l-la Finance vs. Economics and Accounting Finance grew out of economics and accounting. Economists - asset value is based on the future cash flows the asset will provide Accountants - provided information regarding the likely size of cash flows 1-1b Finance within an Organization BOD - top governing body CEO - chairperson of the board; highest-ranking individual COO - firm's president; directs the firm's operations (marketing, manufacturing, sales, human resources, and other operatin g depB.(cnicf Ope.ral,ng ey'fiZcr) CFO - senior VP; 3rd ranking officer; in charge of accounting, financing, credit policy, decisions regarding asset acquisitions and investor relations-communication with stockholders and press. (C n ;c1 7, rcnci a r e fJl' 6c r) .Sarbanes-Qxley Act - law passed by congress that l CFo requires the CEO to certify that their firm's financial statements i are accurate I - I c Corporate Finance, Capital Markets and Investments 1. t (Corporate Finance) assets to acquire - how to needed to buy assets - how to run the firm so as to maximize its value 2 tg - dcatg ut/ ttcttnAes nerkclT r fhan " ia t 1ag5?v' tt'on5 are y'financial institutions that supply capital to business include a number of activities: A) Security Analysis - frnding the proper values of individual securities .-2) Portfulio Theory - best way to structure portfolio of stock and bonds 4) Market Analysis - issue whether stock and bond markets at any given time are "too high", "too low" or "about right" e - investor psychology is examined in an effort to determine if stock prices have been bid up to unreasonable heights in a speculative bubble or driven down to unreasonable lows in a fit of irational pessimism. 1-2 Jobs in Finance .Value-based management - management decisions are evaluated in terms of their effects on the firm's value .Defined contribution pension plans - each year the company puts a specified amount of money into an account that belongs to the employee the employee must decide how those funds are to be invested l-3 Forms of Business Organization l) Proprietorship - an unincorporated business owned by one individual few government regulation bject to lower income taxes than a corporation Disadvantages: unlimited personal liabili mited life, dfficult to raise capital 2) Partnership - an unincorporated business owned by two or more persons tablished relatively easy and inexpensively come allocated on a pro rata basis to the partners ed on an individual basis 4rnl im it e d p ers o n al I i abil ity 4fficulty to raise large amounls of capital 3) Corporation - a legal entity created by stat arale and bject to double taxalion-eamings are taxed and then when its after tax eamings are paid out as dividends, those earnings are taxed again as personal income. (C Corporation) proprietorship/partnership rather than a corporation. 4) Limited Liability Company (LLC) - relatively new tlpe of 5-4 The Stock Market ean - two leaders of stock markets 5-4a Physical Location Stock Exchanges .Ph1'sical Location Exchanges - formal organizations having tangible physical locations that conduct auction markets in desi*srated (lined) securities. 5-lb Orer-the-Counter and the \a:daq Stock llarkets .Over-the-Counter \larket - 3large collection of brokers and dealers. connecld elecronicallv by telephones and computers that prorrds tbr trading in unlised securities. .Dealer illarket - includes all tacrlrues rhat are needed to conduct secuntr transaclrons nol condus-ted on the physical I ocation exchanges. The dealer market svstem consr*s of: llrelativell fet dealers rho hold tn\en:oncs o.irhese seatrities and tho are said to 'mai.e a dart:c:' tn these secltnttes; thousands of brokers t ho act os agerJs n bnnging the dealers together xiIfr inrastor-; and onputers, terntitwls ond clec:arac ne:rorks thot protide o conntuntcdtion ltnJ;.:v.-,rfcn Je;r'ers end brokers- - Bid price - price aI s hrch ther srl t-!:r lhe 5aock - Ask price - price at s hich they urll 31es - Bid-ask spread - difference berueen brd and ask prices, . IIACD- represents the dealer's markup or prol'il Nah'ota|tl<.oc.o{ eatl'/ie9 DcaletT - *{-y7,uQ -dY e/ arrT rrar*.l 5-5 The Market for Common Stock losely Held Corporation (Priretell Orrned) - owned by a few individuals sho are assrxiared *ith the firm's management. (Closely Held Srockt blicly Owned Corporation - o*ned b1 relatively large number of indi"'iduals sho are not acri\el) involved in the firm's management (Pubticli Held Stock) 5-5a Types of Stock Market Transactions 1. s of established publicll owned com.panies that ore troded : secondarl' market 2. sold b1 established publicly ow'ned co m pa nies' primarl, market 3. Initial public offerings made by privately heldf rms: IPO market Going Public - act of selling stock to the public at large by a closely held corporation or its principal stockholders Stock Markets and Returns +There are generally large differences between expected and realized prices and returns. 5-6a Stock Market Reporting +Up until a few years ago, the best source {tto.t quotations was the business section of daily newspapers one problem is that they report yesterday's prices. Now it is possible to obtain real-time quotes through the Internet. Stock Market Efficiency Market Price - current price of stock Intrinsic value price at which the stock would sell if all investors had all knowable information about a stock Equilibrium price - price that balances buy and sell orders at any given time Efficient market - prices are close to intrinsic values and stocks seem to be in equilibrium /oln'ns ic t/alqo 6ased : 1. ;rt uEh $rocL ie n c?ui/ibn'oqn'. bamcc available < caueet +he- pn'c?- hthcn ma*.k aE efr'ciehf: ihue*tors utn buy f .sctl .sfocks r b?- conf'dcn+ +ha, 4ltcyare 3et+in3 ?ood pn'c,es Uhen ta*clc ar< )ne6a'enl: inves+o4 mqy b"- to ih.res+ ! fioy F.r+ ++a'r money "urrdcr l{r.e piltorrt", u/c @;l /cad /o a pcor allo26ts'9n 4 ?;tot i eonornic ,*?narr.an 5-6 5-7 Clrzrpter 5 Financial llarkcts and lnstitutions 5-1 l'he Capital Allocation Process Capital Formation Process l) Direct Transfers - business sells its socks or bonds directlv to savers. 2) Indirect Transfers through Investment Bankers - sells these same securities to savers. Underwriter - serves as a middleman and faci litates the issuance of securities Primary market transaction - new securities are involved and the corporation receives the proceeds ofthe sale 3) [ndirect Transfers through a Financial lntermediary - intermediary obtains from savers in sec rLl it i es. markets Ph;,sical asset markets (tangible/real asset markets) - products such as wheat, autos, real estate, computers and mach inery. z.Financial asset markets - stocks. bonds, notes and mortgages, and derivative securities - values are Cerived from changes in the prices ofassets. Spot markets yersus future ntarkets. Spot markets - assets are bought or sold for "on the spot" delivery. y'Future markets - participants agree loday to buy or sell an asset at some future date. Money ntorkels uersro capital markets oney nrarkets - short -term. highly liquid debt securities. apital markets - intermediate or long term debt and corporate stocks. Primary markets versus secondary markets rimary markets - corporation raise new capital. econdary markets - existing, already outstanding securilies are traded among investors. Private markets versus public markets rivate markets - transactions are negotiates directl y between parties. ublic Markets - standardized contracts are traded on organized exchanges. 5-3 Financial Institutions Investment banks - an organization that underwrites and disributes new investment securities and helps businesses obtain fi nancing. Commercial banks - traditional department store of finance serving a variety ofsavers and borrowers. .4. Financial services corporation - firm that offers a wide range of financial services, including investment banking, brokerage operations, insurance, and I banY.tng.- 1ar1e callom iy, unions - cooperative members are supposed to have a common bond. Pension funds - retirement plans funded by corporations or govemment agencies for their workers and administered primarily by the trust departments of commercial banks or by life insurance companies. K. tite insurance companics - take savings in the form of annual premiums. invest these funds in stocks, bonds, real estate and mortgages; and make payments to the benefi ciaries of the insured parties. s(, Matual funds - organizations that pool investor funds to purchase hnancial instruments and thus reduce risks funds often operated by mutual fund companies. 4 Hedge funds - similar to mutual funds, they accept money from savers and use the funds to buy various securities; largely unregulated in contrast with nruttral funds which are registered and legulated by SEC. Private equity companies - operate much like hedge funds; but rather than buying some of the stock of a firm, private equity players buy and then manage entire firms. the safety ofthese institutions and protect investors. organization that is a hybrid bet a partnershrp and a corporation Limited Liability Partnership (LLP) - similar to an LLC but used for professional firms; .gp1pg;ation but 1-4 Stock Prices and Shareholder Value Primary Goal of the Mgmt. - shareholder wealth maximization .Shareholder wealth maximization - the primary goal for managers of publicly owned companies implies that decisions should be made to maximize the long-run value of the firm's common slock mottira;zt'ng ihe Prr'ca orr /-he 7'inni ammon s'toc't 1-5 Intrinsic Values, Stock Prices and Executive Compensation Determinants of Intrinsic Value and Stock Prices Managerial Actions, Economy, Taxes, and Political Conditions - determine stock prices thus investors' returns *investors like high returns but dislike risk so the larger the expected profits and the lower the perceived risk th ue Expected Returns and True Risk - investor *,ould expect if they had a . that existed about the company rceived Returns snd Perceived Risk - what investors expect given th . they actually have trinsic Value - an estimate of a stock's true value based on accurate risk rlcet Price - the stock value based on perceived but possibly incorrect info. as seen by the marginal investor ' Marginal investor - views determine the actual stock price rlcet Equilibrium - Intrinsic Value : Stock Price ftgml.'c qoa/ sfioutd te lo -pke acfr'ons ol.ct?hcd 4c tay,^r'ra thc .frm C e. trol ;lt cut ct / /re)el Vrr< 5 1-6 Important Business Trends arbanes-Oxley D// - requires the CEO and CFO of a firm to certify that the firm's financial statements are accurate. en Increased globalization of business. y?J Ev er- improvin g info rm ation t echno lo gy. rporate governance - way the top managers operate and interface with stockholders 1-7 Business Ethics ol-... 1-8a Managers versus Stockholders Useful motivational tools to motivate managers to act in their shareholder's best interest: Compensation packages - should be suffrcient to attract and retain able managers, should not go beyond u'hat is needed; managers rewarded on the basis of the stock's performance over the long run. g of managers who don't perform u,ell - stockholders can inten'ene directly with managers Threat of hostile tqkeovers .Corporate Raider - an individual who targets a corporation for takeover because it is undervalued .Ilostile Takeover - the acquisition of a company over the opposition of the management I -8b Stockholders versus Bondholders regardless of how well the company does while stockholders do better when the company does better 2) The use ofadditional debt lAqcY RCloftsnsfitp aD oa<lnorc indieituals (pnnc;pats) sirc al / ctX. 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