An Introduction to Financial
Management
Goal of the Firm
1) Profit Maximization?
this goal ignores:
a) TIMING of Returns
(Time Value of Money )
b) UNCERTAINTY of Returns
(Risk )
Goal of the Firm
2) Shareholder Wealth
Maximization?
this is the same as:
a) Maximizing Firm Value
b) Maximizing Stock Price
Legal Forms of Business
1) Sole Proprietorship
• A business owned by a single individual.
• Owner maintains title to the firm’s assets.
• Owner has unlimited liability.
2) Partnership
• Similar to a sole proprietorship, except
that there are two or more owners.
Legal Forms of Business
2a) General Partnership
• All partners have unlimited liability.
2b) Limited Partnership
• Consists of one or more general partners,
who have unlimited liability, and
• One or more limited partners (investors)
whose liability is limited to the amount of
their investment in the business.
Legal Forms of Business
3) Corporation
• A business entity that legally functions
separate and apart from its owners.
• Owners’ liability is limited to the amount
of their investment in the firm.
• Owners hold common stock certificates,
and ownership can be transferred by
selling the certificates.
The Corporation and Financial
Markets
cash
Corporation
Investors
securities
reinvest
Cash flow
dividends,
etc.
tax
Government
Secondary
markets
CONCEPT OF INVESTMENT
• Concept of Investment
• Today’s sacrifice
• Time value
• Prospective Gain
• Financial Investment
• Extent of liability
• Uncertainty
• Impact of time and risk
Varieties of Securities
• The financial stakes represented by securities are stakes
in some
– Business
– Government
– other legal entity
Constituents of a financial system
Financial System
Financial
Financial
Financial
assets
markets
intermediaries
Forex
market
Capital
market
Money
market
Primary
market
Secondary
market
Credit
market
Investment alternatives
Financial assets
Direct investing
indirect investing
Mutual
funds
Non marketable
Money market
Closed end
funds
Capital market
Unit investment
assets
Derivative
securities
Treasury bills
Fixed income
common Stock Corporate Futures
Negotiable CDs
stock
option created
Commercial paper Treasuries
Repurchase
Federal agencies
convertibles
agreement
Municipals
warrants
Bankers acceptance Corporates
Calls
Foreign securities
Foreign
Puts
Mortgage pass throughs
Preferred Stock
Characteristics of the financial markets
Market
Money Market
Purpose
Short-term
finance
Players
Banks, Govt.,
FIs,MFs,
Regulator
Central
Bank
Capital Market
Long-term
finance
Eg.,SEC,
Companies,
Banks,FIs,MFs, SEBI
individuals
Forex Market
Foreign
Currency
finance
Short/long
Term finance
Banks,
companies,
Forex dealers
Banks, FIs
Credit Market
Central
Bank
Central
Bank
Intermediaries operating in financial markets
Intermediary
Market
Role
Stock exchange
Capital market
Secondary market for
securities
Investment bankers
Capital market,
credit market
Corporate advisory
services/Issue of securities
Underwriters
Capital market,
money market
Subscribe to unsubscribed
portion of securities
Registrars, depositories
Capital market
Issue securities to the
investors on behalf of the
issuer and handle share
transfer activity
Primary and secondary dealers
Money market
Market making in
government securities
Forex dealers
Forex market
Facilitate exchange in
currencies
Primary and secondary markets
Primary market
Market in which investors buy newly issued securities
and issuers of securities receive the proceeds from
the sale.
Secondary market
Market where previously issued securities are traded
among the investors.
Money Market
• Market Characteristics
– Wholesale debt market
– Market for low risk, highly liquid, short term
instruments
– Funds can be raised in this market for periods ranging
from one day to one year
• Players in the market
– Government – the biggest borrower
– Banks
– Financial Institutions
– Corporations
– Mutual funds
– Market makers
Money Markets
• Government & Quasi-Government securities
– Treasury bills, notes and bonds
– Municipal Notes
• Banking sector securities
– Call money
– interbank funds
– Negotiable Certificates of Deposit
– Bankers Acceptance
• Corporate sector securities
– Commercial paper
The Capital Market
• Market for financing long term investments
• Basic instruments for raising finance are shares of
stock (equity) and bonds
• Issues are sold to the investing public in the
primary market, through investment bankersfirms that originate, bear the risk of and distribute
non-government security issues.
• Stocks and bonds issued in the primary market
are traded in the secondary market.
The issuance process for new securities in the primary market
Issuer
Originating invt. banks
Underwriting syndicate of investment banks
Selling group
composed of
Underwriting syndicate plus any selected retail brokerage houses
Investors
SECONDARY MARKET TRANSACTION
HOW A TRADE IS MADE
Seller
Buyer
Broker
endorses
order &
returns
to firm
Broking
Firm
Broker
endorses
order &
returns
to firm
Broking
Firm
Order
Order
Floor
Broker
Bid/Ask
Trade
Floor
Broker
Execution
Broking firm
Trade confirmation/
Settlement
Clearing
House/Depository
Trade confirmation/
Settlement
Secondary Markets
Types of securities
Where traded
Equity markets (common stock,
preferred stock, rights & warrants)
Organized exchanges - NSE, BSE,
Regional exchanges
Over the Counter
Third market, fourth market
Bond Markets
(Treasuries, agencies,
municipals, corporates)
Derivatives
(Options & Futures)
Over-the-counter
NYSE & ASE (a relatively small amount)
Organized exchanges
Chicago Board Options Exchange
American Stock Exchange
Pacific Stock Exchange
Philadelphia Stock Exchange,NYSE
Financial Management Axioms
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1) Risk - return trade-off
2) Time value of money
3) Cash - not profits - is king
4) Incremental cash flows count
5) The curse of competitive markets
6) Efficient capital markets
7) The agency problem
8) Taxes bias business decisions
9) All risk is not equal
10) Ethical dilemmas are everywhere in finance