1. Overview of Financial Management and the Financial Environment
Main Source:
BE Chapter 1

2. Company’s Objective Maximization of shareholders’ wealth,
Maximization company’s value by
maximization free cash flows and minimization cost of capital.
See Figure 1.1. (BE)
Watch carefully: Market price of company’s stock.

3. Determinants of Free Cash Flows
Sales revenues
Operating costs (raw materials, labor, etc.) and taxes
Required investments in operations (buildings, machines, inventory, etc.)

4. What is the weighted average cost of capital (WACC)?
The weighted average cost of capital (WACC) is the average rate of return required by all of the company’s investors (stockholders and creditors)

5. What factors affect the weighted average cost of capital?
Capital structure (the firm’s relative amounts of debt and equity)
Interest rates
Risk of the firm
Stock market investors’ overall attitude toward risk

6. What determines a firm’s value?
A firm’s value is the sum of all the future expected free cash flows when converted into today’s dollars:

7. The Markets Two groups: Real (tangible) markets for physical assets
Financial markets for financial instruments
Money markets
Capital markets
See table 1-1 for major financial instruments

8. Financial institutions
Capital formation process
(See fig 1-2 (BE) for the diagram of capital formation process)
Direct transfers
Indirect transfers, through
investment bankers
financial intermediaries

9. What are financial assets?
A financial asset is a contract that entitles the owner to some type of payoff.
Debt
Equity
Derivatives
In general, each financial asset involves two parties, a provider of cash (i.e., capital) and a user of cash.

10. Who are the providers (savers) and users (borrowers) of capital?
Households: Net savers
Non-financial corporations: Net users (borrowers)
Governments: Net borrowers
Financial corporations: Slightly net borrowers, but almost breakeven

11. What are three ways that capital is transferred between savers and borrowers?
Direct transfer (e.g., corporation issues commercial paper to insurance company)
Through an investment banking house (e.g., IPO, seasoned equity offering, or debt placement)
Through a financial intermediary (e.g., individual deposits money in bank, bank makes commercial loan to a company)

12. What are some financial intermediaries?
Commercial banks
Savings & Loans, mutual savings banks, and credit unions
Life insurance companies
Mutual funds
Pension funds

13. What are some types of markets?
A market is a method of exchanging one asset (usually cash) for another asset.
Physical assets vs. financial assets
Spot versus future markets
Money versus capital markets
Primary versus secondary markets

14. The Cost of Money
Interest rate (the “price of money”) is an interaction point between money supply and money demand.
Determinants:
Production opportunities
Time preferences for consumption
Risk
Inflation

15. Required Dividend Capital return yield gain = + .
What do we call the price, or cost, of debt capital?
The interest rate
What do we call the price, or cost, of equity capital?
Required Dividend Capital
return yield gain =

16. Real versus Nominal Rates
= Real risk-free rate.
T-bond rate if no inflation;
1% to 4%.
= Any nominal rate.
= Rate on Treasury securities. r
rRF

17. r = r* + IP + DRP + LP + MRP. Here:
r = Required rate of return on a debt security.
r* = Real risk-free rate.
IP = Inflation premium.
DRP = Default risk premium.
LP = Liquidity premium.
MRP = Maturity risk premium.

18. Financial Management
How to run firm financially to achieve the objective, under a certain condition of financial environment.
Main elements of financial environment:
Financial markets
Financial institutions
Financial regulations