Chapter 01 - Introduction to Finance.pdf

DBCF1113 PRINCIPLES OF FINANCE CHAPTER 01 INTRODUCTION TO FINANCE TOPIC & STRUCTURE OF THE LESSON 1. Finance 2. Goals of the firm 3. Agency Theory 4. Financial markets and types of business organization  Shareholder Wealth Agency Relationship...

DBCF1113 PRINCIPLES OF FINANCE CHAPTER 01 INTRODUCTION TO FINANCE TOPIC & STRUCTURE OF THE LESSON 1. Finance 2. Goals of the firm 3. Agency Theory 4. Financial markets and types of business organization  Shareholder Wealth Agency Relationship Financial Markets KEY TERMS Sole Proprietorships Partnership Corporations  LEARNING OBJECTIVE #1: FINANCE DEFINTION OF FINANCE It covers many areas including investments and portfolio Finance can be defined as the management, public finance, art and science of managing financial institutions and money financial markets, corporate finance and financial management CAREER OPPORTUNITIES IN MANAGERIAL FINANCE ROLES FINANCE IN ORGANIZATIONS  Finance is a broad Because individuals, term that describes businesses and two related activities: government entities Finance is concerned all need funding to the study of how with decisions about operate, the field is money is managed money often separated into and the actual process of acquiring three sub- needed funds. categories: personal finance, corporate finance and public finance. WHAT IS FINANCE? FOUR MAJOR AREAS OF FINANCE Financial markets and institutions Investments Financial services Managerial finance  Banks Insurance companies FINANCIAL INSTITUTIONS Savings and loans Credit unions INVESTMENTS o Major Functions:  Determining the values, risks and returns of financial assets  Determining the optimal mix of securities that should be held in a portfolio. (try to minimize risk while striving for the highest return possible) FINANCIAL SERVICES o Deal with the management of money. o Help individuals and companies determine how to invest money. o One of the largest industries in the world.  MANAGERIAL FINANCE o Financial management: A process involved in an attempt to obtain and allocate financial resources effectively and efficiently to achieve the firm’s goal; that is to maximize the shareholders’ wealth by maximizing the share price. o Important in all areas of business o Decisions made by financial managers:  Financial analysis & planning  Investment decisions  Financing and capital structure decisions  Management of financial resources  Risk management  LEARNING OBJECTIVE #2: GOALS OF THE FIRMS ECONOMIC GOAL : PROFIT MAXIMIZATION Focus on short term goal to be achieved within a year. It stresses on the efficient use of capital resources. In order to maximize profit, the financial manager will implement actions that would result in maximum profits without considering the consequence of his actions towards the company's future performance. Drawbacks of Profit Maximization:  Profit maximization is a short-term concept  Profit maximization does not consider the timing of returns  Profit maximization ignores risk FINANCE GOAL : MAXIMIZATION OF THE SHAREHOLDERS WEALTH  It is being measured by the share price of the stock, which in turn 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.  LEARNING OBJECTIVE #3: THE AGENCY THEORY  \ THE AGENCY THEORY o A theory concerning the relationship between a principal (shareholder) and an agent of the principal (company's managers). o When one party (Principal) hires someone else (Agent) to work for him/her, their interaction is called Agency Relationship o Essentially it involves the costs of resolving conflicts between the principals and agents and aligning interests of the two groups.  A conflict of interest arising between creditors, shareholders and management because of differing goals. AGENCY For example, an agency problem exists PROBLEM when management and stockholders have conflicting ideas on how the company should be run.  LEARNING OBJECTIVE #4: FINANCIAL MARKETS AND TYPES OF BUSINESS ORGANIZATION FINANCIAL MARKETS Definition: o Any marketplace where buyers and sellers participate in the trade of assets such as equities, bonds, currencies and derivatives. o Financial markets are typically defined by having transparent pricing, basic regulations on trading, costs and fees and market forces determining the prices of securities that trade. COMPONENTS Primary Market OF FINANCIAL Secondary Market MARKETS Money Market Capital Market Organized Securities Exchange Private Placement Public Offerings COMPONENTS OF FINANCIAL MARKETS Primary Markets A market that issues new securities on an exchange. Companies, governments and other groups obtain financing through debt or equity based securities. Secondary Markets A market where investors purchase securities or assets from other investors, rather than from issuing companies themselves. For example, NYSE, NASDAQ, Bursa Malaysia are known as secondary markets. COMPONENTS OF FINANCIAL MARKETS Money Markets Financial instruments with high liquidity and very short maturities are traded. The money market is used by participants as a means for borrowing and lending in the short term, from several days to just under a year. For example, negotiable certificates of deposits, T-bills, bankers acceptances. Capital Markets A market in which individuals and institutions trade financial securities. Organizations/institutions in the public and private sectors also often sell securities on the capital markets in order to raise funds. For example, stocks and bonds. COMPONENTS OF FINANCIAL MARKETS Organized Securities Exchange A securities exchange that operates under the rules and regulations formulated by the exchange. Investors actively trading on the exchange are aware of these rules and conduct trades accordingly. Private Placements Raising capital by selling securities to selective/small number of investors. Investors such as large banks, mutual funds, insurance companies and pension funds in this private placements. COMPONENTS OF FINANCIAL MARKETS 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. Initial Public Offering (IPO) The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately owned companies looking to become publicly traded. Associated with primary markets. TYPES OF BUSINESS ORGANIZATIONS Sole-Proprietorship o A company which is not registered with the state as a limited liability company or corporation. o Can work as an independent contractor or operate a small business. o Many home-based business operated by sole-proprietors. o The owner fully liable for any business debts. o Examples: grocery shop, freelance, or tutor. TYPES OF BUSINESS ORGANIZATIONS Partnership o A type of unincorporated business organization in which multiple individuals, called general partners, manage the business and are equally liable for its debts. o Each partner shares equal responsibility for the company's profits and losses. o The partnership itself does not pay income taxes, but each partner has to report business profits or losses on their individual tax return. o Examples: Clinics, or Law/Legal Firm TYPES OF BUSINESS ORGANIZATIONS Corporations o A corporation is created (incorporated) by a group of shareholders who have ownership of the corporation, represented by their holding of common stock. o Shareholders have the right to participate in the profits, through dividends and/or the appreciation of stock, but are not held personally liable for the company's debts. o BOD elected by receiving vote per share from shareholders. o Examples: Banks, Insurance companies. CASE STUDY: ENRON CASE At one time, Enron has been one of the largest companies in United States. Despite being a multibillion-dollar company, Enron began losing money in 1997. It had also 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 $90 to under $1 per share. The company filed for bankruptcy in December 2001, and criminal charges were brought against several key Enron employees including their formers CEO. Based on the situation above, describe the agency problem occurring in Enron. QUESTIONS WHAT ARE THE COMPONENTS OF FINANCIAL MARKET IN MALAYSIA? THANK YOU FURTHER REFERENCES;  Money Market : https://youtu.be/ipOYM0sfW7M