1. Chapter 1: Overview of Finance
Introduction
Defining finance
The Firm: a systemic approach
Corporate Finance: the financial function
The financial objective: value creation
Financial main principles
Finance: historic evolution
Main programs in Finance

2. Introduction: Finance !!!
I am saving for retirement. Should I use a pension fund, mutual fund, direct stock market investment ?
I want that new car. Should I use my cash saving, lease, borrow?
Which is the best way to pay for my holidays, for my house?
I’m thinking about starting a new business. Will it reward me adequately?
Country X has asked for major project financing.
Should my organization provide the funds?

3. Why study Finance ? . To manage your personal resources.
To deal with the world of business.
To pursue interesting and rewarding career opportunities.
To make informed public choices as a citizen.
For the intellectual challenge.

4. What is Finance ???
The discipline that deals with decisions concerning how money is raised and used by businesses, governments and individuals.
3 success keys:
More value is preferred to less.
The sooner cash is received, the more valuable it is.
Less risky assets are more valuable than riskier assets.

5. What is Finance ?
Finance is the study of how and under what terms savings (money) are allocated between lenders and borrowers.
Finance is distinct from economics in that it addresses not only how resources are allocated but also under what terms and through what channels.
Financial contracts or securities occur whenever funds are transferred from issuer to buyer.

6. Finance: Allocation of resources
Finance is the study of how people allocate scarce resources over time.
costs and benefits are distributed over time.
but the actual timing and size of future cash flows are often known only probabilistically
Understanding finance helps you evaluate these uncertain cash flows.

7. Finance: An inter-temporal decision
Finance Theory is the study of the behavior of individuals in the inter-temporal allocation (over time) of their resources in an uncertain environment, and the study of the function of economic institutions and markets in making these allocations possible.

8. Finance: Financial System
When implementing decisions, people make use of the Financial System which can be defined as the set of markets and other institutions used for financial contracting and exchange of assets and risks.

9. Finance: Financial Theory
Financial theory consists of:
the set of concepts that help to organize one’s thinking about how to allocate resources over time.
the set of quantitative models used to help evaluate alternatives, make decisions, and implement them.
These concepts and models apply at all levels and scales of decision making.

10. A Basic of Finance
A basic tenet of finance is that the existence of economic organizations (e.g. firms and governments) facilitate the satisfaction of people’s consumption preferences.

11. Finance: A Process
Finance is the process of transforming existing assets into new, contractual forms, as well as the analytical techniques needed to support this process, for the purpose of wealth creation in modern, capitalistic economies.

12. The Value Creation Function of Finance
The practice of “finance” exists for the creation of value.
Financial contracting brings about the substitution of real wealth (i.e. real business assets) for financial wealth (i.e. securities)
Investing in financial securities has better attributes than in real assets. Value is created in the real assets held by businesses, and then transmitted into the value of financial wealth issued by businesses and held by investors.

13. Finance: Examples (1)
Finance concerns how individuals interact in order to allocate resources (capital) and/or shift consumption across time by borrowing or investing.
If you receive $1 million today, then what decision would you make regarding consumption and investment?
Suppose you spend (consume) $100,000 now.
This leaves you with $900,000. You can postpone consumption to future time periods by investing the $900,000 today.
On the other hand, what if you have $20,000 but need to consume $30,000. You can borrow the $10,000 and pay it back in a future period along with the interest.

14. Finance: Examples (2)
A firm must spend $100 million for the required assets if a proposed project is approved. Important issues are:
Should the project be accepted or rejected? What do investors demand as a (minimum acceptable) project rate of return?
What are the project’s forecasted future cash flows? How risky are these forecasted cash flows?
Where will the $100 million come from, i.e., what mix of equity and debt financing should be used?
If a firm has $200 million of cash flow, but needs reinvest $120 million, what should be done with the remaining $80 million of cash.
Pay it out as a dividend or repurchase some stock?

15. Finance: Examples (3)
A mutual fund manager that manages a fund with $10 billion portfolio receives an additional $100 million in cash from new investors.
Which stocks or bonds to purchase?
How will any proposed new investments affect the expected return and risk of the overall portfolio?

16. General areas of Finance
Financial markets and Institutions: banks, insurance companies, savings and loans, and credits unions
Investments: determining the values, risks, and returns of financial assets (stocks, bonds) and the optimal mix of securities to be held in a portfolio of investments
Financial Services: how to invest money (home purchase, financial stability, budgeting)
Managerial (Business) Finance: firms’ decisions about their cash flows (plant expansion, credit terms, inventory, cash on hand, earnings, dividends,…).

17. The importance of finance in non-finance areas
Finance concepts used everyday.
Finance is part of your life no matter what career you choose.
Every student of business, regardless of her/his major, should be concerned with finance.
Finance is related to non-finance areas: management, marketing, accounting, information systems, economics.

18. Finance Disciplines
Public finance is about the taxing and spending activities of the government.
Focus is on microeconomic functions of government – policies that affect overall unemployment or price levels are left for macroeconomics.
Scope of public finance unclear – government has role in many activities, but focus will be on taxes and spending.
Corporate finance is every decision that a business makes has financial implications, and any decision which affects the finances of a business.
Personal Finance is managing your personal budget, money and investment.

19. Corporate Finance
Corporate Finance addresses the following three major questions:
What long-term investments should the firm engage in?
How can the firm raise money for the required investments?
How much short-term cash flow does a company need to pay its bills?

20. Corporate Finance: The financial function
Corporations face two broad financial questions:
What investments should the firm make?
How should it pay for those investments?
Financial managers are concerned with :
Investment Decisions (use of funds):
The buying, holding or selling of types of assets.
Financing Decisions (raisings of funds).

21. Corporate Finance: First Principles
Invest in projects that yield a return greater than the minimum acceptable hurdle rate.
Choose a financing mix that minimizes the hurdle rate and matches the assets being financed.
If there are not enough investments that earn the hurdle rate, return the cash to stockholders.
Objective: Maximize the Value of the Firm

22. Corporate Finance: The financial function
INVESTMENT / FINANCIAL SUBSYTEM
REAL SYSTEM
FINANCIAL SYSTEM
r ( r > k ) k
FINANCIAL
MANAGEMENT
(CORPORATE
FINANCE)
INVESTMENT
FINANCING
FIRM
OPERATIONS
(Real goods & services
FINANCIAL
MARKETS
REPAYMENT
AND RETURN
RETURN

23. Corporate Governance Separation of Ownership and Control
Board of Directors
Management
Debtholders
Shareholders
Debt
Assets
Equity

24. The Traditional Accounting Balance Sheet
I am assuming that most students who are taking corporate finance have taken accounting before. Consequently, they are familiar with a traditional accounting balance sheet.

25. The Financial View of the Firm
Starts to make the transition from how accounting sees a firm to how we see a firm in corporate finance. I would emphasize two points:
Growth Assets: This is the value of investments in the future. All too often, this does not show up in an accounting balance sheet. In a financial balance sheet, this may be a significant portion of firm value.
Suggested Illustration: Contrast the accounting balance sheet of a high growth firm like Yahoo! with its financial balance sheet.
2.Firm versus Equity: I would emphasize the difference between the two. Many of us think about a firm’s equity as the firm. The firm includes all claimholders and is much more than just its equity investors.
Suggested Illustration: Consider a firm with a significant amount of debt. GE is a good example.

26. The Objective in Decision Making
In traditional corporate finance, the objective in decision making is to maximize the value of the business you run (firm).
A narrower objective is to maximize shareholder wealth. When the share is traded and markets are viewed to be efficient, the objective is to maximize the share price.
All other goals of the firm are intermediate ones leading to firm value maximization, or operate as constraints on firm value maximization.

27. The Classical Objective Function
SHAREHOLDERS
Hire & fire
managers
- Board
- Annual Meeting
Maximize
shareholder wealth
Lend Money
No Social Costs
Managers
SOCIETY
BONDHOLDERS
Costs can be
traced to firm
Protect
bondholder
Interests
Reveal
information
honestly and
on time
Markets are
efficient and
assess effect on
value
FINANCIAL MARKETS

28. What Can Go Wrong? Managers SHAREHOLDERS Managers put their interests
above shareholders
Have little control
over managers
Significant Social Costs
Lend Money
BONDHOLDERS
Managers
SOCIETY
Bondholders can
get ripped off
Some costs cannot be
traced to firm
Delay bad
news or
provide
misleading
information
Markets make
mistakes and
can over react
FINANCIAL MARKETS

29. The Only Self Correcting Objective
SHAREHOLDERS
1. More activist
investors
2. Hostile takeovers
Managers of poorly
run firms are put
on notice.
Good Corporate
Citizen Constraints
Protect themselves
Managers
SOCIETY
BONDHOLDERS
1. Covenants
2. New Types
1. More laws
2. Investor/Customer Backlash
Firms are
punished
for misleading
markets
Investors and
analysts become
more skeptical
FINANCIAL MARKETS

30. The Firm: a systemic approach
Subsistema de
recursos humanos
dirección y gestión
Subsistema
comercial
operaciones
Dinero
Personal
Bienes y servicios
Goods and
Services
Resourses
Expenses
Sales
Incomes
Human Resources
Subsystem
Management
Finance Subsystem
Commercial
Operations
Funds
Human resources
Goods and Services
Personnel

31. The Firm: a systemic approach
FINANCIAL SUBSYTEM
Planificación Financiera
FINANCIACIÓN
Financiación
Externa
Autofinanciación
Beneficio
INVERSIÓN
Financiación en
activo fijo
Inversión en activo
circulante
Costes
Subsistema
de recursos
humanos de
operaciones
comercial
de dirección
y gestión
Demanda de
créditos
Valores
Mercados
Financieros
Dividendos
Impuestos E N T O R
Dinero
Recursos
Expenses
Resources
Amortización
Reservas In
Financial Planning
FINANCING
External
Financing
Retained earnings
Benefit
INVESTMENT
Fixed
Asset
Current
Assets
Costs
Human
Recourses
Subsystem
Operations
Commercial
Management
Subsytem
Debt
Securities
Financial
Market
Dividends
Taxes V I M
Funds
Income
Empoloyees
Depreciation
Reserves

32. Sum Up: Financial main principles
Rational Financial behavior
Risk aversion
Budgetary diversification
Existence of two parts/sides in all financial transaction
Measurement by cash flows
Signaling and informative asymmetry
Efficiency of financial markets
Direct relation of risk and return
Existence of valuable ideas
Financial conduct initiative
The Time Value of the money.

33. History of Financial Markets
Early 1900s - banks were full service financial organizations
Devastating financial crisis of 1907
Bank failures during 1920s
Great depression
Legislative reform-regulation and restrictions
Deregulation since 1970s

34. History of Investments
Early 1900s investments dominated by small group of wealthy investors
Industrialization during world war I
Growth of investment firms by 1920s
Stock market crash 1929 – 1932; market value decreased > 80%

35. History of Investments
Regulations of securities
Prosperity after world war II
Inflation and high interest in 1970s
Increase in individual and institutional investors

36. History of Managerial Finance
Emergence as a separate field of study
Early 1900s
Emphasis on mergers and capitalization
Wave of mergers during 1920s
Bankruptcies in 1930s
Liquidity stressed during 1940s & ‘50s
Analysis and maximizing value in late 1950s and the 1960s
Innovative risk management in 1970s

37. History of Managerial Finance
Focus on valuation continued in 1980s, analysis expanded to include:
Inflation and effects on business decisions
Deregulation of financial institutions
Increase in computer analysis and electronic information transfer
Increased importance of global markets
Innovative financial products

38. Importance of Managerial Finance
Financial managers no longer merely fund the business needs
Financial managers coordinate decisions
People in marketing, accounting, production, and personnel need to understand finance to do their job well.

39. Main programs in finance
Managements of Investments- Capital Budgeting.
Capital Structure and Dividend Policy.
Market Efficiency.
The Capital Asset Pricing Model.
Options Theory
Agency Theory
Financial Planning
Small Firms

40. Career Opportunities in Finance
Financial markets
Investments
Managerial finance

41. Career Opportunities in Financial Markets
Financial institutions
Banks
Insurance companies
Savings and loans
Credit unions

42. Career Opportunities in Investments
Stock brokerage firms
Banks
Investment companies
Insurance companies

43. Responsibility of the Financial Staff
To acquire funds and then help operate resources so as to maximize the value of the firm.
Some specific activities:
Forecasting and planning: coordinating
Investment and financing decisions
Coordination and control
Transactions in the financial markets: money and capital markets
Managing risk: insurance and hedging in the derivatives markets.

44. Role of Finance in a Typical Business Organization

45. QUIZ 1(15 min)
Define Finance in terms of allocation of resources and as an inter-temporal decision
What is the main difference between Public Finance and Corporate Finance?
Discuss and comment the relationship between Managers and Debtholders in a corporate business?