Chapter 1 Book & Class Notes
Chapter 1 Book & Class Notes Fin 301
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This 7 page Class Notes was uploaded by David Kavalerchik on Wednesday January 27, 2016. The Class Notes belongs to Fin 301 at University of Illinois at Chicago taught by Ozgur Arslan Ayaydin in Spring 2016. Since its upload, it has received 42 views. For similar materials see Intro to Finance in Finance at University of Illinois at Chicago.
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Date Created: 01/27/16
http://www.investopedia.com/ The value of a company depends on the present value of ll the future cash flows of its economic life. Fin management aims to give the tools to create and preserve value. Four Financial Areas: 1. Corporate (managerial) What type of decisions should we make to maximize the wealth of our shareholders? 2 decisions (2 steps) that make direct impacts to shareholder wealth. Capital budgeting: Which investment project should we choose? Giving the best investment option. How to finance that investment option: 2 ways to finance a project > through equity and/or debt. Capital Structure the way a company finances its business activities. Usually a mix of bonds (debts) and stocks (equity). 2. Investments Activities centering on the buying and selling of assets, both real and financial. Finding the correct pricing of real and financial assets. Financial assets entitle their holders to have a claim on the income generated by the real assets. Real Assets: physical assets such as property, buildings and commodities including corn, oil and gold. Financial Assets: intangible assets such as stocks and bonds. It’s concerned with the accurate pricing of these assets, the process of buying and selling them and the rules/ regulations that govern the players in these transactions 3. Fin Institutions and Markets The organized financial intermediaries that promote the cycle of money. Examples include banks, insurance companies, foreign exchanges and more. 4. International Deals with the addition of multinational aspects of the finance activities and the situations that arise with it. Financial Markets They are the forums in which buyers and sellers of financial assets like stocks and bonds and commodities meet. Can be both physical and virtual. There are 4 ways to classify financial markets. 1. by type of asset traded Stock bought/sold Equity Market bonds bought/sold Debt Market future contracts/commodities + options on equities,futures or currencies bought/sold Derivative Market (called that b/c the values are derived from their underlined assets) Forward contracts > an informal agreement to buy and sell specific assets (typically currency) at a specified price at a certain future date. Example US company buys machine from Germany, agrees to pay 1,000,000 euros in 6 months. Risk comes with inflation, exchange rate might change against your favor. To protect against that risk; fix the exchange rate that will be applicable with a 3rd party company in those 6 months. Video: https://www.khanacademy.org/economicsfinancedomain/core finance/derivativesecurities/forwardfuturescontracts/v/forwardcontract introduction Options > 2 types; Call Options & Put Options Call Option An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument at a specified price within a specific time period. Video: https://www.khanacademy.org/economicsfinancedomain/core finance/derivativesecurities/putcalloptions/v/americancalloptions Put Option An option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time. This is the opposite of a call option, which gives the holder the right to buy shares. Video: https://www.khanacademy.org/economicsfinancedomain/core finance/derivativesecurities/putcalloptions/v/americanputoptions 2. by the maturity of the assets Maturity means the length of time the borrower has to pay back the borrowed funds. Investors buy/sell financial assets that will mature within the year (aka short term loans) in money markets. Example: Treasury Bills (TBills) Financial assets that have maturities over a year (long term loans) transact in capital markets. Example: Treasury Notes > 1 year and less than or equal to 10 years. Treasury Bonds greater than 10 years Short Money Long Capital 3. by the owner of the assets When an IPO happens the proceeds go to the company, this sale takes place in the Primary (first) Market. SEC regulates this. After initial IPO, when initial buyer chooses to resell the asset to another party this transaction takes place in the Secondary Market. Also regulated by the SEC. *Private Placement > The sale of securities to a relatively small number of select investors as a way of raising capital. These select investors are way more sophisticated and smarter than the average investor. Because they are so smart, they don’t need the SEC’s rules to protect them. Not registered with SEC. Video: http://www.investopedia.com/terms/p/privateplacement.asp 4. by the method of sale Dealer market: individual or firm buys/sells securities (stocks/bonds) out of their own inventory. (Think usedcar dealership). Dealer makes money by purchasing asset at one price and selling it at a higher price later. Auction market: Many security sell at the same time to many buyers. The auctioneers, usually investment banks, receiving percentage of the sales as compensation for conducting the sale. A market in which buyers enter competitive bids and sellers enter competitive offers at the same time. The price a stock is traded represents the highest price that a buyer is willing to pay and the lowest price that a seller is willing to sell at. Matching bids and offers are then paired together and the orders are executed. Broker market: Brings together the buyers and sellers. Brokers do not buy the asset. Chief Financial Officer (CFO) Oversees all the company's financial activities, such as determining the best repayment structure for borrowed funds, which ensures that the company meets its debt obligations in a timely fashion and still has sufficient cash for its daily operations. Financial Management Divided into 3 Main Categories 1. Capital Budgeting: The process of planning evaluating, comparing and selecting the longterm operating projects of the company. What business should we be in over the longterm? 2. Capital Structure: The means by which a company finances its business activities. For public companies this would usually be a mix of bonds (debt) and stocks (equity) sold to investors and owners. Where do we raise the money to conduct our business activities? 3. Working Capital Management: The process of managing daytoday operating needs of the company through its current assets and current liabilities. This is also referred to as shortterm financing activities. Profit Maximization: Can be done but is always a trade off; increase this year’s profits at the expense of future years’ profits by avoiding routine maintenance. It will also potentially add greater costs in future years because postponed maintenance costs are often greater than current maintenance costs. reducing inventories which avoids restocking costs but runs the risk of losing sales/profits by not having product available for customers to purchase. Maximizing Current Stock Price: for a public company the primary objective of the finance manager is to maximize the current stock price of the firm. Stock prices reflect future cash flow, the goal is to increase future cash flow by; maintaining a safe and enjoyable workplace which attracts and retains good employees. Good employees add value to the product/service. work closely with customers to ensure that the products or services are meeting their needs establish good working relationships with suppliers so that the company receives quality materials in a timely fashion must take into account the effect on the environment Maximizing Equity Value: Equity Value is its value to the owners. Equity Value for public company is the stock value. Equity Value for a private company is market value of the company’s assets minus the claims against the company (the liabilities) Goal of a finance manager is to maintain or increase the wealth of the company’s owners. Internal Players: Managers + employees. External Players: the people outside the company who contribute to its success, such as customers and suppliers Legal Forms of Business Sole Proprietorship a business owned entirely by an individual. Least complicated, regulated, least amount of paperwork. Advantages; owner makes all decisions, doesn’t have to consult with partners, keeps all profits. Disadvantages; owner pays all bills, blends company and personal assets. Partnership business owned jointly by 2+ individuals. Types of Partnerships: General: operate daily business Limited: participate only in certain aspects Silent: participate only as investors Disadvantages of the partnership are the potential difficulty of transferring ownership from one partner to a new partner and the survival of the business when one partner dies. Both the sole proprietorship and the partnership have three things in common: 1. Unlimited liability of the owners 2. Limited life of the business 3. Potential difficulty in transferring the ownership of the business Corporations a legal entity separate from its owners, meaning that it can enter into contracts, can sue or be sued, and pays taxes. The key advantage of the corporate organization is that the shareholders or owners have limited liability. Corporation is a legal entity, distinct from the owners, so the personal assets of the owners are separate from those of the company. Hybrid Corporations LLC: hybrid of partnerships and corporations. Popular form of LLC is a professional corporation (PC), which joins together licensed professionals such as doctors, lawyers, accountants, engineers, or architects. The main advantage of a PC is that the owners (licensed partners) in the PC are not personally liable for the malpractice of their partners. NotForProfit ____________________________________________________________________________ The Agency Model Principles owners of the business Agents company managers We call the problem of motivating one party (the agents, or the managers in this setting) to act in the best interest of another party (the principals, or the owners in this setting) the principal agent problem. Agency Cost Any time you pay a cost to an agent acting on behalf of a principal for a service not rendered. Stock Option The right to buy the company stock at a preset price some time in the future. Because the purchase price of the stock is preset, the value of the option increases when the stock price rises. Therefore, the manager has an incentive to increase the current share price of the firm and increase his or her personal compensation. ____________________________________________________________________________ Class Notes 1/22/16 Px = DIV/(KG) Constant Dividend Growth Model
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