2 Explain the different ways of classifying financial markets. LEARNING OBJECTIVESDescribe the cycle of money, the participants in the cycle, and the common objective of borrowing and lending.Distinguish the four main areas of finance and briefly explain the financial activities that each encompasses.Explain the different ways of classifying financial markets.Discuss the three main categories of financial management.
3 LEARNING OBJECTIVES5. Identify the main objective of the finance manager and how that objective might be achieved.6. Explain how the finance manager interacts with both internal and external players.7. Delineate the three main types of business organizations and their respective advantages and disadvantages.8. Illustrate agency theory and the principal-agent problem.9. Review issues in corporate governance and business ethics.
4 Definition of FinanceFinance is the art and science of managing wealth.It is about making decisions regarding what assets to buy/sell and when to buy/sell these assets.Its main objective is to make individuals and their businesses better off.
5 Definition of Financial Management Financial management is generally defined as those activities that create or preserve the economic value of the assets of an individual, small business, or corporation.Financial management comes down to making sound financial decisions.
6 1.1 The Financial Intermediary Function Financial intermediaries assist in the movement of money from lenders to borrowers and back again.This process is termed the cycle of money and its main objective is to make all the participants better off
8 1.1 The Cycle of MoneyThe movement of money from lender to borrower and back to lender from borrower (see page 4 of textbook)Example: You invest money in a venture capital group that invests in new business ventures (this is typically a very risky investment)The pooled funds are used to support a variety of business ventures at the early start up of the companyAs the new start ups take hold, they are able to generate cash flow with their business ideas and “payback” the venture capital firm (usually the liquidation event enables the venture capital firm to make a sizeable gain in its initial investment)All participants are generally better off from this cycle of money
9 1.2 Overview of Finance Areas Four main interconnected and interrelated areas:Corporate FinanceInvestmentsFinancial Institutions and MarketsInternational Finance
10 1.3 The Financial MarketsForums where buyers and sellers of financial assets and commodities meet.Financial markets can be classified by:The Type of Asset TradedThe Maturity of the Financial Assetmoney marketcapital marketThe Issuer of the Financial Assetprimary marketsecondary marketThe Owner vs. Seller of the Financial Assetdealer marketsauction markets
11 1.4 The Finance Manager and Financial Management Determines the best places to borrow moneyDetermines the best repayment structure for the borrowed fundsEnsures that financial obligations are met on timeEnsures that sufficient funds are available for carrying out daily operations
12 1.4 The Finance Manager and Financial Management Financial management involves three main functions:Capital Budgeting (Use of funds)Capital Structure (Source of funds)Working Capital Management (Timing of funds)
13 1.5 Objective of the Finance Manager To make investment and financing decisions that increase the cash flow of the firm, thereby maximizing the current stock priceProfit maximizationvs.Stock price maximizationWhy are they not the same?Which one is more important?Sprinter versus Distance Runner
14 1.6 Internal and External Players Financial managers have to interact with various internal and external stakeholdersInternal players include all the departmental managers and other employeesExternal parties include:CustomersSuppliersGovernmentCreditors
15 1.7 The Legal Forms of Business There are three main legal categories of business organizations: Sole proprietorshipPartnershipCorporationBesides these three main forms, some other forms of business organizations include:Hybrid CorporationsNot-for-Profit Corporations
16 1.7 The Legal Forms of Business Sole ProprietorshipAdvantagesSimplest and easiest form of businessLeast amount of legal documentationLeast regulatedOwner keeps all profitsDisadvantagesOwner pays personal tax rate on profitsObligations of the business are sole responsibility of owner, and personal assets may be necessary to pay obligations (personal and business assets are commingled)Business entity limited to life of ownerCan have limited access to outside funding for the business
17 1.7 The Legal Forms of Business PartnershipAdvantagesAgreements between partners may be easily formedInvolves more individuals as owners and therefore usually more expertiseLarger amount of capital usually available to the business (compared to proprietorship)DisadvantagesAssets of general partners are commingled with assets of the businessProfits treated as personal income for tax purposesDifficult to transfer ownership
18 1.7 The Legal Forms of Business CorporationAdvantagesBusiness is legal, separate entity from ownersOwners have limited liability to obligations of the businessEasy to transfer ownershipUsually greater access to capital for businessOwners do not have any personal liability for defaultDisadvantagesMost difficult business operation to formDouble taxation of company profitsMost regulated
19 1.8 The Financial Management Setting: The Agency Model Agency relationshipAgency conflictWhy does it arise?How can it be minimized?Principal-agent problemAgency theoryAgency costs
20 1.9 Corporate Governance and Business Ethics Corporate governance deals with….how a company conducts its business and implements controls to ensure proper procedures and ethical behavior.The Sarbanes-Oxley Act, enacted in 2002, requires thatThe CEO and CFO attest to the fairness of the financial reports.The company maintains an effective internal control structure around financial reporting.The company and its auditors assess the effectiveness of the controls over the most recent fiscal year.
21 1.10 Why Study Finance?Understand how and why financial decisions are made in large and small companiesHelps individuals increase their own compensationsImproves your personal contributions to the success of your companyUnderstand the tradeoffs we face in making personal financial choices and help us to select the most appropriate action