What is finance?
The management, creation, and study of money.
3 Schools of finance (2 main, one other)
- Asset pricing - investor perspective; portfolio management, CAPM (capital asset pricing model)
- Corporate finance - CEO perspective; capital budgeting, capital structure, working capital management.
What is portfolio management, and why?
Having a collection on investments. It reduces risk as all of your investments are not in the same spot/industry.
Difference between capital budgeting, capital structure, and working capital management
CB - planning and managing long term project of a company.
CS - mix of debt to equity ratio
CWM - planning and managing firm’s current assets and current liabilities
Primary goal of corporate finance
To maximize or increase shareholder value.
3 important questions that are answered using finance
- What long-term investments should the firm take on? (capital budgeting - PPE)
- Where to get long-term financing to pay for investment? (capital structure - equity, debt)
- How to manage everyday financial activities of the firm? (working capital management)
Working Capital equation
WCM = current assets - current liabilities
Who is usually the top financial manager within a firm?
CFO - Chief Financial Officer
What does the treasurer do?
Oversees cash management, capital expenditures, and financial planning.
What does the controller do?
Oversees taxes, cost accounting, financial accounting, and data processing.
Capital structure - if looking at the value of a firm as a pie, what’s the goal/how do we slice it up
Pie consists of debt and equity, no magical ratio, depends on the company and management. Overall goal is to increase the size of the pie
Pros & Cons of sole proprietorship
Pros - easiest to start, least regulated, single owner keeps the profit, taxes once as personal income.
Cons - unlimited liability, limited to life of owner, equity capital limited to owner’s personal wealth, difficult to sell ownership interest
Pros and Cons of partnership
Pros - 2+ owners, more human and financial capital available, relatively easy to start, income taxed once as personal income.
Cons - unlimited liability, partnership dissolves when one partner dies or wishes to sell, difficult to transfer ownership, possible disagreements between partners.
Pros and Cons of corporation
Pros - limited liability, unlimited life, separation of ownership and management, transfer of ownership is easy, easier to raise capital.
Cons - separation of ownership and management, double taxation (income taxed at corporate rate and then dividends are taxed at the personal rate).
3 main goals of financial management and why
- Maximize shareholder wealth
- Maximize share price
- Maximize firm value
These will benefit both the company and the shareholders
What is the agency problem and who should share the same goals?
Separation of ownership and control/management.
- Shareholders (ownership, principal)
- Board of directors (control)
- Top management (implementation, agent)
What is the Agency Relationship
Principal hires an agent to represent their interests.
Stockholders (principals) hire managers (agents) to run the company,
What is an agency problem
The conflict of interest between shareholders and management
2 types of agency costs
Costs resulting from the conflicts between shareholders and management
- Direct agency costs: management benefits but it hurts the shareholders - corp. expenditure as jet and monitoring expense.
- Indirect agency costs : missed growth opportunity.
What are the 2 main markets?
Money market
- short debt, IOUs are bought and sold
Capital markets
- long debt and equity securities are bought and sold
Primary vs Secondary Markets?
P - original sale; IPO, Private Placement. When a corp issues securities, cash flows from investors to the firm.
S - auction markets (regulated, visible bid-ask), dealer markets (no physical space, invisible bid-ask)
What is a financial institution?
Acts as intermediaries between investors and firms raising funds
Indirect vs Direct Finance?
I - interest on the spread between loans and deposits. Pass through financial intermediaries
D - service fees (don’t pass through financial intermediaries)
What is the goal of financial management
To maximize the current value per share of existing stock
