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  1. 1. 1. Career Opportunities in Finance <ul><li>Money and capital markets </li></ul><ul><li>Investments </li></ul><ul><li>Financial management </li></ul><ul><li>Some players have need for capital, others have excess capital. </li></ul><ul><li>Financial Markets bring both parties together </li></ul><ul><li>Investments is the purchase of securities issued by firms/governments for </li></ul><ul><li>income or capital appreciation. </li></ul><ul><li>Examples of parties involved: </li></ul><ul><li>Brokerage: full service vs discount </li></ul><ul><li>Financial consulting: advise individuals how to invest </li></ul><ul><li>Investment portfolio management: for bank, mutual fund </li></ul>
  2. 2. 2. Financial Management Decisions <ul><li>Capital Budgeting </li></ul><ul><li>The process of planning and managing a firm’s long-term </li></ul><ul><li>investments is called capital budgeting. In capital budgeting, the </li></ul><ul><li>financial manager tries to identify investment opportunities that are </li></ul><ul><li>worth more to the firm than they cost to acquire. </li></ul><ul><li>Capital Structure </li></ul><ul><li>Ways in which the firm obtains and manages the long-term </li></ul><ul><li>financing it needs to support its long-term investments. A firm’s </li></ul><ul><li>capital structure refers to the specific mixture of long-term debt </li></ul><ul><li>and equity the firm uses to finance its operations. </li></ul>
  3. 3. Financial Management Decisions <ul><li>Working Capital Management </li></ul><ul><li>The phrase working capital refers to a firm’s short-term assets, </li></ul><ul><li>such as inventory, and its short-term liabilities, such as money </li></ul><ul><li>owed to suppliers. Managing a firm’s working capital is a day-to- </li></ul><ul><li>day activity that ensures the firm has sufficient resources to </li></ul><ul><li>continue its operations and avoid costly interruptions. </li></ul>
  4. 4. 3. Corporation <ul><li>In general, a firm starts as a proprietorship or partnership and becomes a corporation over time. </li></ul><ul><li>Corporation has the following advantages: </li></ul><ul><li>Unlimited life of organization </li></ul><ul><li>Ease of transferring ownership </li></ul><ul><li>Limited liability </li></ul><ul><li>These advantages make it easy for corporations to raise money in capital markets. </li></ul><ul><li>Basic disadvantage is double taxation </li></ul>
  5. 5. 4. Financial Goals of the Corporation <ul><li>The primary financial goal is shareholder wealth maximization, </li></ul><ul><li>which translates to maximizing stock price. </li></ul><ul><li>Is stock price maximization the same as profit maximization? </li></ul><ul><li>For example, what about maximizing this year’s earnings per share? </li></ul><ul><li>Stock price depends on future expected cash flows, their timing and </li></ul><ul><li>riskiness. </li></ul><ul><li>So the difference is: Being accounting vs. cash measure </li></ul><ul><li>Use of a myopic/non-myopic approach </li></ul><ul><li>Ignoring/considering the risk dimension </li></ul>
  6. 6. 5. Agency relationships <ul><li>An agency relationship exists whenever a principal hires an agent </li></ul><ul><li>to act on his/her behalf. </li></ul><ul><li>Within a corporation, agency relationships exist between: </li></ul><ul><li>Shareholders and managers </li></ul><ul><li>Shareholders and creditors </li></ul>
  7. 7. Shareholders versus Managers <ul><li>Managers are naturally inclined to act in their own best interests </li></ul><ul><li>rather than that of shareholders. </li></ul><ul><li>They may have incentive to enjoy perquisites or leisure </li></ul><ul><li>Or they may aim to maximize size of the firm </li></ul><ul><li>Power/status </li></ul><ul><li>Higher salary </li></ul><ul><li>Prone to takeovers </li></ul><ul><li>But the following factors affect managerial behavior: </li></ul><ul><li>Managerial compensation plans </li></ul><ul><li>Direct intervention by shareholders </li></ul><ul><li>The threat of firing </li></ul><ul><li>The threat of takeover </li></ul>
  8. 8. Shareholders versus Managers <ul><li>To align shareholder-manager interest </li></ul><ul><li>Managerial compensation executive stock options </li></ul><ul><li>performance shares </li></ul><ul><li>Shareholder intervention proposal to be voted in annual meeting </li></ul><ul><li>blockholders are usually members in the board of directors </li></ul>
  9. 9. Shareholders versus Creditors <ul><li>Shareholders (through managers) could take actions to maximize stock price that are detrimental to creditors. </li></ul><ul><li>In the long run, such actions will raise the cost of debt and </li></ul><ul><li>ultimately lower stock price. </li></ul><ul><li>Creditors lend funds based on </li></ul><ul><li>Riskiness on firm’s existing assets </li></ul><ul><li>Expectation about riskiness of new assets </li></ul><ul><li>Existing capital structure </li></ul><ul><li>Expectations about changes in capital structure </li></ul><ul><li>Expropriation of wealth from creditors </li></ul><ul><li>Accepting riskier projects </li></ul><ul><li>Issuing new debt (and repurchase stock) </li></ul><ul><li>Creditors will either place restrictive covenants and/or charge a </li></ul><ul><li>higher than normal interest rate </li></ul>
  10. 10. 6. Factors that affect stock price <ul><li>Projected cash flows to shareholders </li></ul><ul><li>Timing of the cash flow stream </li></ul><ul><li>Riskiness of the cash flows </li></ul><ul><li>Basic Valuation Model </li></ul>To estimate an asset’s value, one estimates the cash flow for each period t (CF t ), the life of the asset (n), and the appropriate discount rate (k)
  11. 11. Factors that Affect the Level and Riskiness of Cash Flows <ul><li>Decisions made by financial managers: </li></ul><ul><li>Investment decisions </li></ul><ul><li>Financing decisions (the relative use of debt financing) </li></ul><ul><li>Dividend policy decisions </li></ul><ul><li>The external environment </li></ul><ul><li>Legal constraints </li></ul><ul><li>General level of economic activity </li></ul><ul><li>Tax laws </li></ul><ul><li>Interest rates </li></ul>