Business Finance Basics & Financial Markets Explained

TAKEAWAYS:

• Business finance is the art and science of managing money to achieve a company’s goals, balancing risk and return.
• Financial markets (stock, bond, forex) act as marketplaces where companies raise capital and investors trade securities.
• The primary market issues new securities (e.g., IPOs), while the secondary market trades existing ones (e.g., NEPSE).
• Financial instruments (shares, bonds, derivatives) are legal contracts that transfer risk or ownership.
• Nepal’s NEPSE and global platforms like Google Finance rely on these markets to price assets and allocate capital.
• Exam focus: Differentiate markets, explain instruments, and link theory to real-world examples (e.g., Daraz’s funding rounds).

1. What Is Business Finance?

Business finance is the lifecycle management of a company’s money, from raising funds to investing and distributing profits. It ensures:

• Solvency: Ability to pay debts (e.g., Daraz’s loans from banks).
• Profitability: Maximizing returns for shareholders (e.g., Ncell’s dividends).
• Growth: Funding expansion (e.g., Pathao’s Series B funding).

Key Functions of Business Finance

mindmap
  root((Business Finance))
    Functions
      **1. Investment Decisions**
        - Capital budgeting (e.g., NTC’s fiber-optic network upgrade)
        - Asset allocation (e.g., Kathmandu’s retail store locations)
      **2. Financing Decisions**
        - Debt vs. equity (e.g., Khalti’s bank loans vs. venture capital)
        - Cost of capital (e.g., NEPSE-listed companies’ WACC)
      **3. Dividend Decisions**
        - Payout policies (e.g., Ncell’s dividend announcements)
        - Retained earnings (e.g., eSewa’s reinvestment in tech)
    Goals
      Maximize Shareholder Wealth
      Ensure Liquidity
      Manage Risk

2. Financial Markets: Where Money Meets Opportunity

Financial markets are organized platforms where buyers and sellers trade assets. They enable:

• Companies to raise capital (e.g., NEPSE IPOs).
• Investors to earn returns (e.g., Ncell shareholders).
• Economies to allocate resources efficiently.

Types of Financial Markets

Why It Matters:

• Primary markets bring cash to companies (e.g., Daraz’s funding rounds).
• Secondary markets provide liquidity (e.g., selling Ncell shares on NEPSE).

3. Financial Instruments: The Tools of the Trade

Financial instruments are legal contracts that represent financial assets or obligations. They include:

A. Debt Instruments (Borrowing)

• Bonds: IOUs with fixed interest (e.g., NTC’s government bonds).
• Loans: Bank lending (e.g., Khalti’s SME loans).
• Commercial Paper: Short-term corporate debt (e.g., NMB’s CP issuance).

B. Equity Instruments (Ownership)

• Common Stock: Voting rights + dividends (e.g., NEPSE’s "A" shares).
• Preferred Stock: Fixed dividends, no voting rights (rare in Nepal).
• Derivatives: Contracts tied to underlying assets (e.g., NEPSE futures).

Worked Example: NEPSE’s IPO Process

Scenario: A Nepali retail chain (e.g., Kathmandu’s "Everest Mart") wants to raise Rs. 500 million via an IPO on NEPSE.

1. Primary Market Step:

   • Underwriting: NMB Bank agrees to buy unsold shares (guarantees Rs. 500M).
   • Pricing: Shares priced at Rs. 100 each (total 5M shares).
   • Allotment: Retail investors buy 2M shares; institutions buy 3M.

2. Secondary Market Step:

   • Shares trade on NEPSE at Rs. 120 (premium due to demand).
   • Everest Mart uses Rs. 500M to expand stores in Pokhara and Biratnagar.

Key Takeaway:

• Primary market = New money for the company.
• Secondary market = Investors trade among themselves (Everest Mart gets no new cash here).

4. How Financial Markets Work: The Nepal Example

A. NEPSE (Nepal Stock Exchange)

• Primary Market: IPOs (e.g., NMB Bank’s 2019 listing).
• Secondary Market: Daily trading (e.g., Ncell’s share price fluctuates based on earnings).
• Regulator: SEBON (Securities Board of Nepal) ensures transparency.

B. Real-World Flow: Daraz’s Funding

1. Primary Market: Daraz raises $100M from SoftBank (debt + equity).
2. Secondary Market: Investors trade Daraz shares on private platforms (not yet public).
3. Impact: Daraz uses funds to expand logistics in Nepal.

5. Financial Securities vs. Financial Instruments

Why the Distinction Matters:

• Securities are tangible assets; instruments can be complex contracts (e.g., options).

6. The Role of Financial Markets in Nepal

A. Capital Formation

• Problem: Nepali businesses struggle to raise long-term funds.
• Solution: NEPSE’s capital market allows companies to issue bonds/stocks (e.g., Global IME Bank’s bond issuance).

B. Price Discovery

• How it works: Supply/demand sets stock prices (e.g., Ncell’s share price rises after strong 4G rollout).
• Impact: Investors get fair valuations; companies attract funding.

C. Risk Management

• Tools: Derivatives (e.g., NEPSE’s gold futures help jewelers hedge against price swings).

In the Real World

1. eSewa’s Funding:

   • Primary Market: Raised $20M from Ant Financial (Alibaba’s affiliate) via equity.
   • Secondary Impact: Used funds to expand digital payments in rural Nepal.

2. Pathao’s Series B:

   • Financial Instrument: Convertible notes (debt that turns into equity).
   • Market: Primary (investors like Tiger Global provided capital).

3. NTC’s Bond Issuance:

   • Debt Instrument: Rs. 20 billion bonds sold to banks/pension funds.
   • Purpose: Fund fiber-optic network expansion (reduces reliance on foreign debt).

4. Khalti’s Loan App:

   • Money Market: Offers short-term loans to SMEs at 12–18% interest.
   • Risk: Uses data analytics to assess creditworthiness (financial instrument = algorithmic scoring).

Worked Example: Kathmandu’s Retail Shop Financing

Scenario: A shop owner in Thamel wants to expand but lacks cash. Options:

Calculation:

• Loan Option: Rs. 1M borrowed at 10% interest = Rs. 100,000/year.
• VC Option: 20% equity for Rs. 1M = Rs. 200,000 profit share if shop sells for Rs. 5M later.

Recommendation:

• Use debt if the shop’s cash flows cover repayments.
• Use equity if growth potential justifies giving up ownership.

Exam Tip

1. Differentiate Primary vs. Secondary Markets:

   • Primary: New securities (e.g., IPOs like NMB Bank’s 2019 listing).
   • Secondary: Trading existing securities (e.g., Ncell shares on NEPSE).

2. Define Financial Instruments Clearly:

   • Stocks = Ownership.
   • Bonds = Debt.
   • Derivatives = Contracts (e.g., options).

3. Link Theory to Nepal:

   • Always use NEPSE, banks, or apps (eSewa, Khalti) in answers.
   • Example: "Like Daraz uses venture capital in the primary market, Nepali SMEs can raise funds via bank loans (debt instruments)."

4. Numerical Questions:

   • Expect calculations on dividend growth models (Unit 5) or loan repayments (Unit 8).
   • Tip: Show all steps; partial credit is given for correct formulas.

5. Common Pitfalls:

   • ❌ Confusing securities (tradable assets) with instruments (contracts).
   • ❌ Forgetting Nepal-specific examples (e.g., NEPSE, SEBON).

Final Visual Summary:

flowchart TD
    A["Business Needs Funds"] --> B["Primary Market<br/>(IPOs, Bonds)"]
    B --> C["NEPSE<br/>SEBON Regulation"]
    A --> D["Secondary Market<br/>(Stock Trading)"]
    D --> E["NEPSE<br/>Investor Portfolios"]
    C --> F["Companies Get Capital"]
    E --> G["Investors Earn Returns"]
    F --> H["Growth<br/>(e.g., Daraz Expansion)"]
    G --> I["Liquidity<br/>(e.g., Selling Ncell Shares)"]