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Financial Management

by: Meghan O'Connor

Financial Management BUAD 323

Meghan O'Connor

GPA 3.33

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About this Document

Chapters 1&2 Tested on the first exam
Financial Management
Dr. Claire Cici
Class Notes
financial, market, Intermidiary, institution
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This 5 page Class Notes was uploaded by Meghan O'Connor on Tuesday September 27, 2016. The Class Notes belongs to BUAD 323 at College of William and Mary taught by Dr. Claire Cici in Fall 2016. Since its upload, it has received 4 views. For similar materials see Financial Management in Business at College of William and Mary.


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Date Created: 09/27/16
Types of Businesses  Sole proprietorships o Advantages  Keep all profits  Easily established  Few governmental regulations o Disadvantages  Unlimited liability  Difficult to raise funds  Difficult transfer of ownership  Partnerships o Advantages  Easy to establish  Share all profits  Owners make decisions  Fewer maintenance costs than corporations o Disadvantages  Unlimited liability  Difficult to raise funds  Difficulty when one partner leaves  Corporations o Advantages  Limited liability  Easy transfer of ownership  Easy to raise capital  Permanence  Separation of ownership and management o Disadvantages  Double taxation  Difficult to establish  Many governmental regulations  Separation of ownership and management  Hybrids o Limited partnerships  General partners manage business under unlimited liability  Limited partners have limited liability and little management o Limited Liability partnerships (LLPs)  Partnerships in which all partners have limited liability  Tax advantage of partnership  Limited liability of corporation  All partners manage firm o Professional Corporation  All partners have limited liability except in the area of malpractice Separations of Owners and Managers  Agency relationship: a contract under which one or more principals engage the agent to perform some service on their behalf which involves delegation some decision making authority to the agent  Agency costs o The agent may not always have the same goal as the principal o Ex: real estate buyer  Align interests of shareholders and financial managers through: o Rules and regulations o Compensation plans o Board of directors o Takeovers o Auditors o Other gatekeepers (security analysts, bankers, rating agencies) o Labor market Financial Managers  Goal of the Corporation = Maximize shareholder wealth o Through maximizing the current market value of the shareholders investment in the firm  Financial manager maximizes share value o Shareholders can individually decide how to use the increased wealth: cash out or remain invested o This is not the same as…  Maximizing year's profits  Temporarily eliminating dividends  Contrived accounting profits  Financial manager should not… o Engage in "white collar crime" o Exploit workers  Ex: fashion industry o A firm's reputation means a lot  Mylan pharmaceuticals - EpiPen pricing  Ralph Lauren & speedo - dropping Ryan Lochte  Financial Manager is anyone responsible for a significant corporate investment or financial decision o Treasurer (CFA): responsible for obtaining and managing the company's capital  Manages banking relationships, employee pension funds, and cash o Controller (CPA): checks that money is being used efficiently  Preparation of financial statements, internal auditing to make sure employees aren't robbing the company blind, payroll, taxes o Chief Financial Officer: oversees the treasurer and controller and sets overall financial strategy  In a large firm oversees treasurer and controller, in a small firm her may absorb those job responsibilities  Role of financial manager = risk manager Financial Manager Short term Long term  Investment/Capital Budgeting Decisions o How should a firm spend its money o What investments should the firm make  Tangible and intangible o What real assets should the firm acquire and what resulting cash flows would come in  Financing Decisions o How should the firm pay for an investment o Which financial assets should the firm issue o What are the payment timelines Real vs. Financial Assets  Real assets are used to produce goods and services o Tangible ex: machinery o Intangible ex: expertise  Financial assets are claims to income generated by real assets o Also called securities o Stocks and bonds Cost of Capital Minimum acceptable rate of return on a capital investment  Summary 1 Cash raised from investors 2 Cash invested in firm 3 Cash generated by operations 4 Cash reinvested 5 Cash returned to investors Financial Markets  Markets where securities (financial assets) are issued and traded  Equity Market = stocks o Stock: units "shares" of ownership of a corporation o Primary Market: for the sale of new securities by corporations (IPOs)  Money flows from investors to corporation o Secondary Market: for the trading of previously issued securities  Money flows from investors to other investors  Ex: exchanges (NYSE) or over the counter (NASDAQ)  Spot Markets: items delivered now  Futures Markets: contact due o Ex: currency, crops, oil o Actual contract has value  Money markets: securities with maturity less than one year o Treasury bills, federal funds, commercial paper  Capital markets: capital assets o Bonds with maturity more than one year, preferred stock, common stock Debt Instruments  Bonds: investors lend money to a firm o Firm makes periodic interest payments o Lump sum of debt is paid to the investor at the end of the predetermined investment period o Maturity = payback date o Face value = lump sum o Some binds can be "called" by the firm  Prematurely repaid Debt Market  Most debt is traded on a network of banks and securities dealers OTC but not NASDAQ  Fixed income market = market through which debt is traded  Commercial paper is a debt issue with maturity up to 270 days Financial Intermediaries  Organizations that raise funds from investors and provide financing for individuals, companies, and other organizations  Mutual funds o Raise funds by selling shares to investors o Pool investor funds then invest in a portfolio of securities o Take a fee for managing money and split the returns among shares o Investors can buy and sell shares easily through mutual fund company o Money flows from investor to fund to financial markets o Shares flow from financial markets to fund to investors  Hedge Funds o Pool investor finds then invest and share after cost returns o More opaque than mutual funds o May employ riskier investment strategies o Require larger investments  Exchange Traded Funds (ETFs) o As transparent ad mutual funds o Investors buy and sell shares on the market  Sell between each other, don’t have to sit on cash  Minimizes liquidity issues for fund  Pension Fund o Investment plan established by an employer to provide for employees' retirement o All employee contributions are pooled and then investment manager buys securities o Return is split according to individual contribution o Finds remain invested until retirement, rarely cashed out o Tax deductible contributions Financial Institutions  Intermediaries that do more than just pool and invest savings  Banks, insurance companies  Investment banks Function of Financial Markets and Intermediaries  Channel savings to real investment  Transport purchasing power forward o Take out a loan now and pay later  Transport purchasing power backward o Save money now and have more later  Provide liquidity o The ability to sell or exchange an asset for cash on short notice  Payment methods: credit cards, checking accounts  Reduce risk via insurance or hedging  Constant security valuation = constant company valuation Interest Rates  Factors that influence interest rates o Production opportunities - higher production opportunities lead to higher interest rates since the demand for money is higher o Time preference for consumption - today and tomorrow's money tradeof  Higher value for today's money leads to higher interest rates o Risk - higher risk leads to higher interest rates o Expected inflation - higher expected inflation leads to higher interest rates  Inflation premium: what investors demand as compensation for the loss of a dollar's purchasing power over time  Components of the interest rate o Real risk-free interest rate - r* o Inflation premium - IP o Nominal risk-free rate - RF=r*+IP o Default risk premium - DRP o Liquidity preium - LP o Maturity risk premium - MRP o r=r∗+IP+DRP+LP+MRP o Term structure: they yield curve on a given date  Relationship between years to maturity and interest rates  Upward slope = long term interest rates are higher than short term  Downward slope = long term interest rates are lower and short term


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