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FINANCIAL MANAGEMENT I and II The Scope of Financial Management.

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Presentation on theme: "FINANCIAL MANAGEMENT I and II The Scope of Financial Management."— Presentation transcript:

1 FINANCIAL MANAGEMENT I and II The Scope of Financial Management

2 What is finance? Concerned with maintenance and creation of economic value or wealth. Focuses on decision making with an eye toward creating wealth. The activities involved in managing cash flows in a business environment. Companies must make best use of capital, while balancing needs of corporate shareholders, managers, and other stakeholders.

3 The 5 Core Principles of Finance 1. The Time Value of Money The opportunity to earn a return on invested funds means that a dollar today is worth more than a dollar in the future. Business decisions involved a trade-off between spending money today and receiving money in the future.

4 2. Compensation of Risk Investors expect compensation for bearing risk. 3. Dont Put Your Eggs in One Basket Investors can achieve a more favorable trade-off between risk and return by diversifying their portfolios (Harry Markowitz, 1990). The 5 Core Principles of Finance

5 4. Markets are Smart Competition for information tends to make markets efficient. Prices of financial assets quickly, and accurately, reflect all information that investors have access to. Investors should just simply buy and hold a diversified portfolio than try to pick winners and losers in the stock market. The 5 Core Principles of Finance

6 5. No Arbitrage Arbitrage refers to a trading strategy in which an investor simultaneously buys and sells the same asset in different markets at different prices to earn an instant, risk-free profit. The 5 Core Principles of Finance

7 The 5 Basic Corporate Finance Function Financing (Capital-Raising) Capital Budgeting Financial Management Corporate Governance Risk Management

8 What Should a Financial Manager Try to Maximize? Maximize Profit? Earnings per share are backward-looking, dependant on accounting principles Do not fully consider cash flow timing Ignores risk Maximize Shareholder Wealth? Maximize stock price, not profits Shareholders as residual claimants, have better incentives to maximize firm value.

9 Agency Costs Managers act as agents of the owners who hired them and gave them decision-making authority to manage the firm for the owners benefit. In practice however, self-interests may cause managers to pursue objectives other than shareholder-wealth maximization. This conflict of goals gives rise to managerial agency problems.

10 How Agency Costs Can Be Controlled Ways to overcome agency problems: Takeovers Monitoring and bonding Compensation contracts Executive compensation packages

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