an introduction to financial management 2002, prentice hall, in
TRANSCRIPT
An Introduction to Financial Management
Goal of the Firm
1) Profit Maximization?
this goal ignores:
a) TIMING of Returns(Time Value of Money )
b) UNCERTAINTY of Returns(Risk )
Goal of the Firm
2) Shareholder Wealth Maximization?
this is the same as:
a) Maximizing Firm Valueb) Maximizing Stock Price
Legal Forms of Business
1) Sole Proprietorship • A business owned by a single individual.• Owner maintains title to the firm’s assets.• Owner has unlimited liability.
2) Partnership• Similar to a sole proprietorship, except
that there are two or more owners.
2a) General Partnership • All partners have unlimited liability.
2b) Limited Partnership• Consists of one or more general partners,
who have unlimited liability, and• One or more limited partners (investors)
whose liability is limited to the amount of their investment in the business.
Legal Forms of Business
3) Corporation • A business entity that legally functions
separate and apart from its owners.• Owners’ liability is limited to the amount
of their investment in the firm.• Owners hold common stock certificates,
and ownership can be transferred by selling the certificates.
Legal Forms of Business
The Corporation and Financial Markets
cash Investors
Secondarymarkets
Government
securities
Cash flow
reinvest
tax
Corporation
dividends,etc.
CONCEPT OF INVESTMENT
• Concept of Investment
• Today’s sacrifice
• Time value
• Prospective Gain
• Financial Investment
• Extent of liability
• Uncertainty
• Impact of time and risk
Varieties of Securities
• The financial stakes represented by securities are stakes in some
– Business– Government– other legal entity
Constituents of a financial system
Financial System
Financial Financial Financial
assets markets intermediaries
Forex Capital Money Creditmarket market market market
Primarymarket
Secondarymarket
Investment alternatives
Financial assets
Direct investing indirect investing
Mutual Closed end Unit investment funds funds assets
Non marketable Money market Capital market Derivativesecurities
Treasury bills Fixed income common Stock Corporate Futures
Negotiable CDs stock option created Commercial paper Treasuries Repurchase Federal agencies
convertibles agreement Municipals warrantsBankers acceptance Corporates CallsForeign securities Foreign Puts
Mortgage pass throughs Preferred Stock
Characteristics of the financial markets
Market Purpose
Players Regulator
Money Market Short-termfinance
Banks, Govt.,FIs,MFs,
CentralBank
Capital Market Long-termfinance
Companies,Banks,FIs,MFs,individuals
Eg.,SEC,SEBI
Forex Market ForeignCurrencyfinance
Banks, companies, Forex dealers
CentralBank
Credit Market Short/longTerm finance
Banks, FIs CentralBank
Intermediaries operating in financial marketsIntermediary Market Role
Stock exchange Capital market Secondary market for securities
Investment bankers Capital market, credit market
Corporate advisory services/Issue of securities
Underwriters Capital market, money market
Subscribe to unsubscribed portion of securities
Registrars, depositories Capital market Issue securities to the investors on behalf of the issuer and handle share transfer activity
Primary and secondary dealers Money market Market making in government securities
Forex dealers Forex market Facilitate exchange in currencies
Primary and secondary markets
Primary marketMarket in which investors buy newly issued securities and issuers of securities receive the proceeds from the sale.
Secondary marketMarket where previously issued securities are traded among the investors.
Money Market
• Market Characteristics– Wholesale debt market– Market for low risk, highly liquid, short term
instruments– Funds can be raised in this market for periods ranging
from one day to one year• Players in the market– Government – the biggest borrower– Banks– Financial Institutions– Corporations– Mutual funds– Market makers
Money Markets
• Government & Quasi-Government securities– Treasury bills, notes and bonds– Municipal Notes
• Banking sector securities– Call money – interbank funds– Negotiable Certificates of Deposit– Bankers Acceptance
• Corporate sector securities– Commercial paper
The Capital Market
• Market for financing long term investments• Basic instruments for raising finance are shares of
stock (equity) and bonds• Issues are sold to the investing public in the
primary market, through investment bankers- firms that originate, bear the risk of and distribute non-government security issues.
• Stocks and bonds issued in the primary market are traded in the secondary market.
The issuance process for new securities in the primary market
Issuer
Originating invt. banks
Underwriting syndicate of investment banks
Selling groupcomposed of
Underwriting syndicate plus any selected retail brokerage houses
Investors
SECONDARY MARKET TRANSACTION
HOW A TRADE IS MADE
Buyer
Broking Firm
Order
Seller
Broking Firm
Order
Clearing House/Depository
Bid/AskTrade
Execution
Floor Broker
Floor Broker
Broking firm
Broker endorses order & returns to firm
Broker endorses order & returns to firm
Trade confirmation/Settlement
Trade confirmation/Settlement
Secondary Markets
Types of securities Where traded
Equity markets (common stock, Organized exchanges - NSE, BSE,preferred stock, rights & warrants) Regional exchanges
Over the Counter Third market, fourth market
Bond Markets Over-the-counter(Treasuries, agencies, NYSE & ASE (a relatively small amount) municipals, corporates)
Organized exchanges Chicago Board Options Exchange
Derivatives American Stock Exchange(Options & Futures) Pacific Stock Exchange
Philadelphia Stock Exchange,NYSE
Financial Management Axioms• 1) Risk - return trade-off• 2) Time value of money• 3) Cash - not profits - is king• 4) Incremental cash flows count• 5) The curse of competitive markets• 6) Efficient capital markets• 7) The agency problem• 8) Taxes bias business decisions• 9) All risk is not equal• 10) Ethical dilemmas are everywhere in finance