Chapter 2: The Financial environment AFIN 209 mo.simwami@gmail.com Miss faith moono simwami 12/4/2018

Recommended reading 12/4/2018 J. Wston & E. Brigham: Essentials of Managerial Weston J : Managerial Finance Van Harne: Finance Management & Policy Ross: Corporate Finance Brigham & Cluter: Finance Management 12/4/2018

Revision 12/4/2018 What will corporate finance teach you? What is corporate finance? What are the 5 basic functions in corporate finance? What do they mean? What are the 3 key decisions in corporate finance? What is the goal of the firm? How would I maximize shareholder wealth? What is the agency problem and how can it be resolved? Explain the (3) types of organisation structure and their liabilities. 12/4/2018

Homework Public listed company? 12/4/2018

The Financial Environment The Definition of Financial Market The Function of Financial Markets The types of Financial Markets The factors that affect the Security Expected Returns 12/4/2018

What is a market? A market is a venue where goods and services are exchanged. A financial market is a place where individuals and organizations wanting to borrow funds are brought together with those having a surplus of funds. 12/4/2018

Financial Markets In an economy there exist an interaction between the corporation, financial intermediaries and lenders and borrowers. This occurs in the financial markets and is there for the purpose of facilitating the raising of capital by corporation and other businesses, which in turn lead to economic growth. Unlike commodity markets where trading of physical goods is done, financial markets are markets where financial assets, instruments or securities are traded 12/4/2018

Financial Markets These instruments facilitate the transfer of funds between units that need funds and those that supply funds. The financial markets that are found in any financial system consisting of a number of players. The markets bring together lenders, borrowers (investors) and financial intermediaries (financial institutions). Financial intermediaries are firms such as commercial banks, stock exchanges, investment companies, insurance companies and pension funds. Borrowers and lenders of funds include both individuals and firms. 12/4/2018

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The Function of Financial Markets Financial Markets channel funds from savers to firms, government or other individuals through direct or indirect finance 12/4/2018

How is capital transferred between savers and borrowers? In direct finance, borrowers sell securities (bonds or shares) to lenders Indirect financing involves intermediaries 12/4/2018

Why is the channeling function important? Markets create value: 1. savers get interest rate that they can spend later 2. investors make profits over and above the interest payments 12/4/2018

Types of Financial Markets Financial markets can be categorized using several important features of them: Debt and Equity Markets Primary and Secondary Markets Exchanges and over-the-counter markets Money and capital markets 12/4/2018

Debt & equity market 12/4/2018

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Debt and Equity Markets A firm or an individual can obtain funds in a financial market in two ways: A. issue a debt instrument (a bond) Definition: A bond and its Maturity A bond is a debt security that promises to make payments periodically for a specified period of time until a specified date. The maturity of a debt instrument is the number of years until that instrument’s expiration date. B. issue equities, such as stocks Definition: A stock (equity) Stocks (equities) are claims to a share in the net income (income after expenses and taxes) and the assets of a business 12/4/2018

Term Structure of the Debt and Equity A debt instrument is: short-term, if its maturity is less than a year long-term, if its maturity is ten years or longer intermediate-term, if its maturity is between 1 and 10 years Equity instruments: are only long-term as they do not have a maturity. 12/4/2018

Primary and Secondary Markets What is a primary market? Definition: A primary market is a financial market in which new issues of a security, such as a bond or a stock, are sold to initial buyers by the corporation or government agency who wants to borrow funds. What is a secondary market? Definition: A secondary market is a financial market in which securities that have been previously issued can be resold 12/4/2018

Exchanges and Over-the-Counter Markets Secondary markets are organized in two ways: Exchanges: where buyers and sellers of securities meet in one central location to conduct trades like stock exchange Over-the-counter markets: dealers at different locations who have securities and stand ready to sell them. They are usually computer-traded. 12/4/2018

Money and Capital Markets Money markets: a market where short-term securities are traded (maturity less than 1 year like T-bills and Commercial papers) Capital markets: a market where long-term securities are traded – bonds and equity with maturity of more than 1 year Treasury Bills (T-bills): Short-term, non-interest bearing obligations of the Government issued at a discount and redeemed at maturity for full face value. Commercial Paper: Short-term, unsecured promissory notes, generally issued by large corporation 12/4/2018

Allocation of Funds Funds will flow to economic units that are willing to provide the greatest expected return (holding risk constant). In a rational world, the highest expected returns will be offered only by those economic units with the most promising investment opportunities. Result: Savings tend to be allocated to the most efficient uses. The expected return is the return on a risky asset expected in the future. 12/4/2018

What factors affect Security Expected Returns? Default Risk Marketability Maturity Taxability Expected inflation 12/4/2018

What factors affect Security Expected Returns? Default Risk is the failure to meet the terms of a contract. 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. 12/4/2018

What factors affect Security Expected Returns? Maturity is concerned with the life of the security; the amount of time before the principal amount of a security becomes due. Taxability considers the expected tax consequences of the security. Inflation is a rise in the average level of prices of goods and services. The greater inflation expectations, then the greater the expected return. 12/4/2018

homework 12/4/2018 Research the requirements needed to list a company. What effect does a weakened currency have on the financial market? CASE STUDY: CHINA and a zambian (african) shipping company How is greece similar to zambia? What effects does a devalued currency have on zambia? 12/4/2018

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