UGC NET MBA Unit-5

Financial and Investment Management

This unit integrates financial decision-making, investment analysis, corporate restructuring, and international finance — one of the most important for both theory and numerical concepts in UGC NET.

🔹 1. Value and Returns

A. Time Preference for Money

Concept:
A rupee today is worth more than a rupee tomorrow because of its earning capacity.

Reasons:

Risk and uncertainty
Inflation
Consumption preference
Investment opportunities

Future Value (FV):

$F V = P V (1 + r)^{n}$

Where,
PV = Present Value, r = Interest rate, n = Number of periods

Present Value (PV):

$P V = \frac{F V}{(1 + r)^{n}}$

Annuity: Equal payments made at regular intervals.

Ordinary Annuity: Payments at the end of period
Annuity Due: Payments at the beginning of period

B. Valuation of Bonds

A bond is a long-term debt instrument.

Value of Bond:

$V_{B} = \sum_{t = 1}^{n} \frac{I}{(1 + k d)^{t}} + \frac{P}{(1 + k d)^{n}}$

Where:
I = Interest (coupon), kd = required rate of return, P = Par value, n = years to maturity

If Coupon Rate > Required Return → Premium Bond
If Coupon Rate < Required Return → Discount Bond

C. Valuation of Shares

For Preference Shares:

$V = \frac{D}{K}$

(D = fixed dividend, K = required rate)

For Equity Shares (Dividend Growth Model):

$P_{0} = \frac{D_{1}}{K_{e} - g}$

Where D₁ = expected dividend next year, Ke = cost of equity, g = growth rate.

D. Risk and Return

Return (R):

$R = \frac{(C u r r e n t I n c o m e + C a p i t a l G a i n)}{I n i t i a l I n v e s t m e n t}$

Risk:
Deviation of actual return from expected return.

Standard Deviation (σ):

$σ = \sqrt{\sum (R_{i} - \overset{ˉ}{R})^{2} P_{i}}$

Coefficient of Variation (CV):

$C V = \frac{σ}{\overset{ˉ}{R}} \times 100$

→ Used to compare relative risk between investments.

🔹 2. Capital Budgeting

Nature of Investment:

Capital budgeting involves long-term investment decisions in fixed assets (projects, plants, equipment).

Objectives:

Maximize shareholder wealth
Ensure efficient use of capital

Evaluation Methods:

Technique	Nature	Formula / Description
Payback Period	Non-discounted	Time to recover initial investment
ARR (Accounting Rate of Return)	Non-discounted	Average profit / Average investment
NPV (Net Present Value)	Discounted	PV of inflows – PV of outflows
IRR (Internal Rate of Return)	Discounted	Rate where NPV = 0
PI (Profitability Index)	Discounted	PV of inflows / PV of outflows

Decision Rules:
✅ Accept project if:

NPV > 0
IRR > cost of capital
PI > 1
Shorter payback (for liquidity)

Risk and Uncertainty in Capital Budgeting:

Risk-adjusted Discount Rate
Certainty Equivalent Approach
Sensitivity Analysis
Scenario Analysis
Simulation Analysis

🔹 3. Dividend Theories and Determination

A. Dividend Policy

Decides how much profit is distributed and how much retained.

Factors Affecting Dividend:

Liquidity position
Future growth needs
Shareholder expectations
Legal restrictions

B. Theories of Dividend

Theory	Proponent	Key Idea
Walter’s Model	Prof. James Walter	Dividend relevance; depends on return (r) and cost of capital (k).
Gordon’s Model	Myron Gordon	Investors prefer current dividends due to risk aversion.
M–M Model	Modigliani & Miller	Dividend policy is irrelevant under perfect market conditions.

Walter’s Model Formula:

$P = \frac{D + \frac{r}{k} (E - D)}{k}$

Gordon’s Model:

$P = \frac{E (1 - b)}{k - b g}$

where b = retention ratio, g = growth rate = br

🔹 4. Mergers, Acquisitions & Corporate Restructuring

A. Mergers and Acquisitions (M&A):

Merger: Two companies combine to form one.
Acquisition: One company purchases another.

Types:

Horizontal: Same industry (e.g., Vodafone–Idea)
Vertical: Supplier–buyer relationship
Conglomerate: Unrelated industries

B. Corporate Restructuring

Process of reorganizing ownership, capital, or structure to increase efficiency.

Objectives:

Synergy
Cost efficiency
Tax benefits
Diversification

C. Value Creation in M&A

Occurs if V(AB) > V(A) + V(B)
Reasons: economies of scale, market power, improved management.

D. Leveraged Buyout (LBO):

Acquisition financed largely through borrowed funds, where assets of the target are used as collateral.

E. Takeover:

When a firm acquires controlling interest in another.

Friendly Takeover: Mutual consent
Hostile Takeover: Without consent

🔹 5. Portfolio Management

A. Meaning:

Portfolio = combination of different investments to maximize return and minimize risk.

B. Risk Diversification:

Diversification reduces unsystematic (firm-specific) risk.

Total Risk = Systematic + Unsystematic

C. Capital Asset Pricing Model (CAPM):

$E (R_{i}) = R_{f} + β_{i} [E (R_{m}) - R_{f}]$

Where,
Rf = Risk-free rate,
β = Systematic risk,
Rm = Market return.

Interpretation:

β = 1 → average market risk
β > 1 → aggressive stock
β < 1 → defensive stock

D. Arbitrage Pricing Theory (APT):

Proposed by Stephen Ross, APT assumes multiple factors affect returns (inflation, GDP, interest rate, etc.).

$E (R) = R_{f} + b_{1} F_{1} + b_{2} F_{2} + \dots + b_{n} F_{n}$

🔹 6. Derivatives

Derivatives: Financial instruments whose value depends on underlying assets like stocks, bonds, or commodities.

A. Types:

Forward Contracts: Customized agreements to buy/sell at future date.
Futures Contracts: Standardized exchange-traded forwards.
Options: Right (not obligation) to buy/sell asset at fixed price.
Swaps: Exchange of cash flows or interest rates.

B. Options Terminology:

Call Option: Right to buy.
Put Option: Right to sell.
Strike Price: Agreed price.
Premium: Option cost.

Payoff:

Call Option Payoff = Max(0, S − K)
Put Option Payoff = Max(0, K − S)

C. Option Pricing Models:

Binomial Model – Step-by-step valuation.
Black–Scholes Model – Continuous model for European options.

🔹 7. Working Capital Management

A. Concept:

Working Capital = Current Assets − Current Liabilities
→ Ensures liquidity and smooth operations.

B. Determinants of Working Capital:

Nature of business
Credit policy
Inventory level
Business cycle
Production policy

C. Components:

Cash Management – maintaining optimum cash balance.
Inventory Management – controlling stock levels (EOQ model).
Receivables Management – credit control, collection period.
Payables Management – managing supplier payments.
Factoring: Selling receivables to a factor for immediate cash.

EOQ (Economic Order Quantity):

$E O Q = \sqrt{\frac{2 A O}{C}}$

Where,
A = Annual demand,
O = Ordering cost,
C = Carrying cost per unit.

🔹 8. International Financial Management

A. Definition:

Deals with financial management in international operations, including foreign exchange, risk, and cross-border investment.

B. Foreign Exchange Market:

A global market where currencies are traded.

Functions:

Currency conversion
Hedging and speculation
Financing international trade

C. Exchange Rate Systems:

Fixed Exchange Rate: Controlled by government.
Floating Exchange Rate: Determined by market forces.
Managed Float: Partial control by central bank.

D. Types of Foreign Exchange Risks:

Transaction Risk – due to exchange rate changes before settlement.
Translation Risk – affects accounting statements.
Economic Risk – affects long-term competitiveness.

E. Hedging Techniques:

Forward contracts
Futures
Options
Swaps