Page 14 - DMGT409Basic Financial Management

Unit 1: An Overview of Financial Management

Figure 1.2: Risk and Return Trade Off Notes

Risk-free rate is a rate obtainable from a default-risk free government security. An investor
assuming risk from her investment requires a risk premium above the risk-free rate. Risk-free
rate is a compensation for time and risk premium for risk. Higher the risk of an action, higher will
be the risk premium leading to higher required return on that action. A proper balance between
return and risk should be maintained to maximise the market value of a firm’s shares. Such

balance is called risk-return trade-off, and every financial decision involves this trade-off.

Task Make an analysis on strategies used by Reliance Mutual Fund for maximizing
the return of their customers.

Case Study Bhatt Industries – Basic Planning

T his case will help the reader, develop an approach to structuring a case solution. It
requires a logical approach to solving a general fi nancial problem.

Bhatt Industries has been manufacturing fireworks at a small facility just outside
Greensboro, North Carolina. The firm is known for the high level of quality control in its

production process and is generally respected by distributors in the states, where fi reworks
are legalized. Its selling market is fairly well defined ; it has the capacity to produce 800,000

cases annually, with peak consumption in the summer. The firm is fairly confident, that the

whole of next year’s production can be sold for ` 25 a case.
On September 7, the company has ` 8,000,000 in cash. The firm has a policy against

borrowing, to finance its production, a policy first established by William Bhatt, the owner

of the fi rm. Mr. Bhatt keeps a tight rein on the fi rm’s cash and invests any excess cash in
treasury bonds, that pays a 12 per cent return and involve no risk of default.
The firm’s production cycle revolves around the seasonal nature of the fi reworks business.

Production begins right after Labour Day and runs through May. The firms sales occur in
February through May ; the firm closes from June 1 to Labour Day, when its employees

return to farming. During this time, Mr. Bhatt visits his grandchildren in New York and
Contd...
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