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1-1 1 Basic Areas Of Finance Corporate finance Investments Financial institutions International finance

1-2 Corporate Finance Main subject of the course Will be covered throughout all the chapters 2

1-3 3 Investments Financial assets: stocks and bonds Focus on the risks and rewards of investing in financial assets Job opportunities –Stockbroker or financial advisor –Portfolio manager –Security analyst

1-4 4 Financial Institutions Companies that specialize in financial matters –Banks – commercial and investment, credit unions, savings and loans –Insurance companies –Brokerage firms Job opportunities

1-5 5 International Finance This is an area of specialization within corporate finance, investments, financial institutions It may allow you to work in other countries or at least travel on a regular basis Need to be familiar with exchange rates and political risk Need to understand the customs of other countries; speaking a foreign language fluently is also helpful

1-6 6 Why Study Finance? Marketing –Need to get the greatest payoff from marketing expenditures, need to develop product prices Accounting –Accountants need to make financial decisions –Financial analysts use accounting info Management –Need to know financial implications of business plans Personal finance –Budgeting, retirement planning, college planning, day-to-day cash flow issues

1-7 7 Financial Management Decisions Need to answer the 3 questions: Capital budgeting –What long-term investments or projects should the business take on? Capital structure –How should we pay for our assets? –Should we use debt or equity? Working capital management –How do we manage the day-to-day finances of the firm?

1-8 8 Financial Manager Financial managers try to answer some, or all, of these questions Who is usually the top financial manager within a firm? Who reports to the top financial manager?

1-9 9 Forms of Business Organization Three major forms in the United States –Sole proprietorship –Partnership General Limited –Corporation S-Corp Limited liability company

Sole Proprietorship Advantages –Easiest to start –Least regulated –Single owner keeps all of the profits –Taxed once as personal income Disadvantages –Limited to life of owner –Equity capital limited to owner’s personal wealth –Unlimited liability –Difficult to sell ownership interest

Partnership Advantages –Two or more owners –More capital available –Relatively easy to start –Income taxed once as personal income Disadvantages –Unlimited liability General partnership Limited partnership –Partnership dissolves when one partner dies or wishes to sell –Difficult to transfer ownership

Corporation Advantages –Limited liability –Unlimited life –Separation of ownership and management –Transfer of ownership is easy –Easier to raise capital Disadvantages –Separation of ownership and management (agency problem) –Double taxation (income taxed at the corporate rate and then dividends taxed at personal rate, while dividends paid are not tax deductible)

Limited Liability Company Advantages –Limited liability –Avoids double taxation –Flexibility in drawing up contracts and allocating income Disadvantages –May be determined to be a corporation by the IRS –Limited life –Costs more to set up and maintain than a corporation –Member may have to pay self employment tax on income received

Goal Of Financial Management What should be the goal of a corporation? –Maximize profit? –Minimize costs? –Maximize market share? –Maximize the current value of the company’s stock? Does this mean we should do anything and everything to maximize owner wealth? Sarbanes-Oxley Act

The Agency Problem Agency relationship –Principal hires an agent to represent its interests –Stockholders (principals) hire managers (agents) to run the company Agency problem –Conflict of interest between principal and agent

1-16 Agency Theory All individuals act in their own self interest What is the self interest of the manager(agent)? What is the self interest of the stockholder (principal)? 16

1-17 Agency Theory Manager and stockholders have different risk preferences What is the risk preference of the manager(agent)? What is the risk preference of the stockholder (principal)? 17

1-18 Agency Theory Reduce Agency problem with –Monitoring Audited financial statements –Incentive Compensation Instead of a monetary bonus, award stock options –Vesting period –Threat of takeover Management will be replaced 18

1-19 Proxy fight Used by unhappy shareholders who want to replace existing management What is a proxy? Poorly managed firms are attractive for takeover; there’s greater profit potential 19

Stakeholders Management and shareholders are not the only groups with interest in the company A stakeholder is someone other than a shareholder and creditor who potentially has a claim on the cash flows of the firm

1-21 Cash flows to and from the firm Cash flow TO the firm from financial market Cash flow FROM the firm when it invests in assets Cash flow TO the firm when assets generate cash Cash flow FROM the firm to pay taxes Cash flow FROM the firm to pay creditors and stockholders 21

Financial Markets Cash flows to the firm Bring buyers and sellers together Primary vs. secondary markets –Dealer vs. auction markets –Listed vs. over-the-counter securities NYSE NASDAQ

1-23 Primary markets Original sale of securities by governments and corporations Public offering –Register with SEC –Disclosures required –Accounting, legal, selling costs Private placement –Negotiated sale with a specific buyer –Debt and equity sold to life insurance co or mutual fund 23

1-24 Secondary market One owner or creditor selling to another 2 kinds: –Dealer: over the counter market Dealers buy and sell for themselves Most debt securities traded through dealer Dealers are electronically connected –Auction market Physical location (Wall Street) Dealers play limited role 24

1-25 Secondary Markets NASDAQ –Higher number of companies listed –Most of the companies are smaller in size Microsoft and Intel listed on NASDAQ –Dealer market: trading done electronically New York Stock Exchange NYSE –Accounts for 85% of the volume of shares traded in auction markets 25

1-26 Listed on exchange Stocks trade on the exchange Firm must meet certain minimum requirements –Asset size –# of shareholders NYSE has minimum earnings, minimum market value of outstanding shares 26

1-27 Stock index Measures a section of the stock market Global indexes: MSCI World S&P Global 100 National index: S&P 500 Dow Jones Industrial Average NASDAQ composite 27

1-28 Dow Jones Industrial Average Shows how 30 large publicly owned companies in the US have traded during a trading session 2&e=4&f=2010&g=m&z=66&y=0http://finance.yahoo.com/q/hp?s=%5EDJI&a=09&b=1&c=1928&d=0 2&e=4&f=2010&g=m&z=66&y=0 28

1-29 Companies included in DJIA Company Symbol Industry 3M MMM Conglomerate3MConglomerate Alcoa AA Aluminum AlcoaAluminum American Express AXP Consumer financeAmerican ExpressConsumer finance AT&T T TelecommunicationAT&TTelecommunication Bank of America BAC BankingBank of America Boeing BA Aerospace and defenseBoeingAerospacedefense Caterpillar CAT Construction and mining equip.CaterpillarConstruction Chevron Corporation CVX Oil & gasChevron Corporation Cisco Systems CSCO Computer networkingCisco SystemsComputer networking Coca-Cola KO BeveragesCoca-ColaBeverages DuPont DD Chemical industryDuPontChemical industry ExxonMobil XOM Oil & gasExxonMobilOil & gas General Electric GE ConglomerateGeneral Electric Hewlett-Packard HPQ TechnologyHewlett-PackardTechnology The Home Depot HD Home improvement retailerThe Home DepotHome improvementretailer 29

1-30 Company Symbol Industry. 30 IntelIntel INTC SemiconductorsSemiconductors IBMIBM IBM Computers and technologyComputerstechnology Johnson & Johnson JNJ PharmaceuticalsJohnson & JohnsonPharmaceuticals JPMorgan ChaseJPMorgan Chase JPM BankingBanking Kraft FoodsKraft Foods KFT Food processingFood processing McDonald's MCD Fast foodMcDonald'sFast food MerckMerck MRK PharmaceuticalsPharmaceuticals MicrosoftMicrosoft MSFT SoftwareSoftware PfizerPfizer PFE PharmaceuticalsPharmaceuticals Procter & GambleProcter & Gamble PG Consumer goodsConsumer goods TravelersTravelers Insurance TRV InsuranceInsurance United Technologies CorporationUnited Technologies Corporation UTX ConglomerateConglomerate Verizon CommunicationsVerizon Communications VZ TelecommunicationTelecommunication Wal-MartWal-Mart WMT RetailRetail Walt DisneyWalt Disney DIS Broadcasting and entertainmentBroadcastingentertainment

Quick Quiz What are the four basic areas of finance? What are the three types of financial management decisions, and what questions are they designed to answer? What are the three major forms of business organization? What is the goal of financial management? What are agency problems, and why do they exist within a corporation?