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Jamil Ahmed
Assistant Professor
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What is Finance?
At the macro level, finance is the study of financial
institutions and financial markets and how they operate
within the financial system in both the Local and global
economies.
At the micro level, finance is the study of financial
planning, asset management, and fund raising for
businesses and financial institutions. Financial management can be described in brief using
the following balance sheet.
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What is Finance?
Assets: Liabilities & Equity:
Current Assets Current Liabilities
Cash & M.S. Accounts payable
Accounts receivable Notes Payable
Inventory Total Current Liabilities
Total Current Assets Long-Term Liabilities
Fixed Assets: Total Liabilities
Gross f ixed assets Equity:
Less: Accumulated dep. Common Stock
Goodw ill Paid-in-capital
Other long-term assets Retained Earnings
Total Fixed Assets Total Equity
Total Assets Total Liabilities & Equity
WorkingCapital
Working
Capital
InvestmentDecisions
Financing
Decisions
Macro Finance
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$1,068,232,095
$479,673,700
$149,121,474
$2,808,013,079
Size of Payroll (000s)
1,292,081
2,584,427
622,908
1,011,973
Number of Firms in the U.S.
Corporation
S-Corporation
Partnership
Sole
Proprietorship
Goals and Governance of the
CorporationThis Lecture introduces the corporation, its goals, and the roles
of financial managers.
Source: U.S. Census 2008SUSB Annual Data
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FinancialS
ervices Industry inUK
In UK industry accounts for about a
proportion of National Output as the whole of
Manufacturing Industry (2008).
The growth is still amazing. It contributed
$200 billions, accounting for10% of totaleconomic output.
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Areas ofSpecialization in Finance
Financial Markets
Markets of users and savers of funds.
FinancialServices
Design and delivery of financial advice and
products to individuals, businesses, government.
Managerial Finance
Financial management of business firms.
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Basic Forms ofBusiness
Organization Sole Proprietorship
Owned by one person, operated for personal profit.
Partnerships
Owned by two or more people, operated for joint
profit.
Corporations Legal entity, owned by individuals, operated for
joint profit.
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Sole ProprietorshipSTRENGTHS:
Low organizational cost
Income taxed once as
personal income
Independence
Secrecy Ease of dissolution
WEAKNESSES:
Unlimited liability
Limited funding
Proprietor must be all
Difficult to develop staff
career opportunities Lack of continuity on
death of proprietor
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PartnershipsSTRENGTHS: Improved funding
sources
Increased managerialtalent
Income split bypartnership contract,
taxed as personalincome
WEAKNESSES:
Unlimited liability to
all partners
Partnership dissolvedupon death of partner
Difficult to liquidate or
transfer ownership
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CorporationsSTRENGTHS:
Owners liability limited
Large capitalization
possible, greater funding
Ownership readily
transferable Indefinite life
Professional management
WEAKNESSES:
Higher tax rates/Double
Taxation Expensive organization
Greater governmentregulation
When publicly traded,lacks secrecy
Improper corporatestructures may lead toAgency Problems
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Corporate Organization Chart
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Organization of Finance Functions
CFO Chief Financial Officer
Treasurer responsibilities:
Financial planning, fund raising, capital
expenditure decisions, cash and credit
management.
Controller responsibilities: Corporate accounting, cost accounting, and tax
management.
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What is a Corporation?
Corporation-A business organized as a
separate legal entity owned by stockholders.
Types ofCorporations:
Public Corporations
Private Corporations
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Goals of The Corporation
Managers/Investors forced to make decisions and choices in
the harsh environment.
All must therefore be very clear about the purpose of the
organization and its imperative for the management teams to be
aware of, respect and contribute to the objectives. Achieving Target Market Share.
Keeping Employees at peace.
Survival.
Creating an Industrial Empire.
Maximization of profit.
Maximization ofShareholders Wealth.
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Goals of The Corporation
Wealth maximization vs. profit maximization:
Prospects: Identical profits by two firms but one is valued
more and otherless by shareholders. As profits fails to
reflect the relative potential of two firms.
Risk: Same profits and same future prospectus. But the
returns of one firms have a greater variability.
Accounting Problems
Communications
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The Ethics of Maximizing ValueDoes value maximization justify unethical behavior?
Recent examples: Enron
WorldCom
Bernard Madoff
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Agency Problem
Do managers really maximize value?
Agency Problems
Managers are agents for stockholders, but the
managers may act in their own interests rather than
maximizing value
Shareholders vs. Stakeholders
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Agency Problem
Different Information
Stock prices vs. returns
Dividend Policy
Financing Decisions
Different Objectives
Managers vs.shareholders
Top managers vs. lower
managers
Stockholders vs. banksand lenders
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Agency Problem Solutions
Compensation plans
Board of Directors
Blockholders
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Agency Problem Solutions
Takeovers
Specialist Monitoring
Legal and Regulatory Requirements
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4A. Cash reinvested in the firm
4B. Cash returned to investors
Role of the Financial Manager
Financial
Manager
(1)(2)
(3)
(4a)
(4b)Real assets
Investors
Financial
Assets
Firms
Operations
1. Cash raised from investors (how?)2. Cash invested in firm
3. Cash generated by operations
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The Flow of Capital:Closely Held Corporations
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The Flow of Capital:
Public Corporations
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Financial Markets
Financing Decision
Source of Funds (Capital)
CapitalStructure
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The Flow of Capital:Public Corporations
Financial Market:Market where securities are issued and traded.
Primary Market:
Market for the sale of new securities by corporations.
Secondary Market:Market in which previously issued securities are traded among
investors.
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Financial Markets
Initial Public Offering (
IPO):First offering of stock to the general public.
Fixed-Income Market:Market for debt securities
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Financial Markets:Markets for Debt
Capital Markets are used forlong-term financing
Example oflong-term debt: Bonds
Money Markets are used for short-term financing.
Example of short-term debt: Commercial Paper
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Information Provided byFinancial Markets:
Commodity Prices
Interest Rates
Company Value
Cost ofCapital
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Financial Intermediaries
Mutual FundAn investment company that pools the savings of many
investors and invests in a portfolio of securities
Hedge FundA private investment pool, open to wealthy or institutional
investors, that is only lightly regulated and therefore can pursue
more speculative policies than mutual funds
Pension FundFund set up by an employer to provide for employees
retirement
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Flow of Cash Example:Mutual Fund
$ $
Sells
shares
Issues
shares
Bank ofAmerica
InvestorsExplorerFund
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A Closer Look:
Financial Institutions
CommercialBank
Investment Bank
Insurance Company
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Company
Intermediaries
Banks
Insurance Companies
Brokerage Firms
Obligations Funds
Companies and Intermediaries
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Intermediaries and Investors
Intermediaries
Investors
Depositors
Policyholders
Investors
Obligations Funds
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Cash Flow Example:
Banks
Banks
Depositors
$2.5 mil
Cash
Loan
Deposits
Company
Intermediary
Investor
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Cash Flow Example:
Insurance Company
Insurance
Company
Policyholders
$2.5 mil
Cash
Issue Debt
Sell Policies
Company
Intermediary
Investor
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Function of Financial Markets
Transport cash across time
Risk transfer and diversification
Liquidity
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Function of Financial Markets
Payment mechanism
Provide information