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FINANCIAL MANAGEMENTPart 1: An introduction to finance

Lecture 1: What is finance?


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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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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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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


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.


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


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


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


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


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


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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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


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)


1.1. Introduction:Financial assets: main properties


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DIRECT FINANCING (Markets)



INDIRECTFINANCIAL INVESTMENT

OR INTERMEDIATION FINANCING

BrokersDealers

Intermediaries

FundsFunds

Funds Funds


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DIRECT



INDIRECT

BrokersDealers

Intermediaries

FundsFunds

Funds Funds

Direct Financial AssetsPurchase

Indirect Financial AssetsPurchase

Direct Financial AssetsIssue

Direct Financial AssetsIssue


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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



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



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



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



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



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.


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.


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.


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.


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


(II)


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Lecture 1: What is finance? (II)

1.1. Introduction

1.2. Defining finance



1.5. The financial objective: value creation

1.6. Financial main principles


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




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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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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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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

!

!1 1

.max.Pr..i

i

i

kdiceShareMax


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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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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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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-




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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


Bibliography

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