Title: FINANCIAL MANAGEMENT Part 1: An introduction to finance Lecture 1: What is finance?
1FINANCIAL MANAGEMENTPart 1 An introduction to
financeLecture 1 What is finance?
2Lecture 1 What is finance?
- 1.1. Introduction
- 1.2. Defining finance
- 1.3. The Firm a sistemic approach
- 1.4. Corporate Finance the financial function
- 1.5. The financial objective value creation
- 1.6. Financial main principles
- 1.7. Finance historic evolution
- 1.8. Main programmes in Finance
3Lecture 1 What is finance?1.1. Introduction (1)
- I am saving for retirement. Should I use a
pension fund, mutual fund, direct stock market
investment ? - I want that new car. Should I use my cash
saving, lease, borrow? - Which is the best way to pay for my holidays, for
my house? - Im thinking about starting a new business. Will
it reward me adequately? - Marocco has asked for major project financing.
- Should my organization provide the funds?
4Lecture 1 What is finance?1.1. Introduction (2)
- Why study finance?
- To manage your personal resources
-
- To deal with the world of business
- To pursue interesting and rewarding career
opportunities - To make informed public choices as a citizen
- For the intellectual challenge
5Lecture 1 What is finance?Introduction
Macroeconomic/Spending Sectors
- Household
- Business Firms
- Government
- Foreign Sector
SURPLUS SPENDING UNITS DEFICIT SPENDING UNITS
6Lecture 1 What is finance?1.1. Introduction
Surplus Spending Unit (1)
- Has more cash income flow than expenditure on
consumption and real investments in a period of
time. The surplus is then allocated to the
financial sector. - Other terms for surplus unit are saver, lender,
buyer of financial assets, financial investor,
supplier of loanable funds, buyer of securities.
7Lecture 1 What is finance?1.1. Introduction
Surplus Spending Unit (2)
- The surplus unit may buy financial assets, hold
more money, or pay off financial liabilities
issued earlier when in a deficit situation - The household and foreign sectors are usually a
surplus sector
8Lecture 1 What is finance?1.1.
IntroductionDeficit Spending Unit (1)
- Has more expenditures on consumption and real
goods (investment) in the real sector than income
during a period of time - The deficit unit must participate (borrow) in the
financial sector to balance cash inflows with
outflows
9Lecture 1 What is finance?1.1.
IntroductionDeficit Spending Unit (2)
- Other terms for deficit expending unit are
borrower, demander of loanable funds, and seller
of securities. - The deficit spending unit may issue financial
liabilities, reduce money balances, and sell
financial assets acquired previously when in a
surplus situation
10Lecture 1 What is finance?1.1.
IntroductionFinancial Claims (1)
- Contracts related to the transfer of funds from
surplus to deficit budget units - Financial claims are also called financial assets
and liabilities, securities, loans, and financial
investments. - For every financial asset, there is an offsetting
financial liability. - Total receivable equal total payable in the
financial system - Loans outstanding match borrowers liabilities
11Lecture 1 What is finance?1.1.
IntroductionFinancial Claims (2)
- Financial markets offer opportunity for
- Financing for DSUs (primary)
- Financial investing for SSUs (primary and
secondary) - Providing liquidity via trading financial claims
in secondary markets
12THE FLOW OF FUNDS DIAGRAM
Funds
Funds
Deficit Spending Unit (DSU)
Surplus Spending Unit (SSU)
Financial Assets Financial Claims
13THE FLOW OF FUNDS DIAGRAM
Funds
Funds
Deficit Spending Unit (DSU)
Surplus Spending Unit (SSU)
Saver, lender buyer of financial
assets financial investor supplier of loanable
funds buyer of securities.
Borrower demander of loanable funds seller of
securities
Financial Assets Financial Claims
14Lecture 1 What is finance?1.1.
IntroductionReal Financial assets
- Assets any possession that has value in an
exchange - tangible value depends on particular physical
properties (reproducible and non-reproducible) - intangible legal claims to some future
benefit. Financial assets
15Lecture 1 What is finance?1.1.
IntroductionFinancial assets main properties
- Main properties of financial assets
- Rate of return (R) expected return
- Risk (r) credit risk, market risk
- Liquidity (L) how much sellers stand to lose if
they wish to sell immediately against engaging in
a costly and time-consuming search (J.Tobin)
16THE FLOW OF FUNDS DIAGRAM
DIRECT FINANCING (Markets)
Brokers Dealers
Funds
Funds
Deficit Spending Unit (DSU)
Surplus Spending Unit (SSU)
Funds
Funds
Intermediaries
INDIRECT FINANCIAL INVESTMENT OR INTERMEDIATION
FINANCING
17THE FLOW OF FUNDS DIAGRAM
DIRECT
Direct Financial Assets Purchase
Direct Financial Assets Issue
Brokers Dealers
Funds
Funds
Deficit Spending Unit (DSU)
Surplus Spending Unit (SSU)
Funds
Funds
Intermediaries
Indirect Financial Assets Purchase
Direct Financial Assets Issue
INDIRECT
18Lecture 1 What is finance?1.2. Defining Finance
- What is Finance?
- Types of Finance definitions
- Lack of any specific definition
- Raising and spending funds
- Economic decisions with a time component
- Micro/Macro need for integration
19Lecture 1 What is finance?1.2. Defining Finance
- Finance is analytical.
- Finance is based on economic principles.
- Finance uses accounting information as an input
for decision-making. - Finance is international in perspective.
- Finance is constantly changing.
- Finance is the study of how to invest and raise
money productively
http//garnet.acns.fsu.edu/ppeters/fin3403/
20Lecture 1 What is finance?1.2. Defining Finance
- Finance is the study of how people allocate
scarce resources over time - costs and benefits are distributed over time
- but the actual timing and size of future cash
flows are often known only probabilistically - Understanding finance helps you evaluate these
uncertain cash flows
Bodie and Merton
21Lecture 1 What is finance?1.2. Defining Finance
- When implementing decisions, people make use of
the Financial System which can be defined as the
set of markets and other institutions used for
financial contracting and exchange of assets and
risks
Bodie and Merton
22Lecture 1 What is finance?1.2. Defining Finance
- Financial theory consists of
- the set of concepts that help to organize ones
thinking about how to allocate resources over
time - the set of quantitative models used to help
evaluate alternatives, make decisions, and
implement them - These concepts and models apply at all levels and
scales of decision making
Bodie and Merton
23Lecture 1 What is finance?1.2. Defining Finance
- A basic tenet of finance is that the existence of
economic organizations (e.g. firms and
governments) facilitate the satisfaction of
peoples consumption preferences
Bodie and Merton
24Lecture 1 What is finance?1.2. Defining
Finance Definition 1
- Finance Theory is the study of the behaviour of
individuals in the intertemporal allocation (over
time) of their resources in an uncertain
environment, and the study of the function of
economic institutions and markets in making these
allocations possible.
Economía Financiera Marín, José M. / Rubio,
Gonzalo Antoni Bosch, Editor, Barcelona, 2001
25Lecture 1 What is finance?1.2. Defining
Finance a new paradigm. The Value Creation
Function of Finance
- The practice of finance exists for the creation
of value - Financial contracting brings about the
substitution of real wealth (i.e. real business
assets) for financial wealth (i.e. securities)
Investing in financial securities has better
attributes that in real assets. Value is created
in tthe real assets held by businesses, and then
transmitted into the value of financial wealth
issued by businesses and held by investors.
Norton y Scott, A new Paradigm the value
creation function of finance, january 2001
26Lecture 1 What is finance?1.2. Defining
Finance a new paradigm.Definition 2
- Finance is the process of transforming existing
assets into new, contractual forms, as well as
the analytical techniques needed to support this
process, for the purpose of wealth creation in
modern, capitalistic economies.
Norton y Scott, A new Paradigm the value
creation function of finance, january 2001
27Lecture 1 What is finance?1.2. Defining
Finance the three primary areas of finance
- Financial management (Corporate finance) deals
with how firms raise and use funds to make
short-term and long-term investments. - Investment deals with how the securities markets
work and how to evaluate and manage investments
in stocks and bonds. - Financial Markets and Institutions includes the
study of the banking system and markets.
Peterson and Fabozzi
28FINANCIAL MANAGEMENTPart 1 An introduction to
financeLecture 1 What is finance?(II)
29Lecture 1 What is finance? (II)
- 1.1. Introduction
- 1.2. Defining finance
- 1.3. The Firm a sistemic approach
- 1.4. Corporate Finance the financial function
- 1.5. The financial objective value creation
- 1.6. Financial main principles
- 1.7. Finance historic evolution
- 1.8. Main programmes in Finance
30Lecture 1 What is finance? (II)1.3. The Firm
a sistemic approach
31Lecture 1 What is finance? (II)1.4. The Firm
a sistemic approach
32Lecture 1 What is finance? (II)1.5. Corporate
Finance the financial function
- Corporations face two broad financial questions
- - What investments should the firm make?
- - How should it pay for those investments?
- Financial managers are concerned with
- Investment Decisions (use of funds)
- The buying, holding or selling of types of assets
- Financing Decisions (acquisitions of funds)
-
-
33Lecture 1 What is finance? (II)1.6. Corporate
Finance the financial function
INVESTMENT / FINANCIAL SUBSYTEM
FINANCIAL SYSTEM
REAL SYSTEM
r ( r gt k )
k
FINANCIAL MANAGEMENT (CORPORATE FINANCE)
INVESTMENT
FINANCING
FINANCIAL MARKETS
FIRM OPERATIONS (Real goods services
REPAYMENT AND RETURN
RETURN
34Lecture 1 What is finance? (II)1.7. The
Financial objective value creation
- Goal of management maximize the economic
well-being, or wealth, of the owners (current
shareholders) - gt maximize the price of the stock
- Share price today Present value of all future
expected dividends at required return
35Lecture 1 What is finance? (II)1.8. The
Financial objective value creation
- Financial managers must create or generate value
for their shareholders. - Economic Value Added (EVA) is a measure of a
company's financial performance based on the
residual wealth calculated by deducting cost of
capital from its operating profit (adjusted for
taxes on a cash basis). - The formula for calculating EVA is as follows
- EVA Net Operating Profit After Taxes -
(Capital Cost of Capital) -
36Lecture 1 What is finance? (II)1.9. Financial
main principles
- Rational Financial behavior
- Risk aversion
- Budgetary diversification
- Existence of two parts in all financial
transaction - Measurement by cash flows
- Signaling and informative asymmetry
- Efficiency of financial markets
- Direct relation of risk and return
- Existence of valuable ideas
- Financial conduct initiative
- The Time Value of the money and value
additivity.
37Lecture 1 What is finance? (II)1.10. Finance
historic evolution
Principles of century XX Beginning of the
research in finance
EVENTS
- - Expansion of the Years 20
- The 29 Crises
- Economy military of the 40
- Expansion of the 50
- Crises of the petroleum of the 73
Finance at the present
38Lecture 1 What is finance? (II)1.10. Finance
historic evolution
M o d e r n A p p r o a c h
2000-
Chaos Theory, Non Linear Dynamics
Markets Efficiency
1990-
Methods based on Fuzzy Sets Theory (Kaufmann y
Gil, 1986-87)
Financial Innovation
1980-
Options Valuation Models (Black y Scholes, 1973)
APT Model (Ross, 1970)
CAPM (widening and reformulation)
1970-
Efficient Market Theory (Fama, 1970)
Capital Assets Pricing Model (CAPM) (Sharpe,
1963-4, Lintner, 1965)
Financial Structure (Modigliani, Miller, 1958)
Portfolio selection Theory (Markowitz, 1952,1959)
Dividends Policy (Modigliani, Miller, 1963)
1950-
Classical Approach
1900-
39Lecture 1 What is finance? (II)1.11. Main
programmes in finance
- Managements of Investments- Capital Budgeting.
- Capital Structure and Dividend Policy.
- Market Efficiency.
- The Capital Asset Pricing Model.
- Options Theory
- Agency Theory
- Financial Planning
- Small Firms
40Lecture 1 What is finance?Bibliography
- Kidwell, Peterson, Blackwell, Whidbee Financial
Institutions, Markets, and Money, Eighth Edition,
John Wiley Sons, 2003 - Fabozzi, Modigliani Capital Markets.
Institutions and Instruments. Prentice Hall, 2003 - Bodie, Zvi and Merton, Robert C. Finance.
Prentice Hall, 1999 - Pamela P. Peterson and Frank Fabozzi Financial
Management and Analysis, 2nd Edition, John Wiley
Sons, 2003