An Introduction to Finance

Section 1 The Role and Scope of Finance

What is Finance?
A term that refers to two main activities;
the actual process of attracting money; and
the management of these funds;

The Functions of Finance

Analysis;
Decision-making;

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.,;

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;
Financial Accounting tends to be more concerned with the past;
 Finance tend to be more interested in present and the future;
 Financial Accounting tends to have an income focus;
 Finance tends to have a cash flow focus;

Business Finance Types of Financial Decisions

 Investment Decisions;
 Financing Decisions;
 Asset Management Decisions;

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?

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?

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;

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;

Profit Maximization
 Short-Term Oriented;
 Cannot account for risk;
 Can lead mismanagement;
Wealth Maximization
 Long-term Oriented;
 The risk factor is taken account;
 Recognizes the timing of returns;

Section 2 An Overview of Business Environment

Types of Businesses Sole Proprietorships

 A business that owned and operated by one individual;
 The owner and the business are legally identical;
17. The Pros and Cons of Sole Proprietorships 17
18. Partnerships  A business that owned and controlled by two or more persons who are
equally liable for losses;  Typically governed by partnership agreement; 18
19. The Pros and Cons of Partnerships 19
20. 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
21. The Pros and Cons of Company 21
22. Section 3 Corporate Structure 22
23. The Modern Corporation There exists a SEPARATION between owners and managers.
Modern Corporation Shareholders Management 23
24. Organizational Chart of Corporate Structure 24
25. Role of Management  An agenagentt is an individual authorized by another person, called
the principal, to act in the latter’s behalf;  Management acts as an agentagent for the owners
(shareholders) of the firm; 25
26. Agency Theory Principals must provide incentivesincentives so that management acts in
the principals’ best interests and then monitormonitor results; Incentives include stockstock
options, perquisites,options, perquisites, and bonusesbonuses; 26
27. Section 4 A Quick Tour to Financial Environment 27
28. Financial Markets  Businesses interact continually with the financial markets;financial
markets;  Composed of all institutions and procedures for bringing buyers and sellers of
financial instruments together; 28
29. 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
30. Flow of Funds in the Economy INVESTMENT SECTOR FINANCIAL INTERMEDIARIES
SAVINGS SECTOR FINANCIAL BROKERS SECONDARY MARKET 30
31. 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
32. Financial Intermediaries  Come between ultimate borrowers and lenders by transforming
direct claims to indirect claims;  Commercial banks, insurance funds,mutual funds; 32
33. 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:Result: Savings tend
to be allocated to the most efficient uses; 33
34. What Influences Security Expected Returns?  Default Risk-the failure to meet the terms of
contract;Default Risk-the failure to meet the terms of contract;  Marketability-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
35. What Influences Expected Security Returns?  Maturity-Maturity- is concerned with the life
of the security; the amount of time before the principal amount of a security becomes due; 
Embedded Options-Embedded Options- provide the opportunity to change specific attributes of
the security;  InflationInflation -the greater inflation expectations, then the greater the expected
return; 35
36. Risk-Expected Return Profile RISK EXPECTEDRETURN(%) U.S. Treasury Bills (risk-free
securities)U.S. Treasury Bills (risk-free securities) Prime-grade Commercial PaperPrime-grade
Commercial Paper Long-term Government Bonds Investment-grade Corporate Bonds Medium-
grade Corporate Bonds Preferred Stocks Conservative Common Stocks Speculative Common
Stocks 36
37. Term Structure of Interest Rates A yield curve is a graph of the relationship between yields
and term to maturity for particular securities. Upward Sloping Yield CurveUpward Sloping Yield
Curve Downward Sloping Yield Curve 0246810 YIELD(%) 0 5 10 15 20 25 30 (Usual) (Unusual)
YEARS TO MATURITY 37
38. THANK YOU