1 1.Career Opportunities in Finance Money and capital markets Investments Financial management Some players have need for capital, others have excess capital. Financial Markets bring both parties together Investments is the purchase of securities issued by firms/governments for income or capital appreciation. Examples of parties involved: Brokerage: full service vs discount Financial consulting: advise individuals how to invest Investment portfolio management: for bank, mutual fund

2 2.Financial Management Decisions Capital Budgeting The process of planning and managing a firm’s long-term investments is called capital budgeting. In capital budgeting, the financial manager tries to identify investment opportunities that are worth more to the firm than they cost to acquire. Capital Structure Ways in which the firm obtains and manages the long-term financing it needs to support its long-term investments. A firm’s capital structure refers to the specific mixture of long-term debt and equity the firm uses to finance its operations.

3 Financial Management Decisions Working Capital Management The phrase working capital refers to a firm’s short-term assets, such as inventory, and its short-term liabilities, such as money owed to suppliers. Managing a firm’s working capital is a day-to- day activity that ensures the firm has sufficient resources to continue its operations and avoid costly interruptions.

4 3.Corporation In general, a firm starts as a proprietorship or partnership and becomes a corporation over time. Corporation has the following advantages:  Unlimited life of organization  Ease of transferring ownership  Limited liability These advantages make it easy for corporations to raise money in capital markets. Basic disadvantage is double taxation

5 4.Financial Goals of the Corporation The primary financial goal is shareholder wealth maximization, which translates to maximizing stock price. Is stock price maximization the same as profit maximization? For example, what about maximizing this year’s earnings per share? Stock price depends on future expected cash flows, their timing and riskiness. So the difference is: Being accounting vs. cash measure Use of a myopic/non-myopic approach Ignoring/considering the risk dimension

6 5.Agency relationships An agency relationship exists whenever a principal hires an agent to act on his/her behalf. Within a corporation, agency relationships exist between: Shareholders and managers Shareholders and creditors

7 Shareholders versus Managers Managers are naturally inclined to act in their own best interests rather than that of shareholders. They may have incentive to enjoy perquisites or leisure Or they may aim to maximize size of the firm Power/status Higher salary Prone to takeovers But the following factors affect managerial behavior: Managerial compensation plans Direct intervention by shareholders The threat of firing The threat of takeover

8 Shareholders versus Managers To align shareholder-manager interest Managerial compensationexecutive stock options performance shares Shareholder interventionproposal to be voted in annual meeting blockholders are usually members in the board of directors

9 Shareholders versus Creditors 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. Creditors lend funds based on Riskiness on firm’s existing assets Expectation about riskiness of new assets Existing capital structure Expectations about changes in capital structure Expropriation of wealth from creditors Accepting riskier projects Issuing new debt (and repurchase stock) Creditors will either place restrictive covenants and/or charge a higher than normal interest rate

10 6.Factors that affect stock price Projected cash flows to shareholders Timing of the cash flow stream Riskiness of the cash flows Basic Valuation Model To estimate an asset’s value, one estimates the cash flow for each period t (CF t ), the life of the asset (n), and the appropriate discount rate (k)

11 Factors that Affect the Level and Riskiness of Cash Flows Decisions made by financial managers: Investment decisions Financing decisions (the relative use of debt financing) Dividend policy decisions The external environment Legal constraints General level of economic activity Tax laws Interest rates