Bangladesh University of Business & Technology (BUBT)

Course Title: Introduction to Finance

Course Number: FIN !"
The Business #nvironment & The Financial #nvironment
The Basic Forms of Business
There are three basic forms of business organization:
1. Sole Proprietorship: A business owned by one person and operated for his or
her own profit. The owner of this form of business raises capital from personal
resources or by borrowing and is responsible for all business decision. This
single owner has unlimited liability (the owners liability to satisfy the creditors is
up to the total wealth of the owner) for all debts of the firm.
2. Partnerships: A business form in which two or more individuals act as owners
operated the business for profit. In a general partnership all partners have
unlimited liability for the debts of the firm in a limited partnership one or more
partners may have limited liability.
3. Corporations: A business form legally separated from its owners. Therefore a
corporation is an intangible business entity created by law (often called a !legal
entity). Its distinguishing features include limited liability easy transfer of
ownership unlimited life and an ability to raise large sums of capital.
The Financial Environment
All businesses operate within the financial system which consists of a number of
institutions and mar"ets serving business firms individuals and governments.
Financial Market: #inancial $ar"ets are not so much physical places as they are
mechanisms for channeling savings to the ultimate investors in real assets. All
institutions and procedures for bringing buyers and sellers of financial instruments
together are called financial mar"ets. #inancial $ar"ets provide a forum (meeting) in
which suppliers of funds and demanders of funds can transact business directly. The
purpose of financial mar"ets in an economy is to allocate savings efficiently to the
ultimate users.
Financial markets can be broken into two classes:
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1. Money market: The money mar"et is concerned with the buying and selling
of short%term government and corporate debt securities.
2. Capital market: The capital mar"et deals with relatively long&term debt and
e'uity instruments.
(ithin money and capital mar"ets there e)ists both primary and secondary mar"et:
a) Primary market: A mar"et where new securities are bought and sold for the
first time. Therefore it is a !new issues* mar"et. This is the only mar"et where
in which the issuer is directly involved in the transaction.
b) Secondary market: A mar"et for e)isting securities rather than new
securities. That is the pre%owned securities are traded. +urchases and sales
of e)isting financial assets occur in the secondary mar"et. In this regard
organized e)changes ,-. /-. provide a means by which buy and sell
orders can be deficiently matched. In addition the over%the%counter (0T/)
mar"et serves as part of the secondary mar"et for stoc"s and bonds not listed
on and e)change as well as for certain listed securities. It means a large
collection of bro"ers 1 dealers connected electronically by telephones and
computers which provides for trading in unlisted securities.
Processes of Issuing Securities:
a) Private Placement: To raise money firms can go for private placement.
+rivate placement refers the sale of a new security issue typically bonds or
preferred stoc" directly to an investor or a group of investors (insurance
company pension funds etc.)
b) Public Placement: To raise money most firms raise money through a public
offering of securities which involves the sale of either bonds or stoc"s to the
general public2
The secondary mar"et financial intermediaries and financial bro"ers are the "ey
institutions that enhance funds flows.
Financial Intermediaries
#inancial intermediaries consist of financial institutions those accept money from
savers and use those funds to ma"e loans and other financial investments in their
own name. They include commercial ban"s savings institutions insurance
companies pension funds finance companies and mutual funds.
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Financial Brokers
#inancial bro"ers are not performing a direct lending function but rather are acting as
matchma"ers or middlemen. -uch as:
a) nvestment bankers: A financial institution that underwrites new securities for
resale.
b) Mort!a!e banker: A financial institution that originates mortgages primarily
for resale.
The a!ital "arket
/apital mar"ets are financial mar"ets for the buying and selling of long%term debt% or
e'uity%bac"ed securities. The bac"bone of capital mar"et is formed by the various
securities e)changes that provide a forum for debt and e'uity transaction.
#e$ securities
$a3or securities traded in the capital mar"et include bonds (long%term debt) and both
common and preferred stoc" (e'uity or ownership).
Functions of securities e%changes
The capital mar"et permits the conversion of savings into investment through loans
or through the sale of ownership. The securities e)changes that ma"e up the capital
mar"ets perform a number of important functions.
Creatin! a continuous market: The "ey function of securities e)changes is
to create a continuous mar"et for securities at a price that is not very different
from the price at which they were previously sold. The continuity of securities
mar"ets provides the li'uidity necessary to attract investors funds.
"llocatin! scarce capital: The securities e)changes help allocate scarce
funds to the best users.
#eterminin! and publici$in! security prices: (hat is bought or sold or the
demand and supply for the security determine the price of the individual
security.
"idin! in new %inancin!: -ecurities e)changes also provide firms with a
method of obtaining new financing.
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