MGT201 Short Notes

Short Topics · Keep praying Jazak Allah · 1. Real Assets:

Real assets are tangible assets that have physical characteristics. For instance, land, house, Equipment, car, wheat, fruits, cotton, computers, etc., are different kinds of real assets.

2. Securities:

Security, also known as a financial asset, is a piece of paper representing a claim on an asset. Securities can be classified into two categories.

3. • Direct Securities: Direct securities include stocks and bonds. While valuing

Direct securities we take into account the cash flows generated by the Underlying assets. Discounted Cash Flow (DCF) technique is often used to determine the value of a stock or bond.

4. • Indirect Securities: Indirect securities include derivatives, Futures and Options.

The securities do not generate any cash flow; however, its value depends on the Value of the underlying asset. While in this course, direct securities would be discussed at length, the indirect securities would only be skimmed through in the later chapters.

5. Bonds:

Bonds represent debt. The important features of bonds are given as under.

• Internationally, bonds are the most common way for companies to raise funds.
• A bond is a long-term debt contract (on paper) issued by the borrower (Issuer of the Bond i.e., accompany that wishes to raise funds) to the lenders (bondholders or Investors which may include banks, financial institutions, and private investors).
• Bonds issued by a company are usually shown on the liabilities side of the
• A Bond requires the borrower to pay a pre-determined amount of interest regularly to the lender (Bondholder). The interest rate or the rate of return on a bond can be Fixed or Floating. If an Investor purchases a bond which is offering a rate of 10 % for the life of the bond, the rate would be fixed at 10 percent. However, if the interest rate on the bond is tied to the market interest rates, the rate of interest would be floating. The floating rate implies that the interest rate would fluctuate with any change in the market interest rate.

Types of Bonds:

• Debentures: Unsecured – no asset backing
• Mortgage Bond: Secured by real property i.e. Land, house
• Others: Eurobond, Zeros, Junk, etc.

The details on these different types of bonds would be discussed in later lectures.

Stocks (or Shares):

Stocks (or Shares) are paper certificates representing ownership in a business. Therefore, if a company has issued 1 million shares and an investor owns 1 share only, he is a part owner (or shareholder) of the company. Stocks or shares are represented in the equity section of the balance sheet. A stock certificate is perpetuity, i.e., it lasts as long as the company does. Shareholders have a residual claim (last claim) on whatever net income (or profit) and assets are left over after the bondholders have been fully paid off. It is the most common source of raising funds under Islamic Shariah. Shares are traded in Stock market e.g. Karachi Stock Exchange (KSE), Lahore Stock Exchange (LSE) & Islamabad Stock Exchange (ISE).

Difference between Shares & Bonds:

The main difference between shares and bonds is that shares are representation of ownership in a company while bonds are not representative of ownership. The second difference is that shares last as long as the company lasts where as bonds have limited life. Another difference is that the return on a bond is predetermined, i.e., the investor knows in advance how much return he would get from a bond. However, a stockholder cannot be certain about the return on a stock investment, since the dividends may or may not be paid in a certain year or the percentage of dividends announced may vary.

Types of Stocks (or Shares):

• Common Stock:

Common shareholders receive dividends, or portion of the net income which the Management decides, NOT to reinvest into the company in the form of retained earnings. Dividends are paid in proportion to the number of shares the stockholders own and are announced by the board of directors, who may opt not to announce a dividend in a particular year. Common Stockholders have voting rights to elect the board of directors.

Further details

(A security that represents ownership in a corporation Holders of common stock exercise control by electing a board of directors and voting on corporate policy. Common stockholders are on the bottom of the priority ladder for ownership structure. In the event of liquidation, common shareholders have rights to a company's assets only after bondholders; preferred shareholders and other debt holders have been paid in full)

If the company goes bankrupt, the common stockholders will not receive their money until the creditors and preferred shareholders have received their respective share of the leftover assets. This makes common stock riskier than debt or preferred shares. The upside to common shares is that they usually outperform bonds and preferred shares in the long run.

Preferred Stock:

It is the stock with a predetermined or fixed dividend. In case, the board of directors announces Dividends, the preferred stockholders would have a priority claim on them, i.e., they would be paid Dividends before any dividends are paid to the common stockholders. However, if the board opts to retain earnings, the preferred stock would not yield a dividend, and thus cash flows from a preferred dividend are not as certain as income of the bondholders.