FNNB 113 Financial Management Topic 1 PDF

FNNB 113 FINANCIAL MANAGEMENT TOPIC 1 INTRODUCTION TO FINANCIAL MANAGEMENT FINANCE: AN OVERVIEW What is finance the study of how people and businesses evaluate investments and raise capital to fund them. Why Study Finance? Knowledge of financial tools is...

FNNB 113 FINANCIAL MANAGEMENT TOPIC 1 INTRODUCTION TO FINANCIAL MANAGEMENT FINANCE: AN OVERVIEW What is finance the study of how people and businesses evaluate investments and raise capital to fund them. Why Study Finance? Knowledge of financial tools is critical to making good decisions in both corporate world and personal lives. Many personal decisions require financial knowledge (for example: buying a house, planning for retirement, leasing a car) Three Basic Questions Addressed by the Study of Finance: 1 What long-term investments should the firm undertake? (capital budgeting decision) 2 How should the firm raise money to fund these investments? (capital structure decision) How can the firm best manage its cash flows as 3 they arise in its day-to-day operations? (working capital management) THE NATURE & PURPOSE OF FINANCIAL MANAGEMENT FM is concerned with managing a corporation’s money For example, a company must decide: ❑where to invest its money? ❑whether or not to replace an old asset? ❑when to issue new stocks and bonds? Financial management is an application of general managerial principles to the area of financial decision-making. THREE TYPES OF BUSINESS ORGANIZATIONS Business Forms Sole Partnerships Proprietorships Corporations General Limited Business Organizational Forms Sole Proprietorship Partnership Corporations It is a business owned by a A general partnership is an chosen when large amount of fund single individual who is entitled association of two or more persons needed to all of the firm’s profits and is who come together as co-owners for Corporation legally functions the purpose of operating a business separately and apart from its owners also responsible for all of the for profit. (the shareholders). firm’s debt. In limited partnerships, there are two Corporation can individually sue and The sole proprietors typically classes of partners: general and be sued and can purchase, sell, or raise money by investing their limited. own property. own funds and by borrowing The general partner runs the business The corporation is legally owned by its from a bank. and faces unlimited liability for the current set of stockholders, or firm’s debts, owners. whereas the limited partner is liable The Board of directors are elected by only up to the amount the limited the shareholder, and the board partner invested. The life of the appoints the senior management of partnership is tied to the life of the the firm. general partner. THE GOAL OF THE FINANCIAL MANAGER The goal of the financial manager must be consistent with the mission of the corporation, which is to maximize shareholder’s wealth. THE FIVE BASIC PRINCIPLES OF FINANCE Principle 1: Money Has a Time Value A dollar received today is worth more valuable than a dollar received in the future. We can invest the dollar received today to earn interest. Thus, in the future, we will have more than one dollar, as we will have earned interest on the investment. Principle 2: There is a Risk—Return Trade—off Investors tend to be risk-averse and prefer certain return than uncertain return. Investors will hold risky investments if they expect to be compensated with additional return. Higher the risk, higher will be the expected return. Figure 1: There is a Risk-Return Trade—off  Principle 3: Cash Flows Are the Source of Value Profit is an accounting concept and measures a business’s performance. Cash flow is the amount of cash that can actually be taken out of the business. Company’s profits can differ dramatically from its cash flows. It is possible for a company to report profits without generating any cash. Principle 4: Market Prices Reflect Information Investors respond to new information by buying and selling their investments. The speed of investor reaction and speed of price adjustment determines the efficiency of market. Release of Good News ==> Higher Release of Bad stock prices News ==> Lower stock price Principle 5: Individuals Respond to Incentives Managers (as agents) respond to incentives they are given in the workplace. If the incentives are not properly aligned with those of the firm’s stockholders (the principal) they may not make decisions that are consistent with increasing shareholder value leading to agency costs. Financial Institutions & Markets Firms that require funds from external sources can obtain them in three ways: ❖through a financial institution ❖through financial markets ❖through private placements Financial Institutions & Markets ❑Financial institutions are intermediaries that channel the savings of individuals, businesses, and governments into loans or investments. ❑The key suppliers and demanders of funds are individuals, businesses, and governments. ❑In general, individuals are net suppliers of funds, while businesses and governments are net demanders of funds. Financial Institutions & Markets Commercial banks are institutions that provide savers with a secure place to invest their funds and that offer loans to individual and business borrowers. Investment banks are institutions that assist companies in raising capital, advise firms on major transactions such as mergers or financial restructurings, and engage in trading and market making activities.  Financial Institutions & Markets Commercial Banks Investment Banks 1. Affin Bank Berhad 1. Affin Hwang Investment Bank Berhad 2. Alliance Bank Malaysia Berhad 2. Alliance Investment Bank Berhad 3. AmBank (M) Berhad 3. AmInvestment Bank Berhad 4. Bangkok Bank Berhad 4. May Bank Investment Bank 5. Bank of America Malaysia Berhad 5. KAF Investment Bank 6. Bank of China (Malaysia) Berhad 6. CIMB Investment Bank 7. Bank of Tokyo-Mitsubishi UFJ (Malaysia) Berhad 7. Public Investment Bank Berhad 8. CIMB Bank Berhad 8. RHB Bank 9. Citibank Berhad 9. Hong Leong Bank 10. Deutsche Bank (Malaysia) Berhad 10. United Overseas Bank (Malaysia) 11. EON Bank Berhad 11. Bank Rakyat 12. Hong Leong Bank Berhad 12. OCBC Bank (Malaysia) Berhad 13. HSBC Bank Malaysia Berhad 13. HSBC Bank Malaysia Berhad Financial Institutions & Markets Financial markets are forums in which suppliers of funds and demanders of funds can transact business directly. people trade financial securities and derivatives, and facilitate the interaction between those who need capital with those who have capital to invest. Transactions in short term marketable securities take place in the money market while transactions in long-term securities take place in the capital market. A private placement involves the sale of a new security directly to an investor or group of investors. Most firms, however, raise money through a public offering of securities, which is the sale of either bonds or stocks to the general public. Financial Institutions & Markets The primary market is the financial market in which securities are initially issued; the only market in which the issuer is directly involved in the transaction. Secondary markets are financial markets in which preowned securities (those that are not new issues) are traded. Financial Institutions & Markets Flow of funds for financial institutions and markets: The nature of money market Money market - markets for short-term debt instruments, with maturities of one year or less (such as Treasury bills, Commercial paper). Characteristics of Different Financial Instruments Money Market Debt For the Borrower: Good way of inexpensively raising money for short periods of time. Rates tend to be lower than long-term rates. Can borrow money to match short-term needs. If interest rates rise, the cost of borrowing will immediately rise accordingly. For the Investor: Very liquid—investors have access to their money when they need it. Safe—generally invested in high-quality investments for brief periods. Low returns—rates tend to be close to the rate of inflation. Example of Money Market Instrument Market Major Participants Riskiness Original Maturity Interest Rates* 3-month Malaysian Treasury Money— Short-term securities issued by Default-free 6-month Bills (MTB) Debt Bank Negara Malaysia (BNM) 1-year. 1 month - 1 year Depend on the corporation. short-term debt instruments issued by corporations to raise funds for immediate financing Commercial Money— Low default needs for example to fund paper Debt risk operating expenses or current assets (e.g., inventories and receivables) Default risk Issued by major money-center depends on Negotiable Money— commercial banks the strength certificates of 3 months - 5 years Depend on the banks Debt with a denomination of of the deposit (CDs) RM50,000 to RM1 million. issuing bank  The economic environment for business Economic Environment refers to all the economic factors that affect commercial and consumer behavior. The economic environment consists of all the external factors in the immediate marketplace and the broader economy. These factors can influence a business, i.e., how it operates and how successful it might become.  Importance of ethics in financial management Ethics plays a crucial role in the field of finance, shaping the way financial professionals conduct themselves and make decisions. It is essential to recognize the significance of ethics in finance as it not only impacts individual behavior but also has broader implications for the stability and trustworthiness of the financial system as a whole.