ch01 fin mgt overview [compatibility mode]
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Overview of Financial
Mana ement
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OVERVIEW OF FINANCIALMANAGEMENT
The Corporation Life Cycle
Value Creation & Maximization
Profit vs Cash Financial Institutions & Process of
Capital Formation
Types of Financial Markets
Cost of Money
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The Corporation Life Cycle
ProprietorshipAdvantages:
Easy & inexpensive formation; Subjects to only fewregulations; Not subject to corporate taxation
Limitations:Difficult to raise capital; Unlimited personal liability;
Limited life
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CorporationAdvantages:
Unlimited life; Easy transferability of ownership interest;Limited liability Easy to raise capital
Disadvantages:Complex & time consuming formation;
Subject to double taxation
Advantages:
Easy & inexpensive formation; Subjects to only fewregulations; Not subject to corporate taxation
Limitations:Difficult to raise capital; Unlimited personal liability;
Limited life
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Value Maximization
Risk &
Investment Decisions
Financing Decisions Value
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Return
Income DistributionDecision
Maximization
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Determinants of a Firms Value
Free Cash Flows
SalesRevenue
OperatingCost &Taxes
RequiredInvestment
inOperations
FinancingDecisions
InterestRates
Firm RiskMarket
Risk
Weighted Average Cost
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o ap ta
WACC+1
FCF
...WACC+1
FCF
WACC+1
FCF
=Value 22
1
1
Value of the Firm
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Financial Management& Other Fields of Management
Math &Statistics
AccountingEconomics
FinancialManagement
SocialSciences
OperationManagement
ETHICS
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Profit vs Cash
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Profit vs Cash
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Profit vs Cash
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Profit vs Cash
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Profit vs Cash
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Profit vs Cash
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Profit vs Cash
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Profit vs Cash
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Profit vs Cash
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Financial Institutions:Capital Formation Process
Direct TransferBusiness (Borrowers) sell securities directly to Savers
Through Investment Banking HousesBusiness (Borrowers) sell securities to Savers through investment banking houses
Through Financial Intermediaries Intermediary obtain funds from Savers in exchange for its own securities Intermediaries uses the fund to purchase and hold securities from Business
(Borrowers) Examples: Commercial Banks, Life Insurance Companies, Mutual Funds, Pension
Funds
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Investment Banking& Investment Management
Securities Securities
Sell Side: Underwriting & sellingcorporations securities to investors
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Corporationsnves menBankingHouses
Investors
Dollars Dollars
Buy Side: Advising investors &managing investors fund in buying
securities
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Types of Financial Markets
Physical asset markets vs Financial asset markets
Spot markets & Futures markets
Money markets & Capital markets
Primary Markets & Secondary markets
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r va e mar e s u c mar e s
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Capital Markets:Selected Comparison (ASEAN)
500.0
600.0
700.0 603.9
Market Capitalization (USD billions)
0.0
100.0
200.0
300.0
400.0 . 336.7 280.6
140.9
32.5
as of Nov. 2010
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Capital Markets:Selected Comparison (ASEAN)
800
1,000
984
781 735
Number of Issuers
0
200
400
600 415
256
as of Nov. 2010
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Capital Markets:Selected Comparison (ASEAN)
200
250
300 253.7
159.9
Market Capitalization to GDP (%)
0
50
100
150
83.5 71.546.0 32.8
as of Nov. 2010
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Financial Markets
Implications of active financial markets:
FINANCING alternatives for corporations
INVESTMENT alternatives for investors
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Cost of Money
Cost of debt = Interest Rate
Cost of Equity = Required Rate of Return = Dividend+ Capital Gain
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Factors Affecting Cost of Money
Production opportunities
Time preferences for consumption
Risk
Inflation
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Determinants of Interest Rates
r = r* + IP + DRP + LP + MRP
r = rate of interest on a debt security.
r* = real risk-free rate of interest.
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= n at on prem um.
DRP = default risk premium.
LP = liquidity premium.
MRP= maturity risk premium.
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Term Structure of Interest Rates
Term structure: the relationship between interestrates (or yields) and maturities
Yield curve: graph depicting the term structure.
Interest Rate
U.S. Treasury Bond Interest Rates on Different Dates
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0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
0 5 10 15 20 25 30
(%)
Years to Maturity
Short TermLong Term
IntermediateTerm
Yield Curve for March 1980(Rate of Inflation: 12%)
Yield Curve for April 2003(Rate of Inflation: 2.4%)
Yield Curve for August 1999(Rate of Inflation: 2%)
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8%
10%
12%
Interest Rate(%)
Corporate and Treasury
Yield Curves
AA-rated bond
BBB-rated bond
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0%
2%
4%
6%
Years to Maturity10
Treasury Bond
20 30
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Career Alternatives in Finance
CommercialBanking
Credit Analyst
Loan Officer
CorporateFinance
Treasurer
Financial Analyst
InvestmentBanking
Corporate Finance
Capital Market
Project Finance
Advisory
re t anager
Investor Relation
Controller
FinancialPlanning
Wealth Management
Insurance Actuary
Agent/Broker
Underwriter
Risk Manager
Research
Sales/Brokerage
Rating Analyst
MoneyManagement
Portfolio Manager
Portfolio ManagementMarketing
Investment Advisory
Mutual Fund Analyst