2. 1-2
Introduction
• Every financial transaction has a story.
• There is a complex web of interdependent
institutions and markets making up the
foundation of daily financial transactions.
• The Six Parts of the Financial System.
• The Five Core Principles of Money and
Banking.
3. • What causes a company to have a particular
stock value?
• How can managers make choices that add
value to their companies?
• How can managers ensure that their companies
don’t run out of cash while executing their
plans?
What three questions does financial
management seek to answer?
4. • The primary goal is shareholder wealth
maximization, which translates to maximizing
stock price.
• Should firms behave ethically? YES!
• Do firms have any responsibilities to society at
large?
• YES!
• Shareholders are also members of society.
Goals of the Corporation
5. • An agency relationship exists whenever a
principal hires an agent to act on his or her
behalf.
• Within a corporation, agency relationships exist
between:
• Shareholders and managers
• Shareholders and creditors
Agency Relationships
6. • Managers are naturally inclined to act in their own
best interests.
• But the following factors affect managerial
behavior:
• Managerial compensation plans
• Direct intervention by shareholders
• The threat of firing
• The threat of takeover
Shareholders versus Managers
7. • Shareholders (through managers) could take
actions to maximize stock price that are
detrimental to creditors.
• In the long run, such actions will raise the cost
of debt and ultimately lower stock price.
Shareholders versus Creditors
8. Financial system
• The financial system is the collection of markets,
institutions, laws, regulations, and techniques through
which bonds, stocks, and other securities are traded,
interest rates are determined, and financial services
are produced and delivered around the world.
9. 1-9
Six Parts of the Financial
System
1. Money
To pay for purchases and store wealth.
2. Financial Instruments
To transfer resources from savers to investors and to transfer risk to
those best equipped to bear it.
3. Financial Markets
To buy and sell financial instruments.
4. Financial Institutions
To provide access to financial markets, collect information &
provide services.
5. Regulatory Agencies
To provide oversight for financial system.
6. Central Banks
To monitor financial Institutions and stabilize the economy.
10. 1-10
Six Parts of the Financial System
1. Money
Money is anything that is widely used for making
payments and accounting for debts and credits.
•Money has changed from gold/silver coins to paper
currency to electronic funds.
•Cash can be obtained from an ATM any where in the
world.
•Bills are paid and transactions are checked online.
11. 1-11
Six Parts of the Financial System
2. Financial instruments
A financial instrument is a formal obligation that
entitles one party to receive payments and/or a
share of assets from another party.
• Buying and selling individual stocks used to be
only for the wealthy.
• Today we have mutual funds and other stocks
available through banks or online.
• Putting together a portfolio is open to everyone.
12. 1-12
Six Parts of the Financial System
3. Financial Markets
Places or networks where financial instruments can be
sold quickly and cheaply.
•Once financial markets were located in Coffeehouses
and Pubs.
•Then organized markets were created, like the New
York Stock Exchange.
•Now transactions are mostly handled by electronic
markets.
• This has reduced the cost of processing
financial transactions.
•There is a much broader array of financial instruments
available.
13. 1-13
Six Parts of the Financial System
4. Financial Institutions
Firms that provide savers and borrowers with access
to financial instruments and financial markets.
•Examples: Banks, insurance companies, mutual
funds, brokerage houses etc.
•Banks began as vaults, developed into institutions, to
today’s financial supermarket.
•Offer a huge assortment of financial products and
services.
14. 1-14
Six Parts of the Financial System
5. Government regulatory agencies
• Government regulatory agencies were introduced
by federal government after the Great Depression.
• Government regulatory agencies provide wide-
ranging financial regulation - rules and
supervision.
• Government regulatory agencies examine the
systems a bank uses to manage its risk.
• The 2007-2009 financial crises has led
governments to consider greater regulation.
15. 1-15
Six Parts of the Financial System
6. Central banks
A central bank is a large financial institution that
handles the government's finances, regulates the
supply of money and credit in the economy, and
serves as the bank to commercial banks.
•Central banks began as large private banks to finance
wars.
•Central banks control the availability of money and
credit to ensure low inflation, high growth and
stability of financial system.
•Today’s policymakers strive for transparency in their
operations.
16. 1-16
Five Core Principles of
Financial System
Core Principles of Money and Banking
1.Time has value.
2.Risk requires compensation.
3.Information is the basis for decisions.
4.Markets determine prices and allocation
resources.
5.Stability improves welfare.
17. 1-17
Five Core Principles of
Financial System
A. Time has value
• A dollar today is worth more than a dollar a
year from now…….why????
• Time affects the value of financial
instruments.
• Interest is paid to compensate the lenders
for the time the borrowers have their
money.
• Understanding of interest rates and how to
use them is very important.
18. 1-18
Five Core Principles of
Financial System
B. Risk requires Compensation
• "Risk" refers to potential financial losses,
because of unwanted events.
• For ever asset like stocks and bonds etc. the
higher the risk, the higher the return has to be.
• In a world of uncertainty, individuals will
accept risk only if they are compensated.
• In the financial world, compensation comes in
the form of explicit payments: the higher the
risk the bigger the payment.
19. 1-19
Five Core Principles of
Financial System
C. Information is the basis for decisions
• We live in a world of imperfect information.
• For financial transactions to take place parties must
have adequate information.
• The more important the decision, the more information
we gather.
• Collection and processing of information is the
foundation of the financial system.
• Advances in computer and communications technology
have helped the spread of financial information,
• Thereby paving the way for the growth of financial
markets.
20. 1-20
Five Core Principles of
Financial System
D. Markets determine Prices and Allocate
Resources.
• Markets are the core of the economic system.
• Markets channelize Resources (saver and
Brower)
• And minimize the cost of gathering information
and making transactions.
• The better developed the financial markets, the
faster the country will grow.
21. 1-21
Five Core Principles of
Financial System
E. Stability improves welfare.
• A stable economy reduces risk and
improves everyone's welfare.
• Financial instability in the autumn of 2008
triggered the worse global downturn since
the Great Depression.
• The central banks are now expected to
keep inflation low and stable, and also to
avoid or minimize recessions.
• A stable economy grows faster than an
unstable one.
22. Functions Performed by the Global Financial
System and the Financial Markets
• Savings function. The global system of
financial markets and institutions provides a
conduit for the public’s savings.
• Wealth function. The financial instruments sold
in the money and capital markets provide an
excellent way to store wealth.
• Liquidity function. Financial markets provide
liquidity for savers who hold financial
instruments but are in need of money.
23. Functions Performed by the Global Financial
System and the Financial Markets
• Credit function. Global financial markets
furnish credit to finance consumption and
investment spending.
• Payments function. The global financial system
provides a mechanism for making payments for
goods and services.
24. Functions Performed by the Global Financial
System and the Financial Markets
• Risk protection function. The financial markets
around the world offer businesses, consumers,
and governments protection against life, health,
property, and income risks.
• Policy function. The financial markets are a
channel through which governments may
attempt to stabilize the economy and avoid
inflation.
25. 1-25
Sources
• Daily
• News Paper (English)
• Business Recorder
• The Wall Street Journal
• Financial Times
• Bloomberg.com
• Yahoo Finance
• CFA Blogs
• Thomson Reuters blogs
• Weekly
• The Economist
• Business Week
• Organizational Data
• BIS
• SBP
• World Bank
