FMGT 3550 – FDA

An Introduction to Financial Management – Chapter 1

. What is finance all about?

. What are the main tasks of financial managers?

. How do financial managers contribute to increase the value of the firm?

. What are the main types of financing available to firms?

. How can businesses access these financial resources?

. Who are the main players facilitating business financing?

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1. Key Attributes of Successful Companies

Successful companies need, among other:

 Strong business model
 Skilled people
 Strong relationships with suppliers, customers and other important stakeholders


In order to be able to
 Identify, create and deliver products/services that provide value to customers
 Sell products/services at a price high enough to cover the firm’s costs and provide shareholders
and lenders adequate compensation for their exposure to risk.

How do financial managers contribute to this? What are the main tasks of financial managers?

 Capital Budgeting Decisions

 Business Valuation
 Financing Decisions
 Financial Planning and Analysis (FP&A)
 Working Capital Management
 Financial Risk management.
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In this class we will assume that we are dealing with corporations (private or public).

Corporations

A corporation is a legal entity separate from its owners and managers.

 Unlimited life
 Easier transferability of ownership Advantages
 Limited liability (losses limited to the amount invested)

 Corporate earnings taxed at corporate and individual levels Disadvantages

 More complex reporting and regulatory requirements
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The main objective of a firm is to maximize shareholder wealth in the long run (i.e., if the firm is
publicly listed, maximize the value of the firm or maximize the price of the firm’s stock).

Does it mean that the firm’s other stakeholders are irrelevant?

What are the main determinants

of a firm’s value?
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One of the main difference between corporations, and proprietorships and partnerships is that
corporations allow the separation between owners and managers.

=> Managers may act in their own interest rather than in the owners’ best interests. This is known as an
agency conflict.

Agency problems are addressed by corporate governance, which is a set of rules that guides and
controls a company’s behavior towards its directors, managers, employees, shareholders, creditors,
customers, and other stakeholders. A firm’s corporate governance framework includes Environmental,
Social and Governance (ESG) criteria.

What should you check to assess potential agency conflicts?

> Does the firm’s Chief Executive Officer (CEO) own shares in the firm? Which percentage?
> Are the members of the Board of Director independent?
 Check CEO and top executives’ compensation packages …

Example: Capital iQ – Canada Goose

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2. MAIN types of financing and of financial securities

2.1 Main types of short-term financing

2.1.1. Trade Credit – (we will study this later, week 5)

Suppliers may allow a firm to purchase on credit. In this case, the price paid (list price) is the sum of
the “true price” and a finance charge. Example of terms of credit: 2/10 net 30. The firm receives a 2%
discount if they pay within 10 days.

List price (if the firm does not take the discount) = true price + finance charge.

2.1.2. Short-term bank loans

Commercial banks can grant short-term debt in the form of:

. Line of credit: the bank allows the firm to borrow up to a given amount (maximum amount) over a
period of 1 year.

. Short-term loan: ex. The firm borrows $500,000 for 2 years at 6%.
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2. MAIN types of financing and of financial securities

2.1 Main types of short-term financing - continued

2.1.3. Money market – short term debt securities issues

Investors can provide financial resources to firms in exchange for financial securities (ex. shares,
commercial paper, bonds). Securities are paper (or electronic) documents that specifies the firm’s
obligations towards the securities owners (securities owners’ rights and claims on some of the firm’s
cash flows and/or assets).

Money market: market where high quality (low default risk) large firms and financial institutions
can issue debt securities (promissory note, Commercial Paper) to borrow for up to 1 year at a fixed
interest rate.
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2. MAIN types of financing and of financial securities

2.2 Main types of Long-term debt financing

2.2.1 Medium-term and long-term bank loans

Medium term ( more than 1 year, up to 5 years)

Long term (more than 5 years)

Such loans can be secured: the borrower uses some of its assets as collateral.

For small firms, even corporations, banks will normally require that the largest shareholder personally
guarantee the loan.

Interest rate can be fixed: ex. 7.6%

or
floating: ex. Prime rate + 0.8% = 7.2%* + 0.8 = 8%

* prime rate as at July 13th, 2023.

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2. MAIN types of financing and of financial securities

2.2 Main types of Long-term debt financing

2.2.2 Long-term Debt securities – example: bonds

Bonds are long-term contracts where the borrower (issuer) agrees to pay interest and repay the principal
on specific dates.

Coupon or interest payment: Most bonds pay fixed coupons. Some pay variable interest (floating rate
bonds).

Maturity date: The date at which the amount borrowed must be repaid to bondholders.

Example: ABC Corp. issued bonds that require the company to pay a coupon rate of 5%, on September
15 every year until Sep. 15th, 2040.

If the total amount borrowed (principal) is $100 million, annual interest payment equals $100m(0.05) = $
5m.

Sep. 15th, 2040: ABC Corp. will repay the principal ($100m).
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2.3 Main types of Equity securities

 Common stocks (shares) have residual claims on cash flows: after creditors, lenders and other
stakeholders (employees, suppliers, Canada Revenue Agency, etc.) have been paid.

 Shares represent ownership (equity) in the company.

 Each common share normally comes with one vote. Shareholders vote to elect the members of the
company’s Board of Directors.

 Dual-class shares: allow firm’s founders to maintain control. Different classes of common shares co-
exist. Shares from different classes bear different number of voting rights.

 Preferred stock (shares) provide their owners a stated dividend (fixed dividend). Preferred shares
normally bear no votes but are given priority claim over common shares. Omitting preferred shares
dividend payment cannot force a firm into bankruptcy.
Rogers # shares outstanding Stock price
Communications Dec. 31, 2022 July 13th, 2023 Rogers’ family owns
Class A c/share Voting shares 111,152,011 $59.80 more than 90% of A
Class B c/share Non-voting shares 393,773,306 $59.44 shares (voting shares).

Why is the Rogers Com. B share price so closed to the A share price ?
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3. Cost of capital (Weighted Average of Capital, WACC)

Financial resources provided to the firm, have a cost.

The supply and demand for capital determines the cost of money.
 For debt, the cost of debt is the interest rate
 For equity, the cost is the dividend and capital gains shareholders expect to receive
 Investors are risk averse. The higher the risk they are taking, the higher their required rate
of return, the higher the cost of capital.

The interest rate paid on bonds or loans is the before-tax cost of debt from the company’s perspective.
From the investor’s perspective, the interest rate is the rate of return (required rate of return).

A firm’s cost of capital is the combination (weighted average) of the firm’s cost of equity and cost of
debt after taxes.

Why is it important?
• Business valuation
• Capital budgeting decision
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3. Capital Allocation process
Capital allocation is a process that allows to move capital from savers (capital suppliers, supply side) to
investors (demand side) on a basis acceptable to both parties.
 Can be done:
o Directly
o Through investment banks (a “middleman”)
o Through a financial intermediary (ex. a commercial bank, pension fund, etc.)
 The process involves:
o The creation and issue of new securities (ex. stocks (equity financing), bonds (debt financing))
o Financial institutions
o Financial markets

 Who are the main institutions that participate in the capital allocation process?
o Investment banks Life insurance companies
o Commercial banks Mutual funds/Exchange Traded Funds
(ETFs)
o Trust companies Pension funds
o Credit unions Hedge funds
 Which one is which?

Ex. 1. XYZ borrows $60

million from BMO. XYZ
issues $60 million worth of
bonds, all bought by BMO.

Ex. 2. SmallCorp. Issues

and sells new shares to a
shareholder in exchange of
$10 million of additional
equity capital.

Ex. 3. ABC Corp. borrows

$200 million by issuing
some new bonds, with the
help of RBC Capital
markets, Goldman Sachs
etc.
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4. Main Types of Financial Markets
Financial markets bring organizations seeking capital together with those having excess financial
resources (savers)

Foreign exchange market: market where currencies can be bought/sold

o With immediate payment/delivery (spot market)
o With delayed payment/delivery (forward market)

Money markets are the markets for short-term highly liquid debt securities with maturities of one year or
less. Money market access is reserved to high quality (low default risk) organizations only.
Ex. Commercial Paper: short term promissory notes, issued only by high quality organizations.

Capital markets = Bond Market (long-term debt) plus Stock Market (equity) plus derivative markets*

* Derivative markets (options, futures, swaps etc. this goes beyond the scope of this course).
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Market Capitalization March 2023, in trillion (USD)

New York Stock Exchange (NYSE) 22.7
Nasdaq 18
Shanghai Stock Exchange 7.26
Euronext 6.62
Japan Exchange Group 5.65
Shenzhen Stock Exchange 5.2
Hong Kong Stock Exchange 4.97
Bombay Stock Exchange 3.5
London Stock Exchange 3.27
National Stock Exchange of India 3.2
Toronto Stock Exchange (TSX) 3.02
Saudi Stock Exchange 2.7
Swiss Exchange 1.71
Deutsche Börse 1.70
Source: Word Federation of Exchanges
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Relative Size of the Bond and Stock Markets US markets (USD Canadian markets (CAD
billions) billions)

Average Daily Trading Value, Stocks $207.0 (1) $7.4 (1)

Average Daily Trading Value, Bonds $816.3 (2) $48.8(3)

1. 2018 (World Federation of Exchanges: Electronic Order Book ; NASDAQ, NYSE, BATS, TMX )
2. 2018 (SIFMA, Securities Industry and Financial Markets Association)
3. Investment Industry Regulatory Organization of Canada: Bond Market Secondary Trading 2018 divided by 252 trading days.

Note: regardless of the country, the bond market is much larger than the stock market.