Chapter 1: Financial Management

*create and maintain the value of the companys assets*

What is the cycle of money?

o Cycle of money: movement of money from lender to borrower and back
again

o
Who are the players? Example

o
o Internal players: managers, employees
o External players: customers and suppliers
Who are the regulators (list)?
o Corporate governance: area that deals with how a company conducts its
business and implements controls to ensure proper procedures and ethical
behavior
 Example: Insurance giant AIG
Trip to California after declaring insolvent
o U.S. Congress enacts laws and regulations in response to major economic or
highly visible events
o SEC oversees the issuing of securities and the selling of securities on stock
exchanges
Approve initial sales to public
SOX (Sarbanes-Oxley Act)
o FDIC provide insurance on deposits to guarantee the safety of checking and
savings deposits at banks
o FED - regulates the U.S. monetary and financial system, central bank of the
United States
o OCC federal agency that serves to charter, regulate and supervise the
national banks and the federal branches and agencies of foreign banks
Financial markets: primary vs. secondary
o Type of asset traded
Equity markets: where stocks are bought and sold
Debt markets: where bonds are bought and sold
Derivatives markets: (futures markets and options markets)
Foreign exchange markets: where currencies are bought and sold
o Maturity of assets
Money markets: short-term loans
Within the year
Capital markets: long-term loans
May include bonds or stocks
o Owner of the assets
Primary (first) market: when a company offers stock for sale for the
first time and the proceeds of the sale go to the company
Securities and Exchange Commission (SEC) regulates sales in
the primary market
Secondary market
SEC also regulates sales in the secondary markets
o Method of sale
Dealer market: An individual (or firm) buying and selling securities
(stocks or bonds) does so out of his or her own inventory
Auction market: (such as the government bond market) securities
sell at the same time to many buyers
Areas of finance (4 Corporate finance, Investments, Financial Institutions and
Markets, and International Finance)
o Corporate Finance
Set of financial activities that support the operations of a corporation
or business, its use of money, and those decisions that affect the
wealth of the owners.
Repay borrowed funds through dividends, interest payments,
and principal payments
 o Investments
Activities centering on the buying and selling of assets, both real and
financial
Real assets: physical assets such as property, buildings, and
commodities, including corn, oil, and gold
Financial assets: Intangible assets such as stocks and bonds
Concerned with:
Accurate pricing of assets, process of buying and selling them,
and the rules and regulations that govern the players and
activities in these transactions
o Financial Institutions and Markets
Organized financial intermediaries and the forums that promote the
cycle of money
Commercial banks, investment banks, insurance companies,
pension companies, and foreign exchanges
o Activities: matching lenders and borrowers to managing
larger retirement portfolios for large classes of
employees
Markets are the locations, both physical and virtual
o New York Stock Exchange (NYSE)
o International Finance
Addition of multinational aspects of the finance activities
Complications: Rules and regulations, economic conditions,
currency
Forms of business: compare and contrast

o
 o Partnerships
General partners operate the daily business
Limited partners participate in only certain aspects of the business
Silent partners participate only as investors
o Corporations
Separate owners and managers
Owners are shareholders elect board of directors
Board selects the main corporate officers
Legal entity
Publicly traded
Produce quarterly and annual reports
Distribute reports to current and prospective owners
o Hybrid Corporations
Limited liability corporations (LLCs)
Hybrid of partnerships and corporations
Professional corporation (PC): joins together licensed professionals
Owners in the PC are not personally liable for the malpractice
of their partners
Need PC moniker
S corporation
Small business corporate form with fewer than 100
shareholders
o Avoids taxes at corporate levels
Functions and goals of financial management (3 categories)
o Chief financial officer (CFO): oversees all the companys financial activities
o Capital budgeting: process of planning, evaluating, comparing, and selecting
the long-term operating projects of the company
Whether to invest in product or service
o Capital structure: means by which a company finances its business
activities; for public companies, usually a mix of bonds (debt) and stocks
(equity) sold to investors and owners
Where do we raise the money to conduct our business activities
Working capital management: process of managing the day-to-day
operating needs of the company through its current assets and
current liabilities (short-term financing activities)
How will we manage our day to day business needs
Efficient market: value vs price
o Maximizing current stock price
Primary objective of the finance manager is to maximize the current
stock price of the firm
Maintain a safe and enjoyable workplace to attract and retain
good employees
Work with customers to ensure products meet their needs
Establish good relationships with suppliers
 Take into account the effect on the environment and the
surrounding community
Conflicts:
Competition
Conflicts in some of the desired goals
Uncertainty of economy
Stock price: companys future cash flow
o Maximizing equity value
Maximize the current market value of the equity of the company
Equity value: company value to the owners
Equity value equals stock value for a publicly traded company
Private: market value of the companys assets the claims
against the company (the liabilities)
Increase current stock price or current equity value
Agency issues: What is it? Why does it exist? How to fix it?
o Principals: owners of the business, want the company managers to act in the
owners best interests and maximize the current stock price
o Agents: the managers, want to earn high wages and receive benefits from the
performance of their jobs
o Principal-agent problem: Problem of motivating one party to act in the best
interest of another party
o Agency cost: pay a cost to an agent acting on behalf of a principal for a
service not rendered
o Stock option: right to buy the company stock at a preset price sometime in
the future
Incentive-alignment mechanism
o Agency theory: process surrounding recognition of principal-agent
problems and ways to align the actions of agents with the interests of the
principals