turnaround or restructuring
plans, or just to weather the current environment, including the possibility of bankruptcy
reorganization. Often, an ABL is “transitional” capital for these companies; for a time it
provides incremental liquidity and structural flexibility characteristics that help owners
and managers reposition the company. Once that is completed, these companies often
refinance again in the cash flow credit market.

There are also times when companies use an ABL as transitional capital only to later
realize that many of the characteristics of ABLs fit their business well. They may see that
both the discipline and freedom associated with these loans can enhance the way they
execute their plans. These companies often never go back to the cash flow loan market.
In fact, there are several Fortune 500 companies that have opted to used ABLs.

Qualifying companies


Manufacturers, wholesale distributors, retailers, and some forms of service companies
are prime candidates for ABLs. Solid ABL candidates will usually have tangible asset-rich
balance sheets, often with at least half of their total assets in working capital assets,
such as accounts receivable and inventory.

Like all lenders, asset-based loan providers look for companies with solid management
teams and a history of being able to effectively manage their businesses, even when
facing difficult circumstances. They also look for companies with excellent financial
accounting information systems that can provide reliable data about both operating and
asset performance.

Does company size matter in qualifying for an ABL?

No. Companies of all sizes can qualify for an ABL as long as their business is a good match
for the characteristics that asset-based lenders look for. For midsized companies, annual
revenues between $35 million and $250 million are typical of today’s borrowers. But ABLs
are also delivered just as easily to multibillion-dollar revenue companies.

What about credit ratings?
Since asset-based lending is always secured, its target market is non-investment grade
companies (companies with an actual or equivalent S&P rating of BB+ and below, or a
Moody’s rating of Ba1 and below). External credit ratings are not required to issue an ABL.

Which assets qualify as collateral under ABL structures?
Accounts receivable and inventory—assets that have a high degree of market liquidity
and can be easily valued and monitored—head the list of qualifying assets. Long-term
assets such as equipment and real estate are often used as additional collateral when
the ABL is structured as a term loan with a fixed amortization schedule.
Some proportion of even the most liquid of asset classes are typically ineligible in ABLs.
Examples include substantially past due accounts receivable, some types of work-inprocess
inventory or assets held for sale not in the ordinary course of business.

http://corp.bankofamerica.com/documents/10157/67594/Frequently_Asked_Questions_about_Asset_Based_Lending.pdf





Project Finance
Project Finance can be characterised in a variety of ways and there is no universally adopted definition
but as a financing technique, the author’s definition is:
 “the raising of finance on a Limited Recourse basis, for the purposes of developing a large capitalintensive
infrastructure project, where the borrower is a special purpose vehicle and repayment of the
financing by the borrower will be dependent on the internally generated cashflows of the project”
The terms ‘Project Finance’ and ‘Limited Recourse Finance’ are typically used interchangeably and
should be viewed as one in the same. Indeed, it is debatable the extent to which a financing where the
Lenders have significant collateral with (or other form of contractual remedy against) the project
shareholders of the borrower can be truly regarded as a project financing. The ‘limited’ recourse that
financiers have to a project’s shareholders in a true project financing is a major motivation for
corporates adopting this approach to infrastructure investment.
Project financing is largely an exercise in the equitable allocation of a project’s risks between the
various stakeholders of the project.
https://www.hsbcnet.com/gbm/attachments/products-services/financing/project-finance.pdf


MBA Core Management Knowledge - One Year Revision Schedule

Role of Finance Managers in Enterprise Risk Management

Companies should be managed so that they do not go into financial distress. Benjamin Graham tells conservative investors not to invest in a company that made a loss in the last ten years.

Financial distress is associated with having operating cash flows fall below minimum required levels. Risk management can reduce the likelihood of low cash flows and hence of financial distress.



Risk management meant buying insurance against fire, theft, and liability losses sometime back. Now finance managers have more alternatives.

 In an article in CFO, Scott Lange, who was head of Microsoft Risk at the time the article appeared, identified these 12 major sources of risk:


1. Business partners (interdependency, confidentiality, cultural conflict, contractual risks).
2. Competition (market share, price wars, industrial espionage, antitrust allegations).
3. Customers (product liability, credit risk, poor market timing, inadequate customer support).
4. Distribution systems (transportation, service availability, cost, dependence on distributors).
5. Financial (foreign exchange, portfolio, cash, interest rate, stock market).
6. Operations (facilities, contractual risks, natural hazards, internal processes and control).
7. People (employees, independent contractors, training, staffing inadequacy).
8. Political (civil unrest, war, terrorism, enforcement of intellectual property rights, change in leadership,
revised economic policies).
9. Regulatory and legislative (antitrust, export licensing, jurisdiction, reporting and compliance, environmental).
10. Reputations (corporate image, brands, reputations of key employees).
11. Strategic (mergers and acquisitions, joint ventures and alliances, resource allocation and planning, organizational agility).
12. Technological (complexity, obsolescence, workforce skill sets).

 Lange defined the role of finance in risk management: The role of finance is to put on paper all of
the risks that can be identified and to try to quantify them. When possible, use a number—one number perhaps or a probability distribution. For example, what is the probability of losing $1 million on a product? $10 million?


MBA Core Management Knowledge - One Year Revision Schedule

Financial Management Aspects of Mergers and Acquisitions

An acquisition of a company or substantial portion of its shares is an investment. Financial managers have to appraise it to see whether return on such investment is higher than the cost of the capital for the company.

Financial managers and theorists have proposed many reasons for acquisitions and merger activity. The primary economic motives mentioned are:


Synergy

Synergistic effects can arise from four sources: (1) operating economies, which result from economies of scale in management, marketing, production, or distribution due to combining operations; (2) financial economies, including lower transactions costs and better coverage by security analysts; (3) differential efficiency, which implies that the management of one firm is more
efficient and  will increase the return from that the weaker firm’s assets after the acquisition or  merger; and (4) increased market power due to reduced competition.





Tax Considerations
Tax considerations have stimulated a number of mergers. For example, a profitable firm in the highest tax bracket could acquire a firm with large accumulated tax losses. These losses could then be turned into immediate tax savings rather than carried forward and used in the future. Thus excess cash can be used  as a way of minimizing taxes.

Purchase of Assets below Their Replacement Cost
Sometimes a firm acquires a company because the cost of replacing its assets is considerably higher than its market value. If the new management uses the assets appropriately, the market value will increase in the future.

Diversification
Managers contend that diversification helps stabilize a firm’s earnings and thus benefits its owners as risk premium of the company's comes down. Stabilization of earnings is certainly beneficial to employees, suppliers, and customers; but its value is less certain from the standpoint of stockholders. Stockholders also can buy the stock of both firms? Many studies find that diversified firms are worth significantly less than the sum of their individual parts as top managements cannot provide adequate managerial expertise to diversified businesses.

Breakup Value
 Recently, takeover specialists have identified breakup value as  a basis for
valuation. A company’s breakup value, is the value of the individual parts of the firm if they are sold off separately. If this value is higher than the firm’s current market value, a takeover specialist could acquire the firm at or even above its current market value, sell it off in pieces, and earn a substantial profit. Such a breakup value is mainly appearing in diversified companies.

Types of Mergers


Mergers are classified into four types:
(1) horizontal,
(2) vertical,
(3) congeneric, and
(4) conglomerate.


A horizontal merger occurs when one firm combines with another in its same line of business.
An example of a vertical merger is a steel producer’s acquisition of one of its own suppliers, such
as an iron or coal mining firm. Congeneric means “allied in nature or action”; There is a relationship but not producers of the same product (horizontal) or firms in a producer-supplier relationship (vertical). A clothing retailer may acquire a food retailer.  A conglomerate merger occurs when unrelated enterprises combine.

Vertical and horizontal mergers generally provide the greatest synergistic operating benefits

Financial Analysis

The acquiring firm performs an analysis to value the target company based on its expected cash flows and cost of capital applicable and then determines whether the target can be bought at that value or, preferably, for less than the estimated value.

The target company also makes an analysis of its cash flows and makes a valuation of them and will accept the offer if the price exceeds either its value if it continued to operate independently or the price it could receive from some other bidder.


MBA Core Management Knowledge - One Year Revision Schedule

Management of Cash and Marketable Securities

Sophistication is increasing  in cash management by corporations. The trend has been toward reducing cash—the firm’s most liquid asset—to a minimum.  and the funds are invested in interest earning securities or in earning assets. This trend can be attributed to rising interest rates on securities, which make the opportunity cost of holding cash more expensive, to innovations in cash management, and to economies of scale in cash management as corporations grow larger.

A number of methods have come into existence in recent years to speed up this collection process and maximize available cash. These methods helps cash management in the following ways:
(1) speed the mailing time of payments from customers to the firm;
(2 ) reduce the time during which payments received by the firm remain uncollected funds; and
(3) speed the movement of funds to disbursement banks.


Multiple Collection Centers

 Instead of a single collection center located at the company headquarters, multiple collec-
tion centers are established. The purpose is to shorten the period between the time a customer mails in his payment and the time when the company has the use of the funds. Customers in a particular geographic area are instructed to remit their payments to a collection center in that area.  When
payments are received, they are deposited in the collection center’s local bank. Surplus funds are then transferred from these local bank accounts to a concentration bank or banks. A bank of concentration is one with which the company has a major account—usually a disbursement account.


Bank Collection of Checks from Post Offices


Another means of accelerating the flow of funds is a lock-box arrangement. The purpose
of a lock-box arrangement is to eliminate the time between the receipt of remittances by the company and their deposit in the bank. The company rents a local post office box and authorizes its bank in
each of these cities to pick up remittances in the box. Customers are billed with instructions to mail their remittance to the lock box. The bank picks up the mail several times a day and deposits the checks in the company’s account. This procedure frees the company from handling and depositing the checks. The main advantage of a lock-box system is that checks are deposited at banks sooner and become collected balances sooner than if they were processed by the company prior to deposit. No doubt, the bank will take an extra fee for the service. But the service is utilized only when it is profitable for the company to employ it.


Frequently, firms give special attention to the handling of large remittances so that they may be deposited in a bank as quickly as possible. This special handling may involve personal pickup of these checks or the use of airmail or special delivery.. The firm should exercise tight control over interbank transfers of cash and transfers between various units of the company, such as divisions or subsidiaries. Excessive funds may be tied up in various divisions of the firm.

Some companies maintain too many bank accounts, thereby creating unnecessary pockets of idle funds. With less number of accounts also similar service can be provided at a lesser cost to the company.


MBA Core Management Knowledge - One Year Revision Schedule

Management of Investment in Accounts Receivable

Management of Accounts Receivable


Accounts receivable is a current asset that appears due to the extension of open-account credit
by one firm to other firms and to individuals. Credit has to be extended to generate sales.
Therefore, accounts receivable are necessary investment, but require careful analysis. Receivables can be managed efficiently so that the level of investment in them is optimal.

Credit policy involves a tradeoff between the profits on sales that give rise to receivables on one hand and the cost of carrying these receivables plus bad-debt losses on the other. Credit policy determines
the amount of credit risk  accepted. In turn, the risk accepted or taken affects the slowness of receivables as well as the amount of bad-debt losses. Collection procedures also affect these factors. Thus, proper the credit granting and collection procedures of the firm determine the success of the firm’s overall credit management and collection policies.

CREDIT AND COLLECTION POLICIES


The policy variables include the quality of the trade accounts accepted, the length of the credit period, the cash discount given, any special terms given, such as seasonal datings, and the collection program of the firm. Together, these elements largely determine the average collection period and the proportion of bad-debt losses.

Credit Standards

Credit policy can have a significant influence upon sales. If competitors extend credit liberally and if a firm does not, the policy may have a dampening effect upon the marketing effort. Trade credit is one of many factors that influence the demand for a firm’s product.  In theory, the firm can lower its quality standard for accounts accepted as long as the expected profitability of sales generated exceeds the added costs of the receivables. What are the costs of relaxing credit standards? The incremental cost comes from the increased probability of bad-debt losses. Also a slower average collection
period will occur.

To determine the profitability of a more liberal extension of credit, we must know the profitability of additional sales; the added demand for products arising from the relaxed credit standards; the increased slowness of the average collection period; and the required return on investment.


Suppose a firm’s product sells for $ 10 a unit, of which $7 represents variable costs before taxes, including credit department costs. Current annual sales are $2.4 million, represented entirely by credit sales, and the average total cost per unit at that volume is $9 before taxes. The firm is considering a more liberal extension of credit, which will result in a slowing in the average collection period from one to two months. This relaxation in credit standards is expected to produce a 25 per cent increase in sales, to $3 million annually.  With this percentage increase, the unit sales and total costs of the firm become:


Cost of Present sales  =  240,000 units X $9 = $2,160,000
Marginal cost of Additional sales =  60,000 units X $7 = 420,000
Total cost =  $2,580,000
The average cost per unit of sale at the new level of sales is
$2,580,000/300,000

Assume that the firm’s required return on investment is 20 per cent before taxes.

Inasmuch as the profitability on additional sales, $180,000 (60,000 * $3), exceeds the required return on the additional investment in accounts receivable, $50,000, the firm is advised to relax its credit standards. An optimal credit policy would involve extending trade credit more liberally until the marginal profitability on additional sales equals the required return on the additional investment in receivables necessary to generate those sales.


MBA Core Management Knowledge - One Year Revision Schedule

Financial Management of Inventory

INVENTORY CONTROL AND THE FINANCIAL MANAGER



Inventory management usually is not the direct operating responsibility of the financial manager. But  the investment of funds in inventory is a very important aspect of financial management. The finance manager has to appraise the proposed investment in inventory like the appraisal he does for fixed capital assets. Consequently, the financial manager must be familiar with methods proposed in the theory to plan and control inventories. Planning of the inventory is based on minimising the costs associated with keeping inventory.

The inventory control or management methods described give  a means for determining an optimal level of inventory, and also to decide when to ordered and in what quantity. . These tools are necessary for
managing inventory efficiently and balancing the advantages of additional inventory against the cost of carrying this inventory. With the use of computers, great improvements in inventory control have been made
and are continuing to be made. Also there are manyu applications of operations research to inventory management.

New ideas to reduce inventory required normally occur with in the inventory management theory. But even finance theory sometimes may come out with principles related to optimizing inventory. When the innovation occurs in the finance field, finance managers have to take the responsibility of implementing it within their activity or within inventory management activity.

Inventories, like receivables, represent a significant portion of most firms’ assets, and, accordingly, require substantial investments. Inventories must be managed efficiently.

Inventories provide a very important link in the production and sale of a product. For a company engaged in manufacturing, a certain amount of inventory is absolutely necessary in the production distribution system. Toyota Production System came out of the efforts of managers identify and eliminate excess inventory which was thought at that time as essential.

 The obvious disadvantages of inventory are the total cost of holding the inventory, including storage and handling costs, and the required return on capital tied up in the investment in inventory. Inventories, like accounts receivable, should be increased as long as the resulting savings exceed the total cost of holding the added inventory. The balance finally reached depends upon the estimates of actual savings, the cost of carrying additional inventory, and the efficiency of inventory control.

INVENTORY CONTROL

Without inventory between production stages, each stage of production would be dependent upon the preceding stage’s finishing its operation on a unit of production. As a result, there probably would be delays and considerable idle time in certain stages of production.

According to traditional inventory theory,  the advantages of increased inventories, then, are several. The firm can effect economies of production and purchasing and can fill customer orders more quickly. In short, the firm is more flexible.

For a given level of inventory, the efficiency of inventory control affects the flexibility of the firm. Two essentially identical firms with the same amount of inventory may have significantly different degrees of
flexibility in operations due to differences in inventory control. Inefficient procedures may result in an unbalanced inventory —the firm may frequently be out of certain types of inventory, and overstock other
types, necessitating excessive investment. These inefficiencies ultimately have an adverse effect upon profits. Turning the situation around, differences in the efficiency of inventory control for a given level of flexibility
affect the level of investment required in inventories. The less efficient the inventory control, the greater the investment required. Similarly, excessive investment in inventories affects profits adversely.

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ECONOMIC ORDER QUANTITY


The economic order quantity (EOQ) is an important concept in inventory management.

The optimal order quantity for a particular item of inventory, given its forecasted usage, ordering cost, and carrying cost is determined using mathematics. Ordering can mean either the purchase of the item or its production. Assume for the moment that the usage of a particular item of inventory is known with certainty. Moreover, assume that ordering costs per order, O, are constant regardless of the size of the order. In the purchase of raw materials or other items, these costs represent the clerical costs involved in placing an order as well as certain costs of receiving and checking the goods once they arrive.


For finished-goods inventories, ordering costs involve scheduling a production run. For in-transit inventories, ordering costs are likely to involve nothing more than record keeping. The total ordering cost for
a period is simply the number of orders for that period, times the cost per order. It is important to state at this point that Toyota reduced its ordering cost or set up cost and thereby reduced its economic order quantities.


Carrying costs per period, C, represent the cost of inventory storage, handling, and insurance, together with the required rate of return on the investment in inventory. These costs are assumed to be constant per unit
of inventory, per unit of time. Thus, the total carrying cost for a period is the average number of units of inventory for the period, times the carrying cost per unit. In addition, it is  assumed  that inventory orders are filled immediately, without delay.

If the usage of an inventory item is perfectly steady over a period of
time and there is no safety stock, average inventory (in units) can be expressed
as:  EOQ/2

The EOQ formula is  SQRT(2AS/I)

A = annual demand
S = ordering cost
I = inventory carrying cost per unit

UNCERTAINTY AND SAFETY STOCKS

In practice, the demand or usage of inventory generally is not known with certainty; usually it fluctuates during a given period of time. Typically, the demand for finished-goods inventory is subject to the fluctuation. . In addition to demand or usage, the lead time required to receive delivery of inventory once an order is placed is usually subject to some variation. Owing to these fluctuations, it is not feasible in most cases to allow expected inventory to fall to zero before a new order is expected to be received, as could be done when usage and lead time were known with certainty.


Most firms maintain some margin of safety, or safety stock; otherwise, they may at times be unable to satisfy the demand for an item of inventory. There are opportunity costs to being out of stock. In the case of
finished-goods inventory, the customer is likely to become irritated and may take his business elsewhere. In the case of raw-materials and intransit inventories, the cost of being out of stock is a delay in production.
While this opportunity cost is measured more easily than that associated with finished-goods inventory, a stockout of the latter has a cost; and the firm must recognize it.


. If we know the cost per unit of stockout, we can calculate the expected cost of stockouts and then compare this cost with the cost of carrying additional inventory.

Uncertainty o f Lead Time. Suppose that the lead time required for procurement, like demand or usage, is subject to a probability distribution. Based on this probability distribution can determine the optimal level of safety stock for the period.

ORDER POINT FORMULA

At order point which is a stock level, an order is placed.

Order Point* = S(L) +  Safety Stock


where S is the usage, L is the lead time required to obtain additional inventory




Suggestions for Inventory Efficiency



When demand or usage of inventory is uncertain, the financial manager may try to effect policies that will reduce the average lead time required to receive inventory once an order is placed. The lower the
average lead time, the lower the safety stock needed and the lower the total investment in inventory, all other things held constant. The greater the opportunity cost of funds invested in inventory, the greater the
incentive to reduce this lead time. In the case of purchases, the purchasing department may try to find new vendors that promise quicker delivery or place pressure on existing vendors for faster delivery. In the
case of finished goods, the production department may be able to schedule production runs for faster delivery by producing a smaller run. In either case, there is a tradeoff between the added cost involved in reducing the lead time and the opportunity cost of funds tied up in inventory. This discussion serves to point out the importance of inventory management to the financial manager. The greater the efficiency with which
the firm manages its inventory, the lower the required investment in inventory, all other things held constant.


The modern inventory system is zero inventory system. It is also being called lean system (non stock system). To know how nonstock highly efficient systems were developed in Toyota read
Toyota Production System Industrial Engineering.


MBA Core Management Knowledge - One Year Revision Schedule

Working Capital Finance - USA

This article  introduces the five major forms of debt used to finance working capital. The purpose of this information is to provide insight into the different ways in which debt for working capital can be structured and prepare finance professonals  to choose and structure  debt best suited to a firm’s financial situation and needs.


Line of Credit

A line of credit is an open-ended loan with a borrowing limit that the business can draw against or repay at any time during the loan period. This arrangement allows a company flexibility to borrow funds when the need arises for the exact amount required. Interest is paid only on the amount borrowed, typically on a monthly basis. A line of credit can be either unsecured, if no specific collateral is pledged for repayment, or secured by specific assets such as accounts receivable or inventory.

The standard term for a line of credit is 1 year with renewal subject to the lender’s annual review and approval. Lenders usually require full repayment of the line of credit during the annual loan period
and prior to its renewal. This repayment is sometimes referred to as the annual cleanup.

Lenders require a fee for providing the line of credit, based on the line’s credit limit, which is paid whether or not the firm uses the line. This fee, usually in the range of 25 to 100 basis points, covers the bank’s costs for underwriting and setting up the loan account in the event that a firm does not use the line and the bank earns no interest income. A second cost is the requirement for a borrower to maintain a compensating balance account with the bank. Under this arrangement, a borrower must have a deposit account with a minimum balance equal to a percentage of the line of credit, perhaps 10% to 20%. If a firm normally maintains this
balance in its cash accounts, then no additional costs are imposed by this requirement. However, when a firm must increase its bank deposits to meet the compensating balance requirement, then it is incurring an additional cost. In effect, the compensating balance reduces the business’s net loan proceeds and increases its effective interest rate.

 Like most loans, the lending terms for a line of credit include financial covenants or minimal financial standards that the borrower must meet. Typical financial covenants include a minimum current ratio, a minimum net worth, and a maximum debt-to-equity ratio. The advantages of a line of credit is that it allows a company to minimize the principal borrowed and the resulting interest payments.

With full repayment required each year and annual extensions subject to lender approval, a line of credit cannot finance medium-term or long-term working capital investments.


Accounts Receivable Financing

Loans secured by accounts receivable are a common form of debt used to finance working capital.
Under accounts receivable debt, the maximum loan amount is tied to a percentage of the borrower’s accounts receivable.  The firm must use customer payments on these receivables to reduce the loan balance. The borrowing ratio depends on the credit quality of the firm’s customers and the age of the accounts receivable. A firm with financially strong customers should be able to obtain a loan equal to 80% of its accounts receivable. With weaker credit customers, the loan may be limited to 50% to 60% of accounts
receivable. Lenders may exclude receivables beyond a certain age (e.g., 60 or 90 days) in the base used to calculate the loan limit.

Since accounts receivable are pledged as collateral, when a firm does not repay the loan, the lender will collect the receivables directly from the customer and apply it to loan payments. The bank receives
a copy of all invoices along with an assignment that gives it the legal right to collect payment and apply it to the loan. In some accounts receivable loans, customers make payments directly to a bank-controlled account (a lock box).


Firms gain several benefits with accounts receivable financing arrangements. Borrowing capacity grows automatically as sales grow. This automatic matching of credit increases to sales growth provides a ready means to finance expanded sales, which is especially valuable to fast-growing firms. Accounts receivable financing allows small businesses with creditworthy customers to use the stronger credit of their customers to
help borrow funds.

Factoring

Factoring entails the sale of accounts receivable to another firm, called the factor, who then collects payment from the customer. Through factoring, a business can shift the effort and costs of collection and the risk of nonpayment to a third party. In a factoring arrangement, a company and the factor work out a credit limit and average collection period for each customer. As the company makes new sales to a customer, it provides an invoice to the factor. The customer pays the factor directly, and the factor then pays the company based on the agreed upon average collection period, less a slight discount
that covers the factor’s collection costs and credit risk.

A factor may advance payment for a large share of the invoice, typically 70% to 80%, providing the
company with immediate cash flow from sales. In this case, the factor charges an interest rate on this advance and then deducts the advance amount from its final payment to the firm when an invoice is collected

Factoring saves the cost of establishing and administering its own collection system. Second, a factor can often collect accounts receivable at a lower cost than a small business, due to economies of scale, and transfer some of these savings to the company. Third, factoring is a form of collection insurance that provides an enterprise with more predictable cash flow from sales. On the other hand, factoring costs may be higher than a direct loan,.The business loses control over the collection  part of the customer relationship, which may affect overall customer relations, especially when the factor’s collection practices differ from those of the company.

Inventory Financing

Inventory financing is a secured loan with inventory as collateral.  Firms with an inventory of standardized goods with predictable prices, such as automobiles or appliances, will be more successful at securing
inventory financing than businesses with a large amount of work in process or highly seasonal or perishable goods. Loan amounts also vary with the quality of the inventory pledged as collateral, usually ranging from 50% to 80%. For most businesses, inventory loans yield loan proceeds at a lower share of pledged assets than accounts receivable financing. When inventory is a large share of a firm’s current assets, however, inventory financing has to be sought to finance working capital.


Lenders need to control the inventory pledged as collateral to ensure that it is not sold before their loan is repaid. Two primary methods are used to obtain this control: (1) warehouse storage; and (2) direct assignment by product serial or identification numbers.  Under one warehouse arrangement, pledged inventory is stored in a public warehouse and controlled by an independent party (the warehouse operator). A warehouse receipt is issued when the inventory is stored, and the goods are released only upon
the instructions of the receipt-holder. When the inventory is pledged, the lender has control of the receipt and can prevent release of the goods until the loan is repaid. A field warehouse, can also be established. Here, an independent public warehouse company assumes control over the pledged inventory at the
firm’s site.  Direct assignment by serial number is a simpler method to control inventory used for manufactured goods that are tagged with a unique serial number. The lender receives an assignment or trust
receipt for the pledged inventory that lists all serial numbers for the collateral. The company houses and controls its inventory and can arrange for product sales. However, a release of the assignment or return of the trust receipt is required before the collateral is delivered and ownership transferred to the buyer. This release occurs with partial or full loan repayment.


While inventory financing involves higher transaction and administrative costs than other loan instruments, it is an important financing tool for companies with large inventory assets.


Term Loan

Term loans can finance medium-term noncyclical working capital. A term loan is a form of medium-term debt in which principal is repaid over several years, typically in 3 to 7 years. Since lenders prefer not to bear interest rate risk, term loans usually have a floating interest rate set between the prime rate and prime plus 300 basis points, depending on the borrower’s credit risk.
.
Term loans have a fixed repayment schedule that can take several forms. Level principal payments over the loan term are most common. In this case, the company pays the same principal amount each month plus interest on the outstanding loan balance. A second option is a level loan payment in which the total payment amount is the same every month but the share allocated to interest and principle varies with each payment. Finally, some term loans are partially amortizing and have a balloon payment at maturity. Term loans can be either unsecured or secured; a business with a strong balance sheet and a good profit and cash flow history might obtain an unsecured term loan, but many small firms will be required to pledge assets. Moreover,
since loan repayment extends over several years, lenders include financial covenants in their loan agreements to guard against deterioration in the firm’s financial position over the loan term. Typical financial covenants
include minimum net worth, minimum net working capital (or current ratio), and maximum debt-to-equity ratios. Finally, lenders often require the borrower to maintain a compensating balance account equal to 10% to 20% of the loan amount.

To be rewritten once again.

MBA Core Management Knowledge - One Year Revision Schedule

Chapter 15. Working Capital Management

Chapter 15 -- Working Capital Management



. Working capital, net working capital, and net operating working capital
. Current asset investment and financing policies
. Cash conversion cycle
. Cash and marketable securities
. Inventories
. A/R and A/P (trade credit)
. Bank loans






. Working capital, net working capital, and net operating working capital


 Working capital refers to current assets

Net working capital = currents assets - current liabilities

Net operating working capital = current assets - (current liabilities - notes payable)





. Current assets investment and financing policies


Current assets investment policy: how much current assets a firm should have

 Relaxed current asset policy: carry a relatively large amount of current assets

 along with a liberal credit policy with a high level of A/R

 Restricted current asset policy: carry constrained amount of current assets along
with restricted credit policy

Moderate current asset policy: in between the relaxed and restricted policies




 Current asset financing policy: the way current assets are financed







Permanent assets vs. temporary assets

 Permanent assets: to be held for more than one year

 Temporary assets: to be held for less than one year



 Maturity matching approach: a policy that matches asset and liability maturities
and it is a moderate policy



 Aggressive approach: uses more short-term, non-spontaneous debt financing

 Conservative approach: uses more long-term debt and equity financing



Permanent assets should be financed by intermediate and long-term debt,
preferred stock, and common stock.



Temporary assets should be financed by notes and short-term loans.





. Cash conversion cycle


 (1) The cash conversion cycle (CCC)

 The average length of time funds are tied up in working capital or the length of
time between paying for working capital and collecting cash from the sale of the
working capital

(2) Inventory conversion period (days of sales in inventory, DSI)

The average time required to convert materials into finished goods and then sell
them

(3) Average collection period (ACP)

The average length of time required to convert the firm’s receivables into cash

(4) Payables deferral period (days of payable outstanding, DPO)

The average length of time between the purchase of materials and labor and
the payment of cash for them






The relationship is: DPO + CCC = DSI + ACP, or CCC = DSI + ACP - DPO



Minimizing working capital: speeding cash collection (reducing ACP), increasing
inventory turnovers (reducing DSI), and slowing down cash disbursement
(increasing DPO)





. Cash and marketable securities


 Refer to currency and demand deposits in addition to very safe and highly liquid
marketable securities that can be sold quickly at a predictable price and thus be
converted to bank deposits





. Inventories


 Include supplies, raw materials, work-in-process, and finished goods





. A/R and A/P (trade credit)


 A/R: funds due from customers



 Credit policy: a set of rules that includes credit period, discounts, credit standards,
and collection policy



 Credit terms: for example, 2/10, net 30 means that the firm allows a 2% price
discount if payment is received within 10 days of the purchase; if the discount is
not taken, the full payment is due in 30 days



 Credit score: a numerical score from 1 to 10 that indicates the likelihood that a
person or business will pay on time



 A/P (trade credit): debt arising from credit sales and recorded as an account
receivable by the seller and as an account payable by the buyer



 Trade credit may be free or it may be costly. For example, the terms 2/10, net 30 are offered when a firm makes the purchase on its credit card. Assuming 365 days per year,

 discount % 365

Nominal annual cost of trade credit = --------------------*-------------------------------

 100-discount % credit days-discount days

 2 365

 = ------------- * ------------- = 37.24%

 100 - 2 30 - 10





. Bank loans


 Promissory note: a document specifying the terms and conditions of a loan



 Line of credit: an agreement in which a bank agrees to lend up to a specified

 maximum amount of funds during a designated period



 Cost of bank loans:

 interest 1

 Annual Percentage Rate (APR) = -------------*-------

 principal time





Accrued wages and taxes



Commercial papers: unsecured, short-term promissory notes issued by large firms


MBA Core Management Knowledge - One Year Revision Schedule





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Chapter 14. Dividend Policy

Chapter 14 -- Dividend Policy



. Dividend vs. retained earnings
. Dividend policy: three basic views
. The clientele effect
. The information content or signaling hypothesis
. Dividend policy in practice
. Dividend payment procedures
. Factors influencing dividend policy
. Stock repurchase, stock dividends and stock splits






. Dividend vs. retained earnings


 Dividend payout ratio vs. profit retention ratio: a review

 Higher dividends mean lower retained earnings, which means lower growth rate
and less capital gains





. Dividend policy: three basic views


 Dividend policy: to determine the optimal payout ratio to maximize the stock price



 View 1: dividend policy is irrelevant (Irrelevance Theory by MM 1961)



Assumptions: perfect capital markets with no taxes, no transaction costs, no
flotation costs, etc.



 Result: dividend policy doesn't matter; dividend policy does not affect a firm ‘s
value or its overall cost of capital



 View 2: high dividends increase stock price (Bird-in-the-hand theory 1979)



 Result: investors feel more secure to receive cash dividends than the income from
capital gains. Therefore, the higher the cash dividend, the better the stock



 View 3: low dividends increase stock price (Tax differential theory 1979)



 The tax rates on cash dividends were higher than the tax rates on long-term
capital gains before 2003. In addition, capital gains tax can be delayed until the
stocks are sold (time value of money) or can be avoid if stocks are passed to
beneficiaries provided the original owner passes away.



 Result: the lower the cash dividend, the better the stock




. The clientele effect


 Different dividend policies will attract different investors





. The information content or signaling hypothesis


 Information asymmetry: insiders and outsiders have different information


 Dividends reveal some inside information about firm's future profitability. By
increasing dividends, managers signal to the market that the firm will have enough
earnings to support future projects.



 Result: an increase in dividend is regarded as a good signal, which causes the stock

 price to go up.





. Dividend policy in practice


 Residual dividend model

 A model that states that the dividends to be paid should equal to the capital left over
after financing of profitable investments.








 Alternatives:

 Constant dividend payout ratio

 Stable dividend per share

 Low regular dividend plus extras when time is good


. Dividend payment procedure


 Declaration date

 Holder-of record date

 Ex-dividend date: two business days prior to the holder-of record date

 Payment date

 2 business   days



 Declaration Ex-div Record Payment



 Tax implications: if you buy the stock before Ex-dividend date, you will receive
dividend (but you pay a higher price); if you buy the stock after Ex-dividend date,
you will not receive dividend (but you pay a lower price).





. Factors influencing dividend policy


 Constraints:

 Bond indenture

 Preferred stock restrictions

 Impairment of capital structure: dividends cannot exceed the balance sheet item R/E

 Availability of cash

 Penalty tax on improperly accumulated earnings



 Investment opportunities:

 Profitable investment opportunities

 Possibility of accelerating or delaying projects



 Alternative sources of capital:

 Cost of selling new stock

 Ability to substitute debt for equity

 Control of the company



 Effects of dividend policy on cost of equity

(1) Stockholders’ desire for current vs. future income
(2) The perceived riskiness of dividends vs. capital gains
(3) The tax advantage of capital gains
(4) The information (signaling) content







. Stock repurchase, stock dividend and stock splits


 Stock repurchase: transactions in which a firm buys back shares of its own stock



 Effects:

 Internal investment opportunity

 Decreasing the number of shares outstanding

 Changing capital structure

 Increase in EPS

 Changing the ownership

 Taking tax advantage



Stock dividend: a distribution of new shares to current stock holders based on a
pro rata basis. For example, a 20% stock dividend will give a shareholder with
100 shares additional 20 shares (usually in small percentages)



Stock splits: an action taken by a firm to increase the number of shares
outstanding. For example, a 2-for-1 stock split will give a shareholder with 100
shares additional 100 shares (usually for large percentages)



 After stock dividend or stock split, the number of shares outstanding increases,

 earnings per share, dividend per share, and stock price all decline



 Why stock dividends and/or stock splits?

 Conserve cash

 Optimal stock price range

 Positive signals

Higher total value



 Examples: APPLE is using stock buyback program to increase its stock price


MBA Core Management Knowledge - One Year Revision Schedule





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