Introduction to Finance Lectures 1 & 2 PDF

Topic 1 Introduction to Finance Lectures 1 & 2 1 Aims and objectives 1. To introduce the elements of finance 2. To describe the alternative perspectives on finance corporate finance investments financial markets and intermediaries 3. To summarize the status of finance as an academic discipline 2 4....

Topic 1 Introduction to Finance Lectures 1 & 2 1 Aims and objectives 1. To introduce the elements of finance 2. To describe the alternative perspectives on finance corporate finance investments financial markets and intermediaries 3. To summarize the status of finance as an academic discipline 2 4. To relate finance to other disciplines 5. To describe the different forms of business structure 6. To give a brief overview of the financial markets in which companies and investors operate 7. To describe how the London Stock Exchange works 3 Finance is concerned with decisions involving the valuation of future cash flows and what affects these values  main elements 1. money 2. time 3. uncertainty or risk 4. information 5. taxation 4 Example: investing in shares 1. Monetary return in the future (a) dividends, (b) capital gain 2. Both are uncertain when you make the investment 3. Information (a) resolves uncertainty (b) asymmetrically shared 4. Taxation (a) after-tax returns 5 Perspectives on finance 1. Corporate finance (a) (real) investment/capital budgeting (b) financing (i) shareholder funds including retained profits (ii) bank loans (iii) bonds and debenture loans (c) liquidity/working capital management 6 2. Investments 3. Financial intermediaries and markets [4. Government] (a) gilts (b) tax (c) regulation 7 Financial intermediaries Individual investors banks, pension funds, unit trusts, etc Investments Financial markets stocks, bonds, options, futures, foreign exchange, etc. Corporate finance investment, financing, liquidity decisions Government Exchanges of money and financial assets 8 Status of finance Theoretical research develops models/theories to explain financial phenomena or to value securities (future cash flows) Theories to explain – relative prices of different securities – share price movements – companies’ dividend decisions 9 …. – how to value real investments – how to value share options and other securities Empirical research tests these theories using actual data How well do these theories perform? – empirical anomalies 10 Relation to other disciplines Economics Accounting – financial reporting – management accounting Sociology/psychology Quantitative techniques/econometrics Law Business management 11 Forms of business structure 1. Unincorporated: sole traders, partnerships Advantages ☺ cheap and easy to establish ☺ ownership & control concentrated ☺ no requirement to publish accounts 12 Disadvantages  difficult to sell  finite life  business owner  unlimited liability  difficult to raise funds to grow 13 2. Incorporated: separate legal identity from its owners Companies limited by shares—private, PLCs PLC — characteristics established by shareholders financed by share and debt capital share capital — permanent debt capital — money borrowed for fixed period 14 shareholders — residual owners, limited liability shareholders elect Board of Directors Board appoint managers 15 Advantages ☺ ownership can be transferred by selling shares  infinite life ☺ business is legally separate from its owners  limited liability ☺ funds can be raised publicly through equity and debt markets Disadvantages     difficult and expensive to establish tax disadvantages management is separate from owners requirement to publish accounts 16 Business structures in other countries Most countries have a similar structure relating to unincorporated and incorporated companies though the rules and regulations may be different. The definition of ‘partnership’ is different across Europe – In the UK, partnership is deemed to be a corporate entity where as in Germany (PartG) it isn’t. 17 Business structures in other countries Directors of incorporated firms in Europe are elected in two main ways – In single-tier board countries (UK, Ireland, Sweden) shareholders elect board of directors who then select the managers. – In two-tier board countries (Denmark, Germany, the Netherlands) there are two boards. The executive board manages the day to day operations and reports to the supervisory board which monitors the executive board’s performance. 18 Business structures in other countries Incorporated firms have many variations around the world – They are called different names: joint stock companies, public limited companies, limited liability companies etc. – Table 2.1 (page 20) of the course textbook provides information on the different types of names used in international corporations. A shorter version of the table is shown in the next slide. 19 Source: Table 2.1, page 20, Fundamentals of Corporate Finance, HCRWJ 20 Financial markets and intermediaries Financial Markets Money and capital markets allow investors to buy and sell financial claims (securities) and facilitate this exchange 21 Stock markets 1. Primary market—companies raise new equity finance by issuing new securities 2. Secondary market—investors buy and sell existing shares (a) information motivated (b) liquidity motivated Advantages ☺ investment v. borrowing horizons ☺ liquidity / marketability ☺ active market gives correct valuations 22 Intermediaries debt finance(overdrafts, bank loans, leasing) Commercial/ investment banks tailored finance (eg swaps, FRAs) London stock exchange (LSE) Individuals Institutional investors: pension funds, insurance companies, investment/unit trusts international investment Foreign markets 23 new equity finance New debt finance (Eurobonds, Loan stock) debt/equity finance C o r p o r a t e s e c t o r Stock exchange primary market IPOs: initial public offerings (new issue market) rights issues: secondary/seasoned offerings Stock exchange secondary market Big-bang—27 October 1986 ‘Big-bang II’—20 October 1997 24 Pre- Big-Bang: single capacity (a) (stock)jobbers (b) stockbrokers Problems increased concentration/reduced competition in jobbing fixed brokerage commissions LSE membership restricted jobbers undercapitalized Restrictive Practices Court International competitiveness 25 Post- Big-Bang: dual capacity (a) broker/dealer (b) market makers (c) trading floor v. SEAQ & telephone Big Bang II- More changes to the trading system 30th anniversary BBC article on Big Bang https://www.bbc.co.uk/news/business-37751599 26 Summary The main elements of finance: time, money, uncertainty, information, & taxation Three perspective on finance: corporate, investor, financial intermediaries & markets Finance theory tries to explain financial phenomena and to value future cash flows; empirical finance tests these theories 27 BMAN 10522 focuses on incorporated stock market quoted companies stock market have primary and secondary markets the LSE has undergone two significant changes in its trading system since 1986 28