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FINANCIAL MANAGEMENTPart 1: An introduction to finance
Lecture 1: What is finance?
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Lecture 1: What is finance?
1.1. Introduction
1.2. Defining finance
1.3. The Firm: a sistemic approach
1.4. Corporate Finance: the financial function
1.5. The financial objective: value creation
1.6. Financial main principles
1.7. Finance: historic evolution
1.8. Main programmes in Finance
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Lecture 1: What is finance?
1.1. Introduction (1)
I am saving for retirement. Should I use a pension fund,mutual fund, direct stock market investment ?
I want that new car. Should I use my cash saving, lease,
borrow?Which is the best way to pay for my holidays, for myhouse?
Im thinking about starting a new business. Will it rewardme adequately?
Marocco has asked for major project financing.
Should my organization provide the funds?
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Lecture 1: What is finance?
1.1. Introduction (2)
Why study finance?
To manage your personal resources
To deal with the world of business
To pursue interesting and rewarding careeropportunities
To make informed public choices as a citizen
For the intellectual challenge
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Household
Business Firms
Government
Foreign Sector
Lecture 1: What is finance?
Introduction: Macroeconomic/Spending Sectors
SURPLUS SPENDINGUNITS
DEFICIT SPENDING
UNITS
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Has more cash income flow thanexpenditure on consumption and realinvestments in a period of time. The surplusis then allocated to the financial sector.
Other terms for surplus unit are saver,lender, buyer of financial assets, financialinvestor, supplier of loanable funds, buyer
of securities.
Lecture 1: What is finance?
1.1. Introduction: Surplus Spending Unit (1)
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The surplus unit may buy financial assets,hold more money, or pay off financialliabilities issued earlier when in a deficitsituation
The household and foreign sectors areusually a surplus sector
Lecture 1: What is finance?
1.1. Introduction: Surplus Spending Unit (2)
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Has more expenditures on consumption andreal goods (investment) in the real sectorthan income during a period of time
The deficit unit must participate (borrow) in
the financial sector to balance cash inflowswith outflows
Lecture 1: What is finance?
1.1. Introduction:Deficit Spending Unit (1)
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Other terms for deficit expending unit are
borrower, demander of loanable funds, andseller of securities.
The deficit spending unit may issue
financial liabilities, reduce money balances,and sell financial assets acquired previouslywhen in a surplus situation
Lecture 1: What is finance?
1.1. Introduction:Deficit Spending Unit (2)
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Contracts related to the transfer of funds from
surplus to deficit budget units Financial claims are also called financial assets and
liabilities, securities, loans, and financialinvestments.
For every financial asset, there is an offsettingfinancial liability.
Total receivable equal total payable in the financial system Loans outstanding match borrowers liabilities
Lecture 1: What is finance?
1.1. Introduction:Financial Claims (1)
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Financial markets offer opportunity for:
Financing for DSUs (primary)
Financial investing for SSUs (primary and
secondary) Providing liquidity via trading financial claims
in secondary markets
Lecture 1: What is finance?
1.1. Introduction:Financial Claims (2)
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THE FLOW OF FUNDS DIAGRAM
Deficit SpendingUnit (DSU)
Surplus SpendingUnit (SSU)
FundsFunds
Financial Assets = Financial Claims
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THE FLOW OF FUNDS DIAGRAM
Deficit SpendingUnit (DSU)
Surplus SpendingUnit (SSU)
FundsFunds
Financial Assets = Financial Claims
Borrowerdemander of loanable fundsseller of securities
Saver, lenderbuyer of financial assets
financial investorsupplier of loanable funds
buyer of securities.
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Assets: any possession that has value in an
exchange
tangible: value depends on particular physicalproperties (reproducible and non-reproducible)
intangible: legal claims to some future benefit.Financial assets
Lecture 1: What is finance?
1.1. Introduction:Real & Financial assets
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Main properties of financial assets
Rate of return (R): expected return
Risk (r): credit risk, market risk
Liquidity (L): how much sellers stand to lose ifthey wish to sell immediately against engaging ina costly and time-consuming search (J.Tobin)
Lecture 1: What is finance?
1.1. Introduction:Financial assets: main properties
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THE FLOW OF FUNDS DIAGRAM
DIRECT FINANCING (Markets)
Deficit SpendingUnit (DSU)
Surplus SpendingUnit (SSU)
INDIRECTFINANCIAL INVESTMENT
OR INTERMEDIATION FINANCING
BrokersDealers
Intermediaries
FundsFunds
Funds Funds
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THE FLOW OF FUNDS DIAGRAM
DIRECT
Deficit SpendingUnit (DSU)
Surplus SpendingUnit (SSU)
INDIRECT
BrokersDealers
Intermediaries
FundsFunds
Funds Funds
Direct Financial AssetsPurchase
Indirect Financial AssetsPurchase
Direct Financial AssetsIssue
Direct Financial AssetsIssue
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Lecture 1: What is finance?
1.2. Defining Finance
What is Finance?
Types of Finance definitions
Lack of any specific definition Raising and spending funds
Economic decisions with a time component Micro/Macro: need for integration
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Finance is analytical. Finance is based on economic principles. Finance uses accounting information as an
input for decision-making. Finance is international in perspective.
Finance is constantly changing. Finance is the study of how to invest and
raise money productively
Lecture 1: What is finance?
1.2. Defining Finance
http://garnet.acns.fsu.edu/~ppeters/fin3403/
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Finance is the study of how people allocate
scarce resources over time costs and benefits are distributed over time but the actual timing and size of future cash
flows are often known only probabilistically
Understanding finance helps you evaluatethese uncertain cash flows
Lecture 1: What is finance?
1.2. Defining Finance
Bodie and Merton
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When implementing decisions, people makeuse of the Financial System which can bedefined as the set of markets and otherinstitutions used for financial contracting and
exchange of assets and risks
Lecture 1: What is finance?
1.2. Defining Finance
Bodie and Merton
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Financial theory consists of: the set of concepts that help to organize ones
thinking about how to allocate resources overtime
the set of quantitative models used to helpevaluate alternatives, make decisions, andimplement them
These concepts and models apply at all levels andscales of decision making
Lecture 1: What is finance?
1.2. Defining Finance
Bodie and Merton
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A basic tenet of finance is that the existenceof economic organizations (e.g. firms andgovernments) facilitate the satisfaction of
peoples consumption preferences
Lecture 1: What is finance?
1.2. Defining Finance
Bodie and Merton
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Finance Theory is the study of the behaviour of
individuals in the intertemporal allocation (overtime) of their resources in an uncertainenvironment, and the study of the function ofeconomic institutions and markets in making these
allocations possible.
Lecture 1: What is finance?
1.2. Defining Finance: Definition 1
Economa Financiera
Marn, Jos M. / Rubio, Gonzalo
Antoni Bosch, Editor, Barcelona, 2001
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The practice of finance exists for thecreation of value
Financial contracting brings about thesubstitution of real wealth (i.e. real
business assets) for financial wealth (i.e.
securities) Investing in financial securities has betterattributes that in real assets. Value is created in tthe realassets held by businesses, and then transmitted into the value
of financial wealth issued by businesses and held byinvestors.
Lecture 1: What is finance?
1.2. Defining Finance: a new paradigm. TheValue Creation Function of Finance
Norton y Scott, A new Paradigm: the value creationfunction of finance, january 2001
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Finance is the process of transforming
existing assets into new, contractual forms,as well as the analytical techniques neededto support this process, for the purpose of
wealth creation in modern, capitalisticeconomies.
Lecture 1: What is finance?
1.2. Defining Finance: a new paradigm.
Definition 2
Norton y Scott, A new Paradigm: the value creationfunction of finance, january 2001
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Financial management (Corporate finance) dealswith how firms raise and use funds to make short-
term and long-term investments. Investment deals with how the securities markets
work and how to evaluate and manage investments instocks and bonds.
Financial Markets and Institutions includes the studyof the banking system and markets.
Lecture 1: What is finance?
1.2. Defining Finance: the three primary areas of finance
Peterson and Fabozzi
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FINANCIAL MANAGEMENT
Part 1: An introduction to finance
Lecture 1: What is finance?
(II)
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Lecture 1: What is finance? (II)
1.1. Introduction
1.2. Defining finance
1.3. The Firm: a sistemic approach
1.4. Corporate Finance: the financial function
1.5. The financial objective: value creation
1.6. Financial main principles
1.7. Finance: historic evolution
1.8. Main programmes in Finance
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Subsistema de
recursos humanos
Subsistema de
direccin y gestin
Subsistema de
direccin y gestin
Subsistema
comercial
Subsistema de
operaciones
Dinero
Dinero
Bienes y servicios
Personal
Personal
Goods and
Services
Resourses Expenses SalesIncomes
Subsistema de
recursos humanos
Human Resources
Subsystem
Subsistema de
direccin y gestin
Management
Subsystem
Subsistema de
direccin y gestin
Finance Subsystem
Commercial
Subsystem
Operations
Subsystem
Funds
Funds
Goods and Services
Personnel
Human Resources
Resourses
Lecture 1: What is finance? (II)
1.3. The Firm: a sistemic approach
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Lecture 1: What is finance? (II)
1.5. Corporate Finance: the financial function
Corporations face two broad financial questions:- What investments should the firm make?- How should it pay for those investments?
Financial managers are concerned with :
Investment Decisions (use of funds):
The buying, holding or selling of types of assets
Financing Decisions (acquisitions of funds)
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Lecture 1: What is finance? (II)
1.6. Corporate Finance: the financial function
FINANCIALMANAGEMENT
(CORPORATE
FINANCE)
r ( r > k ) k
FINANCIAL SYSTEMREAL SYSTEM
INVESTMENT FINANCING
INVESTMENT / FINANCIAL SUBSYTEM
RETURNREPAYMENTAND RETURN
FINANCIAL
MARKETS
FIRM
OPERATIONS
(Real goods & services
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Lecture 1: What is finance? (II)
1.7. The Financial objective: value creation
Goal of management: maximize the economic well-being, orwealth, of the owners (current shareholders)
=> maximize the price of the stock
Share price today = Present value of all future expecteddividends at required return
g
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.max.Pr..i
i
i
kdiceShareMax
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Lecture 1: What is finance? (II)
1.8. The Financial objective: value creation
Financial managers must create or generate value for theirshareholders.
Economic Value Added (EVA) is a measure of a company'sfinancial performance based on the residual wealth calculated bydeducting cost of capital from its operating profit (adjusted fortaxes on a cash basis).
The formula for calculating EVA is as follows:
EVA = Net Operating Profit After Taxes - (Capital * Cost ofCapital)
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Lecture 1: What is finance? (II)
1.9. Financial main principles Rational Financial behavior Risk aversion Budgetary diversification
Existence of two parts in all financial transaction Measurement by cash flows Signaling and informative asymmetry Efficiency of financial markets
Direct relation of risk and return Existence of valuable ideas Financial conduct initiative The Time Value of the money and value additivity.
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Lecture 1: What is finance? (II)
1.10. Finance: historic evolutionPrinciples of century XX:Beginning of the research in finance
EVENTS
Finance at the present
- Expansion of the Years 20- The 29 Crises- Economy military of the 40- Expansion of the 50
- Crises of the petroleum of the 73
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Modern
Approach
1900-
1950-
1970-
1980-
1990-
Classical Approach
APT Model
(Ross, 1970)
Options Valuation Models (Black y Scholes, 1973)
Portfolio selection Theory
(Markowitz, 1952,1959)
CAPM (widening and reformulation)
Dividends Policy (Modigliani, Miller, 1963)
Capital Assets Pricing Model
(CAPM) (Sharpe, 1963-4, Lintner,1965)
Efficient
Market Theory
(Fama, 1970)
Financial Structure
(Modigliani, Miller, 1958)
Financial InnovationMethods based on Fuzzy Sets Theory
(Kaufmann y Gil, 1986-87)
Chaos Theory,
Non Linear DynamicsMarkets Efficiency
Paradigmy
ears70
Behavioral finance
2000-
Lecture 1: What is finance? (II)
1.10. Finance: historic evolution
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Lecture 1: What is finance? (II)
1.11. Main programmes in finance
Managements of Investments- Capital Budgeting. Capital Structure and Dividend Policy.
Market Efficiency. The Capital Asset Pricing Model. Options Theory Agency Theory Financial Planning Small Firms
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Kidwell, Peterson, Blackwell, Whidbee: FinancialInstitutions, Markets, and Money, Eighth Edition, John
Wiley & Sons, 2003 Fabozzi, Modigliani: Capital Markets. Institutions and
Instruments. Prentice Hall, 2003
Bodie, Zvi and Merton, Robert C.: Finance. PrenticeHall, 1999
Pamela P. Peterson and Frank Fabozzi: FinancialManagement and Analysis, 2nd Edition, John Wiley &Sons, 2003
Lecture 1: What is finance?
Bibliography
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