Introduction to Finance

Introduction to Finance

• Finance is the art and science of managing money, covering areas including investments, portfolio management, public finance, financial institutions, and corporate finance.

Definition of Finance

• Finance is concerned with decisions about money management and the process of acquiring needed funds.

Career Opportunities in Managerial Finance

• Managerial finance is a broad term that describes two related activities: the study of how money is managed and the actual process of acquiring needed funds.

Four Major Areas of Finance

• Financial markets and institutions
• Investments
• Financial services
• Managerial finance

Financial Markets and Institutions

• Financial institutions include banks, insurance companies, savings and loans, and credit unions.

Investments

• Major functions:
  • Determining the values, risks, and returns of financial assets
  • Determining the optimal mix of securities in a portfolio

Financial Services

• Deal with the management of money
• Help individuals and companies determine how to invest money
• One of the largest industries in the world

Managerial Finance

• Financial management: a process involved in attempting to obtain and allocate financial resources effectively and efficiently to achieve the firm's goal
• Decisions made by financial managers:
  • Financial analysis and planning
  • Investment decisions
  • Financing and capital structure decisions
  • Management of financial resources
  • Risk management

Goals of the Firm

• Economic goal: profit maximization
  • Focus on short-term goal to be achieved within a year
  • Stresses on the efficient use of capital resources
  • Drawbacks: short-term concept, ignores risk, and does not consider the timing of returns

Finance Goal: Maximization of Shareholders' Wealth

• Measured by the share price of the stock, which is based on the timing of returns, the amount of the returns, and the risk or uncertainty of the returns
• Shareholders' wealth maximization can be achieved by considering the present and potential future earnings per share, timing of returns, dividend policy, and other factors that affect the market price of the company's stock

The Agency Theory

• A theory concerning the relationship between a principal (shareholder) and an agent of the principal (company's managers)
• When one party (principal) hires someone else (agent) to work for him/her, their interaction is called an agency relationship
• Essentially, it involves the costs of resolving conflicts between the principals and agents and aligning their interests

Agency Problem

• A conflict of interest arising between creditors, shareholders, and management because of differing goals

Financial Markets

• Definition: any marketplace where buyers and sellers participate in the trade of assets such as equities, bonds, currencies, and derivatives
• Components:
  • Primary Market
  • Secondary Market
  • Money Market
  • Capital Market
  • Organized Securities Exchange
  • Private Placement
  • Public Offerings

Components of Financial Markets

• Primary Market: a market that issues new securities on an exchange
• Secondary Market: a market where investors purchase securities or assets from other investors, rather than from issuing companies themselves
• Money Market: financial instruments with high liquidity and very short maturities are traded
• Capital Market: a market in which individuals and institutions trade financial securities
• Organized Securities Exchange: a securities exchange that operates under the rules and regulations formulated by the exchange
• Private Placement: raising capital by selling securities to a selective or small number of investors
• Public Offerings: the sale of equity shares or other financial instruments by an organization to the public in order to raise funds for business expansion and investment

Types of Business Organizations

• Sole-Proprietorship: a company that is not registered with the state as a limited liability company or corporation
• Partnership: a type of unincorporated business organization in which multiple individuals manage the business and are equally liable for its debts
• Corporation: a corporation is created by a group of shareholders who have ownership of the corporation, represented by their holding of common stock

Case Study: Enron Case

• Enron, a multibillion-dollar company, began losing money in 1997 and had started incurring a tremendous amount of debt
• Fearing a drop in stock prices, Enron's management team tried to disguise the problems by misrepresenting them through inappropriate accounting methods, which resulted in confusing and misleading financial statements
• Disaster started to unfold in 2001, when common stock fell from 90tounder90 to under 90tounder1 per share, and the company filed for bankruptcy in December 2001