Finman Overview

8/11/2019 Finman Overview

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Chapter I An Overview of Financial Management

l-l What is Finance?l-la Finance vs. Economics and AccountingFinance grew out of economics and accounting.

Economists - asset value is based on the future cash flows

the asset will provideAccountants - provided information regarding the likely

size of cash flows

1-1b Finance within an Organization

BOD - top governing body

CEO - chairperson of the board; highest-ranking individual

COO - firm's president; directs the firm's operations

(marketing, manufacturing, sales, human resources, and

other operatin g depB.(cnicf Ope.ral,ng ey'fiZcr)

CFO - senior VP; 3rd ranking officer; in charge of

accounting, financing, credit policy, decisions regarding asset

acquisitions and investor relations-communication with

stockholders and press. (C n ;c1 7, rcnci a r e fJl' 6c r).Sarbanes-Qxley Act - law passed by congress that

l CForequires the CEO to certify that their firm's financial statements

iare accurate

I - I c Corporate Finance, Capital Markets and Investments

1. t (Corporate Finance)

assets to acquire

- how to needed to buy assets- how to run the firm so as to maximize its value

2 tg - dcatg ut/ ttcttnAes nerkclT rfhan " ia t 1ag5?v' t'on5

are

y'financial institutions that supply capital to business

include a number of activities:

A) Security Analysis - frnding the proper values ofindividual securities

.-2) Portfulio Theory - best way to structure portfolio ofstock and bonds

4) Market Analysis - issue whether stock and bondmarkets at any given time are "too high", "too low" or "aboutright"

e - investor psychology is

examined in an effort to determine if stock prices have been bid

up to unreasonable heights in a speculative bubble or driven

down to unreasonable lows in a fit of irational pessimism.

1-2 Jobs in Finance

.Value-based management - management decisions are

evaluated in terms of their effects on the firm's value

.Defined contribution pension plans - each year the company

puts a specified amount of money into an account that belongs to

the employee the employee must decide how those funds are to

be invested

l-3 Forms of Business Organization

l) Proprietorship - an unincorporated business owned by oneindividual

few government regulation bject to lower income taxes thancorporation

Disadvantages: unlimited personal liabili mited life,dfficult to raise capital

2) Partnership - an unincorporated business owned by two or

more persons

tablished relatively easy and inexpensively

come allocated on a pro rata basis to the partners

ed on an individual basis

4rnl im it e d p ers o n al I i abil ity

4fficulty to raise large amounls of capital3) Corporation - a legal entity created by stat arale and

bject to double taxalion-eamings are taxed and then when

its after tax eamings are paid out as dividends, those earnings are

taxed again as personal income. (C Corporation)

proprietorship/partnership rather than a corporation.

4) Limited Liability Company (LLC) - relatively new tlpe of


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5-4 The Stock Market

ean

- two leaders of stock markets

5-4a Physical Location Stock Exchanges

.Ph1'sical Location Exchanges - formal organizationshaving tangible physical locations that conduct auction

markets in desi*srated (lined) securities.

5-lb Orer-the-Counter and the \a:daq Stock llarkets.Over-the-Counter \larket - 3large collection ofbrokers and dealers. connecld elecronicallv bytelephones and computers that prorrds tbr trading in

unlised securities.

.Dealer illarket - includes all tacrlrues rhat are needed to

conduct secuntr transaclrons nol condus-ted on thephysical I ocation exchanges.

The dealer market svstem consr*s of:

llrelativell fet dealers rho hold tn\en:oncs o.irheseseatrities and tho are said to 'mai.e a dart:c:' tn these

secltnttes;

thousands of brokers t ho act os agerJs n bnnging thedealers together xiIfr inrastor-; and

onputers, terntitwls ond clec:arac ne:rorks thot

protide o conntuntcdtion ltnJ;.:v.-,rfcn Je;r'ers end

brokers-

- Bid price - price aI s hrch ther srl t- :r lhe 5aock

- Ask price - price at s hich they urll 31es- Bid-ask spread - difference berueen brd and ask prices,

IIACD- represents the dealer's markup or prol'ilNah'ota|tl


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Clrzrpter 5 Financial llarkcts and lnstitutions

5-1 l'he Capital Allocation Process Capital Formation Process

l) Direct Transfers - business sells its socks or bondsdirectlv to savers.

2) Indirect Transfers through Investment Bankers -

sells these same securities to savers.

Underwriter - serves as a middleman andfaci litates the issuance of securities

Primary market transaction - new securities areinvolved and the corporation receives the proceeds ofthe sale

3) [ndirect Transfers through a Financiallntermediary - intermediary obtains from savers in

sec rLl it i es.

markets

Ph;,sical asset markets (tangible/real asset markets)

- products such as wheat, autos, real estate,computers and mach inery.

z.Financial asset markets - stocks. bonds, notes andmortgages, and derivative securities - values areCerived from changes in the prices ofassets.

Spot markets yersus future ntarkets.

Spot markets - assets are bought or sold for "on the

spot" delivery.

y'Future markets - participants agree loday to buy orsell an asset at some future date.

Money ntorkels uersro capital markets

oney nrarkets - short -term. highly liquid debtsecurities.

apital markets - intermediate or long term debtand corporate stocks.

Primary markets versus secondary markets

rimary markets - corporation raise new capital.

econdary markets - existing, already outstanding

securilies are traded among investors.

Private markets versus public markets

rivate markets - transactions are negotiatesdirectl y between parties.

ublic Markets - standardized contracts are tradedon organized exchanges.

5-3 Financial Institutions

Investment banks - an organization that underwrites

and disributes new investment securities and helps

businesses obtain fi nancing.

Commercial banks - traditional department store of

finance serving a variety ofsavers and borrowers.

.4. Financial services corporation - firm that offers awide range of financial services, including investment

banking, brokerage operations, insurance, andI banY.tng.- 1ar1e callom

unions - cooperativemembers are supposed to have a common bond.

Pension funds - retirement plans funded bycorporations or govemment agencies for their workers

and administered primarily by the trust departments of

commercial banks or by life insurance companies.

K. tite insurance companics - take savings in the formof annual premiums. invest these funds in stocks, bonds,

real estate and mortgages; and make payments to the

benefi ciaries of the insured parties.

s(, Matual funds - organizations that pool investor funds

to purchase hnancial instruments and thus reduce risks

funds often operated by mutual fund companies.

4 Hedge funds - similar to mutual funds, they acceptmoney from savers and use the funds to buy various

securities; largely unregulated in contrast with nruttralfunds which are registered and legulated by SEC.

Private equity companies - operate much like hedge

funds; but rather than buying some of the stock of a firm,

private equity players buy and then manage entire firms.

the safety ofthese institutions and protect investors.


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organization that is a hybrid bet a partnershrp and a corporation

Limited Liability Partnership (LLP) - similar to an LLC but

used for professional firms; .gp1pg;ation but

1-4 Stock Prices and Shareholder Value

Primary Goal of the Mgmt. - shareholder wealth maximization

.Shareholder wealth maximization - the primary goal for

managers of publicly owned companies implies that decisions

should be made to maximize the long-run value of the firm's

common slockmottira;zt'ng ihe Prr'ca orr /-he 7'inni ammon s'toc't

1-5 Intrinsic Values, Stock Prices and Executive Compensation

Determinants of Intrinsic Value and Stock Prices

Managerial Actions, Economy, Taxes, and Political Conditions

- determine stock prices thus investors' returns*investors like high returns but dislike risk so the larger the

expected profits and the lower the perceived risk th

ue Expected Returns and True Risk

- investor *,ould expect if they had a . thatexisted about the company

rceived Returns snd Perceived Risk- what investors expect given th . they

actually have

trinsic Value

- an estimate of a stock's true value based on accurate risk

rlcet Price

- the stock value based on perceived but possiblyincorrect info. as seen by the marginal investor

' Marginal investor- views determine the actual stock price

rlcet Equilibrium

- Intrinsic Value : Stock Pricegml.'c qoa/ sfioutd te lo -pke acfr'ons ol.ct?hcd 4c tay,^r'rac .frm C e. trol ;lt cut ct / /re)el Vrr< 5

1-6 Important Business Trends

arbanes-Oxley D// - requires the CEO and CFO of a firm to

certify that the firm's financial statements are accurate.

en Increased globalization of business.

y?J Ev er- improvin g info rm ation t echno lo gy.

rporate governance - way the top managers operate and

interface with stockholders

1-7 Business Ethics

1-8a Managers versus Stockholders

Useful motivational tools to motivate managers to act in

their shareholder's best interest:

Compensation packages

- should be suffrcient to attract and retain able managers, should

not go beyond u'hat is needed; managers rewarded on the basis o

the stock's performance over the long run.

g of managers who don't perform u,ell

- stockholders can inten'ene directly with managers

Threat of hostile tqkeovers

.CorporateRaider - an individual who targets a

corporation for takeover because it is undervalued.Ilostile Takeover - the acquisition of a company over

the opposition of the management

I -8b Stockholders versus Bondholders

regardless of how well the company does while stockholders do

better when the company does better

2) The use ofadditional debt


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Finman Overview

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