An Introduction

To Finance
 Section 1
The Role and Scope of
Finance

2
 What is Finance?

A term that refers to two

main activities;
othe actual process of
attracting money;
oand the management of
these funds;

3
The Functions of Finance

Analysis;

Decision-making;

4
 The Areas of Finance

 Business or Corporate Finance-the firm’s ability

to make good finance decisions;

 Personal Finance-retirement provision, saving

plans etc.,;

Public Finance-income distribution, stability plans

etc.,;
5
 Finance v
Accounting
 Financial Accounting
concentrates on record keeping
and submitting of financial
statements;

 Finance focuses on making

decisions and carrying out
analysis based on information
presented by accounting;

6
 Finance v
Accounting(cont.)

Financial Accounting tends to be more

concerned with the past;

 Finance tend to be more interested in

present and the future;

7
 Finance v
Accounting(cont.)

 Financial Accounting tends to have an

income focus;

 Finance tends to have a cash flow focus;

8
 Business Finance
Types of Financial Decisions

 Investment Decisions;

 Financing Decisions;

 Asset Management
Decisions;

9
 Investment Decisions

 Should we built this component or buy it?

 What specific assets should be acquired?
 Should we introduce a new product?
 Which projects should be undertaken?

10
 Financing Decisions

 What is the best structure of

financing(debt versus equity)?
 How much of our debt should be short-
term as opposite to long-term?
 What is the best dividend policy?
 How will the funds be physically acquired?

11
 Asset-Management
Decision
 How do we manage existing assets
efficiently?

 Financial Manager has varying degrees of

operating responsibility over assets;

 Greater emphasis on current asset

management than fixed asset
management; 12
 The Goal of the Business
 The target of business is
the maximize
shareholder’s wealth;

 It’s measured as the

price of stocks;

 Wealth maximization
concept adjusts for
deficiencies of previous
concept;
13
 Comparison of Two
Concepts
Wealth
Profit Maximization Maximization
 Short-Term Oriented;  Long-term Oriented;

 Can not account for risk;  The risk factor is taken

account;
 Can lead
mismanagement;  Recognizes the timing of
returns;

14
 Section 2
An Overview of Business
Environment

15
 Types of Businesses
Sole Proprietorships

 A business that owned

and operated by one
individual;

 The owner and the

business are legally
identical;
16
The Pros and Cons of
Sole Proprietorships

17
 Partnerships

 A business that owned

and controlled by two or
more persons who are
equally liable for losses;

 Typically governed by
partnership agreement;
18
The Pros and Cons of
Partnerships

19
 Company
• Business that owned by
shareholders;

• Shareholder liability is
limited to nominal value of
shares that they own;

• Business is legally
separate from it’s owners;
20
The Pros and Cons of
Company

21
 Section 3
Corporate Structure

22
 The Modern
Corporation

Modern Corporation

Shareholders Management

There exists a SEPARATION between

owners and managers.
23
Organizational Chart of
Corporate Structure

24
 Role of Management

 An agent is an individual authorized by

another person, called the principal, to act
in the latter’s behalf;

 Management acts as an agent for the

owners (shareholders) of the firm;

25
 Agency Theory

Principals must provide

incentives so that
management acts in the
principals’ best interests and
then monitor results;

Incentives include stock

options, perquisites, and
bonuses;
bonuses
26
 Section 4
A Quick Tour to Financial
Environment

27
 Financial Markets

 Businesses interact continually with the

financial markets;

 Composed of all institutions and

procedures for bringing buyers and sellers
of financial instruments together;

28
 The Purpose of Financial
Markets
 Mobilization of savings-uselessly lying fund is made to
flow the place where it is really needed;

 Facilitate price discovery-the price is determined by the

forces of demand and supply;

 Provide liquidity to financial assets-buyers or sellers of

securities are available all the times;

 Reduce the cost of transaction-making all necessary

information available without any cost;
29
 Flow of Funds
in the Economy

INVESTMENT SECTOR

INTERMEDIARIES
FINANCIAL
FINANCIAL BROKERS

SECONDARY MARKET

SAVINGS SECTOR

30
 Types of Financial
Markets
 Money Market-market for trading of short-term
securities(Repo, CDO, commercial paper, T-bills);

 Capital Market-where the transaction of long-term

securities takes place(corporate bonds, government
bonds);

 Primary Market-newly issued instruments are bid;

 Secondary Market-already issued stocks are sold and

bought;
31
 Financial Intermediaries
 Come between
ultimate borrowers
and lenders by
transforming direct
claims to indirect
claims;
 Commercial banks,
insurance
funds,mutual funds;

32
 Efficient Allocation of
Funds
 Funds will flow to economic units that are willing
to provide the greatest expected return;

 The highest expected returns will be offered only

by those economic units with the most promising
investment opportunities;

 Result: Savings tend to be allocated to the most

efficient uses;
33
 What Influences Security
Expected Returns?

 Default Risk-the failure to meet the terms of contract;

 Marketability- is the ability to sell a significant volume of

securities in a short period of time in the secondary
market without significant price concession;

34
 What Influences
Expected Security
Returns?
 Maturity- is concerned with the life of the security; the
amount of time before the principal amount of a
security becomes due;

 Embedded Options- provide the opportunity to

change specific attributes of the security;

 Inflation -the greater inflation expectations, then the

greater the expected return;

35
Risk-Expected Return
Profile
Speculative Common Stocks
Conservative Common Stocks
EXPECTED RETURN (%)

Preferred Stocks
Medium-grade Corporate Bonds
Investment-grade Corporate Bonds
Long-term Government Bonds
Prime-grade Commercial Paper
U.S. Treasury Bills (risk-free securities)

RISK
36
 Term Structure of
Interest Rates
Upward Sloping Yield Curve
(Usual)
0 2 4 6 8 10
YIELD (%)

Downward Sloping Yield Curve

(Unusual)

0 5 10 15 20 25 30
YEARS TO MATURITY

A yield curve is a graph of the relationship between yields

and term to maturity for particular securities. 37
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