brooks pp ch 1 rtp

7/30/2019 Brooks Pp Ch 1 Rtp

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1. Describe the cycle of money, the participants in thecycle, and the common objective of borrowing andlending.

2. Distinguish the four main areas of finance and brieflyexplain the financial activities that each encompasses.

3. Explain the different ways of classifying financialmarkets.

4. Discuss the three main categories of financialmanagement.

LEARNING OBJECTIVES


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LEARNING OBJECTIVES5. Identify the main objective of the finance manager and how

that objective might be achieved.

6. Explain how the finance manager interacts with both

internal and external players.

7. Delineate the three main types of business organizationsand their respective advantages and disadvantages.

8. Illustrate agency theory and the principal-agent problem.

9. Review issues in corporate governance and business ethics.


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Definition of Finance

Finance is the art and science of managing wealth.

It is about making decisions regarding what assets tobuy/sell and when to buy/sell these assets.

Its main objective is to make individuals and theirbusinesses better off.


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Definition of Financial Management Financial management is generally defined as those

activities that create or preserve the economic value of

the assets of an individual, small business, orcorporation.

Financial management comes down to making soundfinancial decisions.


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1.1 The Financial Intermediary Function

Financial intermediaries assist in the movement of

money from lenders to borrowers and back again.

This process is termed the cycle of moneyand its mainobjective is to make all the participants better off


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1.1 The Cycle of Money The movement of money from lender to borrower and back to

lender from borrower (see page 4 of textbook)

Example: A mutual fund issues shares, which are bought by

individuals The pooled funds are invested by the mutual fund company in shares

that are issued by firms

The firms pay dividends periodically, which are received by the mutualfund and passed through to their shareholders, or reinvested inadditional shares, and the cycle of money starts again. The mutual fund managers earn fees The firms whose securities are bought are able to raise capital for

growth and future returns The mutual fund shareholders earn dividends and capital gains

Thus, all participants are generally better off.


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1.2 Overview of Finance AreasFourmain interconnected and interrelatedareas:

Corporate Finance Investments

Financial Institutions and Markets

International Finance


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1.3 The Financial Markets Forums where buyers and sellers of financial

assets and commodities meet.

Financial markets can be classified by: The Type of Asset Traded The Maturity of the Financial Asset

moneymarket capital market

TheOwner of the Financial Asset primary market secondary market

TheNature of the Transaction dealer markets auction markets


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1.4 The Finance Manager and

Financial Management

The Finance Manager

Determines the best repayment structure forborrowed funds

Ensures that debt obligations are met on time

Ensures that sufficient funds are available forcarrying out daily operations


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1.4 The Finance Manager and

Financial Management

Financial management involves three main

functions:

Capital Budgeting

Capital Structure

Working Capital Management


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1.5 Objective of the Finance ManagerTo make investment and financing decisions that

increase the cash flow of the firm, therebymaximizing the current stock price

Profit maximizationvs.

Stock price maximization

Why are they not the same? Which one is more important?


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1.6 Internal and External Players Financial managers have to interact withvarious internal and external stakeholders

Internal players include all the departmentalmanagers and other employees

External parties include:

Customers Suppliers

Government

Creditors


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1.7 The Legal Forms of BusinessThere are three main legal categories of business

organizations: Sole proprietorship

Partnership Corporation

Besides these three main forms, some other forms of

business organizations include: Hybrid Corporations Not-for-Profit Corporations


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1.7 The Legal Forms of Business

Sole Proprietorship

Advantages1. Simplest and easiest form of business2. Least amount of legal documentation3. Least regulated4. Owner keeps all profits

Disadvantages

1. Owner pays personal tax rate on profits2. Obligations of the business are sole responsibility of owner,and personal assets may be necessary to pay obligations(personal and business assets are commingled)

3. Business entity limited to life of owner4. Can have limited access to outside funding for the business


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Partnership Advantages

1. Agreements between partners may be easily formed

2. Involves more individuals as owners and therefore usuallymore expertise3. Larger amount of capital usually available to the business

(compared to proprietorship)

Disadvantages

1. Assets of general partners are commingled with assets ofthe business2. Profits treated as personal income for tax purposes3. Difficult to transfer ownership


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Corporation Advantages

1. Business is legal, separate entity from owners

2. Owners have limited liability to obligations of thebusiness3. Easy to transfer ownership4. Usually greater access to capital for business5. Owners do not have any personal liability for default

Disadvantages1. Most difficult business operation to form2. Double taxation of company profits3. Most regulated


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1.8 The Financial Management

Setting: The Agency ModelAgency relationship

Agency conflict

Why does it arise?

How can it be minimized?

Principal-agent problem

Agency theoryAgency costs


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1.9 Corporate Governance and

Business Ethics Corporate governance deals with.

how a company conducts its business and implementscontrols to ensure proper procedures and ethical behavior.

The Sarbanes-Oxley Act, enacted in 2002, requires that

The CEO and CFO attest to the fairness of the financialreports.

The company maintains an effective internal controlstructure around financial reporting.

The company and its auditors assess the effectiveness of thecontrols over the most recent fiscal year.


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1.10 Why Study Finance? Understand how andwhy financial decisions are

made in large and small companies

Helps individuals increase their own compensations

Improves contributions to the success of thecompanies that people work for

Understand the tradeoffs we face in making personalfinancial choices and help us to select the mostappropriate action

brooks pp ch 1 rtp

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