NOTES

Financial Management is an applied economics, which is concerned

with the allocation of a companys scarce financial resources among
competing choices.
Fundamental Financial Management Decision: The decision function
of financial management can be broken down into three major areas: the
investment, financing, and asset management decisions.
Investment Decision: The selection of assets to be held by the firm as it
attempts to generate future cash flows called investment decision. This
decision gives us the answer of what asset should the firm own?
Financing Decision: Once the firm has committed itself to new
investments, it must decide how to finance them. A large portion of these
financing needs will be predictable as the firm replaces old assets with
new ones and implements previously established investment plans.
Asset Management Decisions: The acquired assets must be managed
efficiently and for this, the financial manager is charged with varying
degrees of operating responsibility over existing assets. These
responsibilities require that the financial manager be more concerned with
the management of current assets than with that of fixed assets.
Goal of the firm: Stockholders wealth maximization is the firms
ultimate goal not to increase the firms profit.
Stockholders
wealth
maximization means to maximize the current market price of the stock.
Agency Problem is the potential conflict between shareholders
(principals) and managers (agents). It occurs when stockholders employ
other individuals to act on their behalf.
Monitoring Costs is the costs shareholders incur to ensure that
managers act in their best interests.
Agency Costs is the set of costs that arises when an agent is designated
to act in the best interests of a principal and whose own interest may
conflict with that of the principal.
Risk Averse:

Basic Concept: Money has a time value because of the opportunity to

invest it at some rate of return, and cash flows received in the future are
not as valuable as cash flows received today.
Present value is the current value of a future amount of money, or a
series of payments, evaluated at a given interest rate.
Future value (terminal value) is the amount to which one or more
payment will grow when compounded at a stated rate for a stated period.
Interest is the money paid or earned for the use of money.
Simple interest is interest paid or earned on only the original amount, or
principal, borrowed or lent.
Compound Interest is interest paid or earned on any previous interest
earned as well as on the principal borrowed or lent.
Discount rate (capitalization rate) is the interest rate used to convert
future values to present values.
Compounding is the mathematical process of computing the final value
of one or more payments when compound interest is involved.
Annuity is a series of equal payments or receipts of a specified amount
for a specified period.
Ordinary (deferred) annuity is an annuity whose first payment is to be
received one period from now that is at the end of the period.
Annuity Due is an annuity whose first payment is immediate rather than
one period from now.
Future Value of an annuity is the amount of equal payments for a
specified period when compound interest is involved.
Perpetuity is an ordinary annuity whose payments or receipts continue
forever.
Nominal (stated) interest rate is a rate of interest quoted for a year
that has not been adjusted for frequency of compounding.
Effective annual interest rate is the actual rate of interest earned or
paid after adjusting the nominal rate for factors such as the number of
compounding periods per year.

Amortization schedule is a table showing the repayment schedule of

interest and principal necessary to pay off a loan by maturity.