Notesale: Turn your study into money

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What is Finance?
• What is Finance?
• The science that describes the management of
money, banking, credit, investments, and assets
• Basically, finance looks at anything that has to do
with money and the market
...

• The field of finance deals with the concepts of time,
money, and risk and how they are interrelated
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Important of finance
• Finance may help u to solve many personal decisions
such as investing your saving and choosing the best
alternative for your housing loans
• To make good & effective biz decision, one need to an
integrated knowledge of marketing, production,
personnel, finance & accounting
...

• To evaluate the performance of company and to make
any preventive and corrective actions if necessary
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• Financial markets are defined by having transparent
pricing, basic regulations on trading, costs and fees
and market forces in determining the prices of
securities that trade
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Financial Market
• Financial markets can be found in nearly every nation in the
world
...

• Most financial markets have periods of heavy trading and
demand for securities; in these periods, prices may rise above
historical norms
...

• Information transparency is important to increase the
confidence of participants and therefore foster an efficient
financial marketplace
...

• The main difference between a trader and an investor is the
duration for which the person holds the asset
...

• One main problem with engaging in short-term trading is
commission costs
...

• However, an increasing number of highly competitive discount
brokerages has made this cost less of an issue

Investors
• 2 types of investors: Retail investor and Industrial
investor
• Retail Investor
– Individual investors who buy and sell securities for
their personal account, and not for another company
or organization
...

– Retail investors buy in much smaller quantities than
larger institutional investors

Investors
• Institutional Investor
• A non-bank person or organization that trades securities in
large enough share quantities or dollar amounts that they
qualify for preferential treatment and lower commissions
...

• Watching what the big money is buying can sometimes be a
good indicator, as they (supposedly) know what they are
doing
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Financial Services/ Institution
• Own mostly financial assets
– Banks
– Insurance companies
– Mutual funds

Financial Management Decisions
• Capital budgeting
– What long-term investments or projects should the business
take on?

• Capital structure
– How should we pay for our assets?
– Should we use debt or equity?

• Working capital management = ca - cl
– How do we manage the day-to-day finances of the firm?

failure is an instrumental part of every success

The Scope and Nature of Corporate Finance
• Some important questions that are answered using finance

– What long-term investments should the firm take on?
– Where will we get the long-term financing to pay for the investment?
– How will we manage the everyday financial activities of the firm?

• Corporate Finance is about how firms:

– select their investments
– Finance their investments and operations
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• In contrast with asset pricing, asset prices and returns are taken
as given
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The Firm as a Nexus of Contracts

The Firm as a Nexus of Contracts
• It relies on real assets (machinery, factories,
offices, patents, expertise, human capital,
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• It raises capital from financiers, who require a
return on their investment
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Analyse & Plan
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–
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The FM needs to analyse the co’s strength & weakness
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Coordination & control
–
–

The FM need to coordinate and control any resources
needed & used by the co, by, liaison with other top mgt
As this may allow the FM to implement any plan he/
they make successfully

The fx of The Financial Manager
3
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The FM anticipates the financial needs by:

–

–
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•
•

Involved in the planning processes of other department &
top mgt
Monitoring the development in the economic that have
the most impact upon the co
Keeping the track of what is keeping in the fin markets

The fx of The Financial Manager
4
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• So, FM need to maintain the composition of the
assets as to facilitate the operation of the firm – by
having appropriate investment in current and fixed
assets
• It shouldn’t over emphasis one another
...
Making financial decision
– Financing decision (capital mix decision)
– The FM need to find the best way to acquire &
manage fund needed to finance the asset
– 2 types of fund:
• Internal fund/ equity fund: retained earning (profit), shares
(preference/ ordinary)
• External fund/ borrowed fund: creditors and lenders (bank,
long & short term loan, financial institution)

– 2 issues in acquiring funds:
• The appropriate proportion of debt & equity – to
get the optimal capital structure
...


The fx of The Financial Manager
4
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• It involved both financing & investment decision
– Investment decision:
» the payment of dividend represent the outflow of cash
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– Financing decision:
» Profit generated by co represent the usage of funds
» So, the dividend policy is interrelated to the financing decision
as the creation and maintenance of fund came from proper
financial decision
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– To the degree that they are correlated with the long term
health and value of the company, they work well
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• A narrower objective is to maximize stockholder
wealth
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Maximizing Stock Prices is too “narrow” an
objective: A preliminary response
• Maximizing stock price is not incompatible with
meeting employee needs/ objectives
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• Maximizing stock price does not mean that
customers are not critical to success
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• Maximizing stock price does not imply that a
company has to be a social outlaw
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• Stock price is easily observable and constantly updated
(unlike other measures of performance, which may not
be as easily observable, and certainly not updated as
frequently)
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• The objective of stock price performance provides
some very elegant theory on:

– Allocating resources across scarce uses (which investments
to take and which ones to reject)
– how to finance these investments
– how much to pay in dividends

The Classical Objective Function

What can go wrong?

• Traditional corporate financial theory breaks down when the
interests/objectives of the decision makers in the firm conflict with the
interests of stockholders
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– Financial markets do not operate efficiently, and stock prices do not reflect
the underlying value of the firm
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Solutions:
• Choose a different mechanism for corporate governance
• Choose a different objective:
– Maximizing earnings / revenues / firm size / market share

– The key thing to remember is that these are intermediate objective
functions
...
To the degree that they do not,
the firm can end up with a disaster
• Maximize stock price, but reduce the potential for conflict and breakdown:
– Making managers (decision makers) and employees into stockholders
– Providing information honestly and promptly to financial markets

Counter reaction

Counter reaction

• The strength of the stock price maximization objective
function is its internal self correction mechanism
...

• stockholders taking advantage of bondholders has lead to
bondholders protecting themselves at the time of the
issue
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The Modified Objective Function
• At this point in time, the following statement best
describes, in terms of the right objective function for
decision making in a business:
a) Maximize stock price, with no constraints
b) Maximize stock price, with constraints on being a good
social citizen
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d) Maximize profits or profitability
e) Maximize earnings growth
f) Maximize market share
g) Maximize revenues
h) Maximize social good
i) None of the above

The Modified Objective Function
• For publicly traded firms in reasonably efficient markets,
where bondholders (lenders) are protected:
– Maximize Stock Price: This will also maximize firm value

• For publicly traded firms in inefficient markets, where
bondholders are protected:
– Maximize stockholder wealth: This will also maximize firm
value, but might not maximize the stock price

• For publicly traded firms in inefficient markets, where
bondholders are not fully protected
– Maximize firm value, though stockholder wealth and stock
prices may not be maximized at the same point

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