1. 1
Chapter 2
The Business, Tax,
and Financial
Environments

2. 2
The Business, Tax, and
Financial Environments
The Business Environment
The Tax Environment
The Financial Environment

3. 3
The Business
Environment
The PAK has four basic forms of
business organization:
Sole Proprietorships
Partnerships (general and limited)
Corporations
Limited liability companies

4. 4
The Business
Environment
Sole Proprietorship -- A business
form for which there is one owner.
This single owner has unlimited
liability for all debts of the firm.
Oldest form of business organization.
Business income is accounted for on
the owner’s personal income tax form.
form

5. 5
Summary for
Sole Proprietorship
Advantages
Disadvantages
Simplicity
Unlimited liability
Low setup cost
Hard to raise
additional capital
Quick setup
Single tax filing on
individual form
Transfer of
ownership
difficulties as
compared to
corporations.

6. 6
The Business
Environment
Partnership -- A business form in
which two or more individuals
act as owners.
Business income is accounted
for on each partner’s personal
income tax form.
form

7. 7
Types of Partnerships
General Partnership -- All partners have
unlimited liability and are liable for all
obligations of the partnership.
Limited Partnership -- Limited partners
have liability limited to their capital
contribution (investors only). At least
one general partner is required and all
general partners have unlimited liability.

8. 8
Summary for Partnership
Advantages
Can be simple
Low setup cost, higher
than sole
proprietorship
Relatively quick setup
Limited liability for
limited partners
Disadvantages
Unlimited liability for
the general partner
Difficult to raise
additional capital, but
easier than sole
proprietorship
Transfer of ownership
is difficult because of
legal requirements.

9. 9
The Business
Environment
Corporation -- A business form
legally separate from its owners.
An artificial entity that can own
assets and incur liabilities on its
name.Business income is
accounted for on the income tax
form of the corporation.
corporation

10. 10
Summary for Corporation
Advantages
Disadvantages
Limited liability
Double taxation
Unlimited life
More difficult to
establish
Easier to raise large
quantities of capital
More expensive
to set up and
maintain

11. 11
The Business
Environment
Limited Liability Companies -- A
business form that provides its owners
(called “members”) with corporatestyle limited personal liability and the
federal-tax treatment of a partnership.
Business income is accounted for on
each “member’s” individual income tax
form.
form

12. 12
Limited Liability
Company (LLC)
Generally, an LLC will possess only the
first two of the following four standard
corporation characteristics
Limited liability
Centralized management
Unlimited life
Transfer of ownership without other
owners’ prior consent

13. 13
Summary for LLC
Advantages
Limited liability
Eliminates double
taxation
No restriction on
number or type of
owners
Easier to raise
additional capital
Disadvantages
Transfer of
ownership
difficulties
(generally)

14. 14
TYPES
Public limited company
Shares are given to general public.
S ALLIED BANK OF PAKISTAN
ASKARI COMMERCIAL BANK
Minimum number of shareholders is 7.
Private limited company
Ownership is restricted
Minimum number of shareholders is 2 and maximum is 20

15. 15
Depreciation
Depreciation represents the
systematic allocation of the cost of
a capital asset over a period of time
for financial reporting purposes, tax
purposes, or both.
Generally, profitable firms prefer to use
an accelerated method for tax
reporting purposes.

16. 16
Common Types of
Depreciation
Straight-line (SL)
Accelerated Types
Double-Declining-Balance
(DDB)
Modified Accelerated Cost
Recovery System (MACRS)

17. 17
Interest Deductibility
Interest Expense is the interest paid
on outstanding debt is an expense
and is tax deductible.
deductible
Cash Dividend is the cash distribution
of earnings to shareholders and is
not a tax deductible expense.

18. 18
What are career
opportunities in managerial
finance for you
Financial analyst
Cash manager
Credit analyst
Pension fund manager
Foreign exchange manager
Project finance manager

19. 19
Financial Environment
Businesses interact continually with
the financial markets.
Financial Markets are composed of all
institutions and procedures for
bringing buyers and sellers of financial
instruments together.
The purpose of financial markets is to
efficiently allocate savings to ultimate
users.

20. 20
Flow of Funds
in the Economy
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
FINANCIAL
INTERMEDIARIES
INVESTMENT SECTOR

21. 21
Flow of Funds
in the Economy
FINANCIAL BROKERS
SECONDARY MARKET
FINANCIAL
INTERMEDIARIES
INVESTMENT
SECTOR
INVESTMENT
SECTOR
Businesses
Government
Households
SAVINGS SECTOR

22. 22
Flow of Funds
in the Economy
FINANCIAL BROKERS
SECONDARY MARKET
FINANCIAL
INTERMEDIARIES
INVESTMENT
SECTOR
SAVINGS
SECTOR
Households
Businesses
Government
SAVINGS SECTOR

23. 23
Flow of Funds
in the Economy
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
FINANCIAL
INTERMEDIARIES
INVESTMENT
SECTOR
FINANCIAL
BROKERS
Investment
Bankers
Mortgage
Bankers

24. 24
Flow of Funds
in the Economy
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
FINANCIAL
INTERMEDIARIES
INVESTMENT
SECTOR
FINANCIAL
INTERMEDIARIES
Commercial Banks
Savings Institutions
Insurance Cos.
Pension Funds
Finance Companies
Mutual Funds

25. 25
Flow of Funds
in the Economy
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
FINANCIAL
INTERMEDIARIES
INVESTMENT
SECTOR
SECONDARY
MARKET
Security
Exchanges
OTC
Market

26. 26
Allocation of Funds
Funds will flow to economic units that are
willing to provide the greatest expected
return (holding risk constant).
In a rational world, the highest expected
returns will be offered only by those
economic units with the most promising
investment opportunities.
Result: Savings tend to be allocated to the
most efficient uses.

27. 27
Financial markets
Not physical places as they are
mechanism for channeling
savings to the ultimate investors
in real assets.

28. 28
Money and capital market
Money market: it is the market
for short term government and
debt securities.
Capital market: the maturity for
relatively long term financial
instruments(e.g;bonds and
stocks)

29. 29
Financial institutions
An intermediary that channels the
savings of individuals,business,and
government. Many financial
institutions directly or indirectly pay
savers interest on deposited funds,
other provide services for a fee( for
example, checking accounts)

30. 30
Financial intermediary
These are financial institutions
that accept money from savers
and use those funds to make
loans and other financial
investments in their own name.

31. 31
Financial markets
Forums in which suppliers of funds and demanders of funds
can transact business directly
Primary market:
private placement; is the sale of a new security issue,
typically bonds or preferred stock, directly to an investor or
group of investor
Secondary market: place where renowned
securities are traded
public offering; the nonexclusive sale of either bonds or
stocks to the general public

32. 32
Financial Broker
Certain financial institutions perform a necessary
brokerage function. when brokers bring together
parties who need funds with those who have savings,
they are not performing a direct lending function but
rather are acting as middlemen
Investment bankers: financial institutions that
underwrites new securities for resale.
Mortgage bankers: financial institution that buys
mortgages primarily for resale. (involve in
acquiring and placing mortgages)

33. 33
Types of brokers
Brokerage firms
Customers can choose the type of broker they wish to use. They
can be classified according to the services offered and fees
charged.
FULL SERVICE BROKERS: A brokerage firm offering a full range
of services including information and advice. Today investors
need more information about economy,industries,individual
companies and the bond market from full time brokers.
DISCOUNT BROKERS: Brokerage firms offering execution
services at prices typically significantly less than full-line
brokerage firms.Commisions vary widely by amount and the
manner in which they are determined. Some discount brokers
offer research information and investment recommendations .

34. 34
EXPECTED RETURN (%)
Risk-Expected
Return Profile
Common Stocks
Preferred Stocks
Medium-grade Corporate Bonds
Investment-grade Corporate Bonds
Long-term Government Bonds
Prime-grade Commercial Paper
U.S/Pakistan Treasury Bills (risk-free securities)
RISK

35. 35
What Influences Security
Expected Returns?
Default Risk is the failure to meet
the terms of a contract.
Marketability is the ability to sell
a significant volume of securities
in a short period of time in the
secondary market without
significant price concession.

36. 36
Ratings by Investment
Agencies on Default Risk
MOODY’S INV SERVICE
STANDARD & POOR’S
Aaa
Best Quality
AAA
Highest Grade
Aa
High Quality
AA
High Grade
A
Upper Med Grade
A
Higher Med Grade
Baa
Medium Grade
BBB
Medium Grade
Ba Possess Speculative BB
Speculative
Elements
C
Lowest Grade
D
In Default
Investment grade represents the top four categories.
Below investment grade represents all other categories.

37. 37
What Influences Expected
Security Returns?
Maturity is concerned with the life
of the security; the amount of
time before the principal amount
of a security becomes due.
Taxability considers the expected
tax consequences of the security.

38. 38
0 2 4 6 8 10
YIELD (%)
Term Structure of
Interest Rates
Upward Sloping Yield Curve
(Usual)
Downward Sloping Yield Curve
(Unusual)
0
5
10
15
20
25
30
YEARS TO MATURITY
A yield curve is a graph of the relationship between
yields and term to maturity for particular securities.

39. 39
What Influences Expected
Security Returns?
Embedded Options provide the
opportunity to change specific
attributes of the security.
Inflation is a rise in the average
level of prices of goods and
services. The greater inflation
expectations, then the greater the
expected return.

40. 40
Assignment /oral quiz
In general, what would be the likely effect
of the following occurrences on the money
and capital markets?
The saving rate of individuals in the
country declines.
Individuals increases their savings at
saving and loan associations and
decreases their savings at banks.