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1. Describe the cycle of money, the participants in thecycle, and the common objective of borrowing andlending.
2. Distinguish the four main areas of finance and brieflyexplain the financial activities that each encompasses.
3. Explain the different ways of classifying financialmarkets.
4. Discuss the three main categories of financialmanagement.
LEARNING OBJECTIVES
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LEARNING OBJECTIVES5. Identify the main objective of the finance manager and how
that objective might be achieved.
6. Explain how the finance manager interacts with both
internal and external players.
7. Delineate the three main types of business organizationsand their respective advantages and disadvantages.
8. Illustrate agency theory and the principal-agent problem.
9. Review issues in corporate governance and business ethics.
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Definition of Finance
Finance is the art and science of managing wealth.
It is about making decisions regarding what assets tobuy/sell and when to buy/sell these assets.
Its main objective is to make individuals and theirbusinesses better off.
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Definition of Financial Management Financial management is generally defined as those
activities that create or preserve the economic value of
the assets of an individual, small business, orcorporation.
Financial management comes down to making soundfinancial decisions.
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1.1 The Financial Intermediary Function
Financial intermediaries assist in the movement of
money from lenders to borrowers and back again.
This process is termed the cycle of moneyand its mainobjective is to make all the participants better off
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1.1 The Cycle of Money The movement of money from lender to borrower and back to
lender from borrower (see page 4 of textbook)
Example: A mutual fund issues shares, which are bought by
individuals The pooled funds are invested by the mutual fund company in shares
that are issued by firms
The firms pay dividends periodically, which are received by the mutualfund and passed through to their shareholders, or reinvested inadditional shares, and the cycle of money starts again. The mutual fund managers earn fees The firms whose securities are bought are able to raise capital for
growth and future returns The mutual fund shareholders earn dividends and capital gains
Thus, all participants are generally better off.
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1.2 Overview of Finance AreasFourmain interconnected and interrelatedareas:
Corporate Finance Investments
Financial Institutions and Markets
International Finance
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1.3 The Financial Markets Forums where buyers and sellers of financial
assets and commodities meet.
Financial markets can be classified by: The Type of Asset Traded The Maturity of the Financial Asset
moneymarket capital market
TheOwner of the Financial Asset primary market secondary market
TheNature of the Transaction dealer markets auction markets
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1.4 The Finance Manager and
Financial Management
The Finance Manager
Determines the best repayment structure forborrowed funds
Ensures that debt obligations are met on time
Ensures that sufficient funds are available forcarrying out daily operations
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1.4 The Finance Manager and
Financial Management
Financial management involves three main
functions:
Capital Budgeting
Capital Structure
Working Capital Management
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1.5 Objective of the Finance ManagerTo make investment and financing decisions that
increase the cash flow of the firm, therebymaximizing the current stock price
Profit maximizationvs.
Stock price maximization
Why are they not the same? Which one is more important?
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1.6 Internal and External Players Financial managers have to interact withvarious internal and external stakeholders
Internal players include all the departmentalmanagers and other employees
External parties include:
Customers Suppliers
Government
Creditors
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1.7 The Legal Forms of BusinessThere are three main legal categories of business
organizations: Sole proprietorship
Partnership Corporation
Besides these three main forms, some other forms of
business organizations include: Hybrid Corporations Not-for-Profit Corporations
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1.7 The Legal Forms of Business
Sole Proprietorship
Advantages1. Simplest and easiest form of business2. Least amount of legal documentation3. Least regulated4. Owner keeps all profits
Disadvantages
1. Owner pays personal tax rate on profits2. Obligations of the business are sole responsibility of owner,and personal assets may be necessary to pay obligations(personal and business assets are commingled)
3. Business entity limited to life of owner4. Can have limited access to outside funding for the business
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1.7 The Legal Forms of Business
Partnership Advantages
1. Agreements between partners may be easily formed
2. Involves more individuals as owners and therefore usuallymore expertise3. Larger amount of capital usually available to the business
(compared to proprietorship)
Disadvantages
1. Assets of general partners are commingled with assets ofthe business2. Profits treated as personal income for tax purposes3. Difficult to transfer ownership
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1.7 The Legal Forms of Business
Corporation Advantages
1. Business is legal, separate entity from owners
2. Owners have limited liability to obligations of thebusiness3. Easy to transfer ownership4. Usually greater access to capital for business5. Owners do not have any personal liability for default
Disadvantages1. Most difficult business operation to form2. Double taxation of company profits3. Most regulated
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1.8 The Financial Management
Setting: The Agency ModelAgency relationship
Agency conflict
Why does it arise?
How can it be minimized?
Principal-agent problem
Agency theoryAgency costs
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1.9 Corporate Governance and
Business Ethics Corporate governance deals with.
how a company conducts its business and implementscontrols to ensure proper procedures and ethical behavior.
The Sarbanes-Oxley Act, enacted in 2002, requires that
The CEO and CFO attest to the fairness of the financialreports.
The company maintains an effective internal controlstructure around financial reporting.
The company and its auditors assess the effectiveness of thecontrols over the most recent fiscal year.
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1.10 Why Study Finance? Understand how andwhy financial decisions are
made in large and small companies
Helps individuals increase their own compensations
Improves contributions to the success of thecompanies that people work for
Understand the tradeoffs we face in making personalfinancial choices and help us to select the mostappropriate action