What is finance: cash flows between capital markets and firm’s operations
The goal of a firm
Forms of business organization
Intrinsic value and market price of a stock
Agency problem
Business ethics
Career opportunities in finance
What is finance: cash flows between capital markets and firm’s operations
(1) Cash raised by selling financial assets in financial markets
(2) Cash invested in firm’s operations and used to purchase real assets
(3) Cash generated from firm’s operations
(4a) Cash reinvested in firms’ operations
(4b) Cash returned to investors
Financing decisions vs. investment decisions: raising money vs. allocating money
Activity (1) is a financing decision
Activity (2) is an investment decision
Activities (4a) and (4b) are financing decisions
The role of a financial manager:
Forecasting and planning of firms’ financial needs
Planning of firm's financial needs involves investment decision - approving the investment proposals made by various operating managers (all departments including marketing and HR are classified under operating managers)
Making financing decisions
Coordinating with other departments/divisions
Dealing with financial markets
Managing risks
Finance within an organization: importance of finance
Finance includes three areas.
(1) Financial management: corporate finance, which deals with decisions related to how many and what types of assets a firm needs to acquire (investment decisions), how a firm should raise capital to purchase assets (financing decisions), and how a firm should do to maximize its shareholders wealth (goal of a firm) - the focus of this class
(2) Capital markets: study of financial markets and institutions, which deals with interest rates, stocks, bonds, government securities, and other marketable securities. It also covers Federal Reserve System and its policies. The knowledge of capital markets is required to know likely conditions in the markets as well as documentation required, procedure to be followed and regulatory requirements of financial markets to raise finance in the form of equity, debt or risk management products.
(3) Investments: study of security analysis, portfolio theory, market analysis, and behavioral finance. This knowledge is required to understand how markets value financial assets and how demand is created for the financial assets of a company through decisions of large number of individual and institutional investors.
The goal of a firm
To maximize shareholder’s wealth (or firm’s long-run value)
Why not profit or EPS maximization?
Profit maximization usually ignores timing and risk of cash flows
EPS is also a profit measure only.
Why not focusing on short-term?
Top executives receive huge bonuses for engaging in risky transactions that could generate short-term profits and those transactions collapse later on, subprime mortgage, for example
Corporation: legal entity created by a state.
Advantages:
Limited liability
Easy to transfer the ownership
Unlimited lifetime of business
Easy to raise capital
Disadvantages:
Double taxation (at both corporate and individual levels)
Cost of reporting
Intrinsic value and market price of a stock
Intrinsic value is an estimate of a stock’s “fair” value (how much a stock should
be worth)
Market price is the actual price of a stock, which is determined by the demand and supply of the stock in the market
Determinants of intrinsic value and stock price
Intrinsic value is supposed to be estimated using the “true” or accurate risk and
return data. However, since sometimes the “true” or accurate data is not directly
observable, the intrinsic value cannot be measured precisely.
Market value is based on perceived risk and return data. Since the perceived risk and return may not be equal to the “true” risk and return, the market value can be mispriced as well.
Stock in equilibrium: when a stock’s market price is equal to its intrinsic value the stock is in equilibrium.
Stock market in equilibrium: when all the stocks in the market are in equilibrium (i.e. for each stock in the market, the market price is equal to its intrinsic value) then the market is in equilibrium
Actual prices vs. intrinsic values
When the intrinsic value of a stock is higher than the market price of the stock, we
say that the stock in the market is under-valued (under-priced)
For example, if the intrinsic value for a stock is $26 and the market price is $25,
then the stock is under-valued.
When the intrinsic value of a stock is lower than the market price of the stock, we
say that the stock in the market is over-valued (over-priced)
For example, if the intrinsic value for a stock is $30 and the market price is $32,
then the stock is over-valued.
When the intrinsic value of a stock is equal to the market price of the stock, we
say that the stock in the market is fairly priced (the stock is in equilibrium)
Agency problem
A potential conflict of interest between two groups of people
Stockholders vs. managers
Instead of shareholders’ wealth maximization, managers may be interested in
their own wealth maximization
Useful motivational tools
Performance shares, executive stock options (positive)
Threat of firing (negative)
Hostile takeover (negative)
Stockholders vs. bondholders
Stockholders prefer high-risk projects for higher returns
Bondholders receive fixed payment and therefore prefer lower risk projects
Business ethics
Standards of conduct or moral behavior toward its employees, customers,
community, and stockholders - all its stakeholders
Measurements: tendency of its employees, adhere to laws and regulations, moral
standards to product safety and quality, fair employment practice, fair marketing
and selling practice, proper use of confidential information, community
involvement, and no illegal payments or practice to obtain business.
Financial markets demand ethical practices and finance managers have to know the ethical codes of various markets and have to put in place an ethical code in their organizations to match them.
Power Point Slides - Brigham and Young 10th Edition
From http://www.swlearning.com/finance/brigham/ffm10e/powerpoint.html
http://www.csun.edu/~zz1802/index.htm
No comments:
Post a Comment