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1. Career Opportunities in Finance

Money and capital markets Investments Financial management

Some players have need for capital, others have excess capital.Financial Markets bring both parties together

Investments is the purchase of securities issued by firms/governments for

income or capital appreciation.

Examples of parties involved:Brokerage: full service vs discountFinancial consulting: advise individuals how to investInvestment portfolio management: for bank, mutual fund

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2. Financial Management Decisions

Capital BudgetingThe process of planning and managing a firm’s long-term investments is called capital budgeting. In capital budgeting,

the financial manager tries to identify investment opportunities

that areworth more to the firm than they cost to acquire.

Capital StructureWays in which the firm obtains and manages the long-term financing it needs to support its long-term investments. A

firm’s capital structure refers to the specific mixture of long-term

debt and equity the firm uses to finance its operations.

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Financial Management Decisions

Working Capital ManagementThe phrase working capital refers to a firm’s short-term

assets, such as inventory, and its short-term liabilities, such as

money owed to suppliers. Managing a firm’s working capital is a

day-to-day activity that ensures the firm has sufficient resources

to continue its operations and avoid costly interruptions.

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3. Corporation

In general, a firm starts as a proprietorship or partnership and becomes a corporation over time.

Corporation has the following advantages:

Unlimited life of organization

Ease of transferring ownership

Limited liability

These advantages make it easy for corporations to raise money in capital markets.

Basic disadvantage is double taxation

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4. Financial Goals of the Corporation

The primary financial goal is shareholder wealth maximization, which translates to maximizing stock price.

Is stock price maximization the same as profit maximization?For example, what about maximizing this year’s earnings per

share?

Stock price depends on future expected cash flows, their timing andriskiness. So the difference is: Being accounting vs. cash measure

Use of a myopic/non-myopic approachIgnoring/considering the risk dimension

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5. Agency relationships

An agency relationship exists whenever a principal hires an agent

to act on his/her behalf.

Within a corporation, agency relationships exist between: Shareholders and managers Shareholders and creditors

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Shareholders versus Managers

Managers are naturally inclined to act in their own best interests rather than that of shareholders.

They may have incentive to enjoy perquisites or leisure

Or they may aim to maximize size of the firm Power/statusHigher salaryProne to takeovers

But the following factors affect managerial behavior:Managerial compensation plansDirect intervention by shareholdersThe threat of firingThe threat of takeover

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Shareholders versus Managers

To align shareholder-manager interest

Managerial compensation executive stock options

performance shares

Shareholder intervention proposal to be voted in annual meeting

blockholders are usually members in the board of directors

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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.

Creditors lend funds based onRiskiness on firm’s existing assetsExpectation about riskiness of new assetsExisting capital structureExpectations about changes in capital structure

Expropriation of wealth from creditorsAccepting riskier projectsIssuing new debt (and repurchase stock)

Creditors will either place restrictive covenants and/or charge a higher than normal interest rate

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6. Factors that affect stock price

Projected cash flows to shareholdersTiming of the cash flow streamRiskiness of the cash flows

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)

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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 Legal constraints General level of economic activity Tax laws Interest rates