financial Management overview intro....
- 1. 1-1 FINANCE Finance studies and addresses the ways in which individuals, businesses, and organizations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects. The term "finance" may thus incorporate any of the following: The study of money and other assets; The management and control of those assets; Profiling and managing project risks; The science of managing money;
- 2. 1-2 FINANCE As a verb, "to finance" is to provide funds for business or for an individual's large purchases (car, home, etc.). The activity of finance is the application of a set of techniques that individuals and organizations (entities) use to manage their money, particularly the differences between income and expenditure and the risks of their investments. An entity whose income exceeds its expenditure can lend or invest the excess income. On the other hand, an entity whose income is less than its expenditure can raise capital by borrowing
- 3. 1-3 FINANCE Personal finance: Finance used by individuals How much money will be needed by an individual at various points in the future? Where will this money come from (e.g. savings or borrowing)? How can people protect themselves against unforeseen events in their lives, and risk in financial markets? How can family assets be best transferred across generations (bequests and inheritance)? Public finance: Finance used by governments Corporate finance: Finance used by businesses, managing corporate finance is also called financial management
- 4. AN OVERVIEW OF FINANCIAL MANAGEMENT Career Opportunities Forms of Businesses Goals of the Corporation Agency Relationships
- 5. 1-5 CAREER OPPORTUNITIES IN FINANCE Money and capital markets Investments Financial management
- 6. 1-6 RESPONSIBILITY OF THE FINANCIAL STAFF Maximize stock value by: Forecasting and planning Investment and financing decisions Coordination and control Transactions in the financial markets Managing risk
- 7. 1-7 SCOPE OF STUDY An overview of Financial Management Financial Environment Financial statements, Cash flows and Taxes Analysis of Financial Statements Risk and Rate of Return Time Value of money Bond valuation Stock Valuation The Cost of Capital The Basics of Capital Budgeting
- 8. 1-9 ROLE OF FINANCE IN A TYPICAL BUSINESS ORGANIZATION nBoard of Directors nPresident nVP: Sales nVP: Finance nVP: Operations nTreasurer nController nCredit Manager nInventory Manager nCapital Budgeting Director nCost Accounting nFinancial Accounting nTax Department
- 9. 1-10 ALTERNATIVE FORMS OF BUSINESS ORGANIZATION Sole proprietorship Partnership Corporation
- 10. 1-11 SOLE PROPRIETORSHIPS & PARTNERSHIPS Advantages Ease of formation Subject to few regulations No corporate income taxes Disadvantages Difficult to raise capital Unlimited liability Limited life
- 11. 1-12 CORPORATION Advantages Unlimited life Easy transfer of ownership Limited liability Ease of raising capital Disadvantages Double taxation Cost of set-up and report filing
- 12. 1-13 FINANCIAL GOALS OF THE CORPORATION The primary financial goal is shareholder wealth maximization, which translates to maximizing stock price. Do firms have any responsibilities to society at large? Is stock price maximization good or bad for society? Should firms behave ethically?
- 13. 1-14 IS STOCK PRICE MAXIMIZATION THE SAME AS PROFIT MAXIMIZATION? No, despite a generally high correlation amongst stock price, EPS, and cash flow. Current stock price relies upon current earnings, as well as future earnings and cash flow. Some actions may cause an increase in earnings, yet cause the stock price to decrease (and vice versa).
- 14. 1-15 AGENCY RELATIONSHIPS An agency relationship exists whenever a principal hires an agent to act on their behalf. Within a corporation, agency relationships exist between: Shareholders and managers Shareholders and creditors
- 15. 1-16 SHAREHOLDERS VERSUS MANAGERS Managers are naturally inclined to act in their own best interests. But the following factors affect managerial behavior: Managerial compensation plans Direct intervention by shareholders The threat of firing The threat of takeover
- 16. 1-17 SHAREHOLDERS VERSUS CREDITORS Shareholders (through managers) could take actions to maximize stock price that are detrimental to creditors. In the long run, such actions will raise the cost of debt and ultimately lower stock price.
- 17. 1-18 FACTORS THAT AFFECT STOCK PRICE Projected cash flows to shareholders Timing of the cash flow stream Riskiness of the cash flows
- 18. 1-19 FACTORS THAT AFFECT THE LEVEL AND RISKINESS OF CASH FLOWS Decisions made by financial managers: Investment decisions Financing decisions (the relative use of debt financing) Dividend policy decisions The external environment
- 19. 1-20 BASIC VALUATION MODEL To estimate an asset’s value, one estimates the cash flow for each period t (CFt), the life of the asset (n), and the appropriate discount rate (k) Throughout the course, we discuss how to estimate the inputs and how financial management is used to improve them and thus maximize a firm’s value. n 1 t t t n n 2 2 1 1 . k) (1 CF k) (1 CF k) (1 CF k) (1 CF Value
- 20. 4-21 THE FINANCIAL ENVIRONMENT Financial markets Types of financial institutions Determinants of interest rates Yield curves
- 21. 1-22 WHAT IS A MARKET? A market is a venue where goods and services are exchanged. A financial market is a place where individuals and organizations wanting to borrow funds are brought together with those having a surplus of funds.
- 23. 1-24 TYPES OF FINANCIAL MARKETS Physical assets vs. Financial assets Debt vs. Equity Money vs. Capital Primary vs. Secondary IPO Spot vs. Futures Public vs. Private
- 24. 1-25 MAJOR MARKET INSTRUMENTS Money Market US Treasury Bills Commercial paper Certificate of deposit (CDs) Money market mutual funds Eurodollar Deposit Capital Market US Treasury notes and Bonds Mortgage Corporate bonds Leases Preferred stocks Common Stocks Derivatives
- 26. 1-27 HOW IS CAPITAL TRANSFERRED BETWEEN SAVERS AND BORROWERS? Direct transfers Investment banking house Financial intermediaries
- 27. 1-28 TYPES OF FINANCIAL INTERMEDIARIES Commercial banks Pension funds Life insurance companies Mutual funds
- 28. 1-29 PHYSICAL LOCATION STOCK EXCHANGES VS. ELECTRONIC DEALER-BASED MARKETS Auction market vs. Dealer market Inventory to minimize transaction cost Bid-Ask Spread (Exchanges vs. OTC) Quantity driven vs price driven NYSE vs. Nasdaq
- 29. 1-30 THE COST OF MONEY The price, or cost, of debt capital is the interest rate. The price, or cost, of equity capital is the required return. The required return investors expect is composed of compensation in the form of dividends and capital gains.
- 30. 1-31 WHAT FOUR FACTORS AFFECT THE COST OF MONEY? Production opportunities Time preferences for consumption Risk Expected inflation
- 31. 1-32 OTHER FACTORS THAT INFLUENCE INTEREST RATE LEVELS Federal reserve policy Federal budget surplus or deficit Level of business activity International factors Trade deficit
- 32. 1-33 RISKS ASSOCIATED WITH INVESTING OVERSEAS Exchange rate risk – If an investment is denominated in a currency other than U.S. dollars, the investment’s value will depend on what happens to exchange rates. Country risk – Arises from investing or doing business in a particular country and depends on the country’s economic, political, and social environment.
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