1.

What is nance

Determine value and making decisions based on the value assessment. The nance functions allocated
resources, including acquiring, investing and managing of resources

Main areas of nance

1. investment
2. Financial markets and intermediaries
3. Corporate nance
• Capital budgeting: What long term investments should the rm take on?
• Capital structure: where will we get long term nancing to pay for the investments
• Working capital management: how will we manage the everyday nancial activities of the rm?

Investors provide nancing to the rm in exchange of nancial securities and the rm will invest the
funds in assets. Income generated by rm assists will then be distributed to the investors.

Assets Liabilities1Equity

current'Assets
Fixed
assets
Longtermdebt
currentliabilities shareholder's
tangible intangible equity
investment
whatlongterm
shouldthefirmengagein
networkingcapital Howcanthefirmraisemoneyfor
therequired
assets
current
Differencebetween investments

account
legcash receivablesinventories
flow
andcurrentliabilities Howmuchshortterm
cash a needs
company
topayitsbills

Investment decisions
Goal: to maximise value.

Finance decision
Goal: How to best slice up the pie

2. Business organisations

Sole proprietorship
Anindividualownsandmanagesthebusiness Disadvantages
Advantages • Limited to life of owner
• Easiest to start • Equity capital limited to owner’s
• Least regulated personal wealth
• Single owner keeps all the pro ts • Di cult to sell ownership interest
• Taxed once as personal income • Unlimited liability
Disadvantages
Partnership
snarePercentage
much they
ofhow • General partnership (unlimited management
e putin
Agroupdindividualscollectivelyownandmanagethe
business liability) daytoday
Advantages • Limited partnership (general notvery
• Two or more owners to
partners and limited partners) involvedinday
• More capital available • Partnership dissolves when one daymanagement
• Relatively easy to start partner dies or wishes to sell
• Income taxed once as personal income • Di cult to transfer ownership

Corporation Disadvantages
• Separation of ownership and
Advantages management and the resulting
• Limited liability potential for agency costs
• Unlimited life • Double taxation: income taxed at
• Separation of ownership and management the corporate rate and dividend
• Transfer of ownership is easy taxed at personal rate (dividend tax
• Easier to raise capital not applicable for SG)

Private companies
• Firm’s shares are usually closely held where ownership is by a relatively small group of shareholders
which often include the companies’ original founders, some nancial backers etc.
• Shares are not traded on any exchange

Public companies
• Firm’s shares are listed on stock exchange, where the company’s shares are widely dispersed and
traded on secondary markets.

Source of funds
Firm
Equity Debt
i Retained l
share Bank Bond
issurance
earnings issurance
Residualclaims Borrowing
contractualobligations

3.Financial managers

Goal of Financial Management

Goal of shareholder: Wealth maximisation aka maximising stock price

Goal of rm: Maximise its value
• Maximise value of the rm
• Maximise the wealth of the owners
• Maximise the price of the stock
• Maximise the contribution to the economy.
The objectives are best realised when the rm uses nance’s systematic value maximising investment
and nancing decision criteria
How to maximise stock price?

Stock price
determined by the underlying rm’s ability to generate cash ow

3 aspects of cash ow that a ect asset value and hence stock prices. They determine the intrinsic
value
• Amount of cash ow as expected by shareholders
• Timing of the cash ow ( the earlier the better)
• Riskiness of the cash ow stream

Intrinsic value: an estimate of a stock’s “true” value based on accurate risk and return data.
• An estimated value, not observable, not a precise objectively known measure
• Often referred to estimated of “fundamental value”

Market value: An observable value. The actual selling price of a stock. It is based on the perceived
information as seen by the marginal investor in the market.

Hence, to maximise stock price, the nancial managers make corporate nance decisions! Capital
budgeting, capital structure and working capital management

Agency problem (con ict of interest)

• Principal hires an agent to represent their interest. Stockholders are principals and managers are
agents. Managers run the company through the Board of directors.
• Con ict of interest between principal and agent
◦share holders and managers
◦Shareholders and creditors
• Direct agency costs
◦ expenditure which bene t the management : high bene ts
◦Monitoring costs: auditors and audit committee
• Indirect agency costs
◦lost opp cost which increase the rm’s value in the long run , if accepted ( engage in a safe
choice when riskier choice can potentially increase value of company. Stockholders want more
money. Managers want safe job)
• Factors that a ect managerial behaviour
◦compensation plans tied to share value
◦Direct intervention by shareholders
◦The threat of ring
◦The threat of takeover
◦Monitoring
• Good corporate governance
◦corporate governance in the rules, processes or laws by which business are operated, regulated
and controlled.
‣ splitting chairman roles and CEO , so the BOD can supervise the actions of nancial
managers, making sure they represent the interest of stockholders.

4. Financial markets
Markets where “ nancial instruments” are traded and act as intermediaries between savers and
borrowers
Money market VS Capital market

Money market
• Where debt securities of less than one years are traded: treasury securities, commercial paper, bills,
inter-bank loans
• Loosely connected dealer markets
• Banks are major players

Capital market
• Equity and long term debt are traded
• Equity is usually traded in auction markets

Primary markets VS Secondary market

Primary market
• For government and corporations initially issued securities.
• Public o ering is costly so it is usually o ered private, where securities ew o ered to large nancial
institutions or wealthy individuals, which is less costly.

Secondary market
• Where existing nancial claims are traded
• Dealer market
◦transactions occurs through dealers
• Auction market
◦buyers and sellers are buying and selling to each other directly. Auction occurs where the
highest bidding price is matched with the lowest asking price