business organization and financial markets some basic concepts financial management: lecture 2
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Financial management: Lecture 2
Today’s agenda
Understand the types and features of business organizations
Understand the goal of corporation and agency problem
Understand financial markets and their functions Understand the concept of the cost of capital and
the time value of money
Organize a business
Types of Business Organizations• Sole Proprietorships
• A business owned and run by one individual
• Partnerships• A business owned by two or more people
• Corporations• A business organized as a separate legal entity
owned by stockholders.
Financial management: Lecture 2
Organize a business
Financial management: Lecture 2
Sole Proprietorship Partnership Corporation
Who owns the business?
The manager Partners Stockholders
Are managers and owners separate?
No No Usually
What is the owner's liability?
Unlimited Unlimited Limited
Are the owner and business taxed
separately?No No Yes
Organize a business
Financial management: Lecture 2
Sole Proprietorships
Corporations
Partnerships
Limited Liability
Corporate tax on profits +
Personal tax on dividends
Unlimited Liability
Personal tax on profits
Financial managers
Chief Financial Officer (CFO)• Oversees the treasurer and controller and sets
overall financial strategy. Treasurer
• Responsible for financing, cash management, and relationships with banks and other financial institutions.
Controller• Responsible for budgeting, accounting, and taxes.
Financial management: Lecture 2
The goal of corporation
The financial managers are supposed to maximize shareholders’ wealth or maximize stock prices
Financial management: Lecture 2
Agency problems
Managers, acting as agents for stockholders, may act in their own interests rather than maximizing shareholders’ value.
This conflict of interest between shareholders and managers causes the agency problem.
Financial management: Lecture 2
Career In Finance
Financial management: Lecture 2
Career Annual SalaryCommercial Banking
Loan Officer $ 90,000 +Department Manager $ 200,000 +
Corporate FinanceFinancial Analyst $ 61-78,000Credit Manager $ 73-92,000Chief Financial Officer $ 222-367,000
Investment Banking (bulge bracket)First Year Analyst $ 90-180,000First Year Associate $ 200-350,000Assistant Vice President $ 300-900,000Director/Principal $ 500k - 2 milManaging Director/Partner $ 600k - 30 milDepartment Head $ 1 mil - 70 mil
Financial management: Lecture 2
Financial
Manager
Firm's
operations
Investors
(1) Investors buy shares with cash
(1)
(2)Cash is invested
(2)
(3) Operations generates cash
(3)
(4a) Cash reinvested
(4a)
(4b) Cash returned to investors
(4b)
Financial markets and investors
Real assets
(timberland)
(stockholders save and invest in closely held firm.)
2- 12
Corporation
Investment in real assets
Investorsworldwide
Financial markets
Stock marketsFixed-income marketsMoney marketsMarkets for Commodities Foreign exchange Derivatives
Financial Intermediaries
Mutual Funds Pension funds
Financial Institutions
Banks Insurance companies
Reinvestment
Financial Markets
2- 13
Total U.S. Financing
27.1
12.6
0.3822.3
28.3
1.4 HouseholdsRest of worldBanksInsurance CosPension FundsMutual FundsOther
% Holdings of Corporate Equities (Qtr 3, 2007)
Financial management: Lecture 2
Financial markets
A financial market • Securities are issued and traded
The classification of the financial market• By seasoning of claim
• Primary market
• Secondary market
• By nature of market• Debt market
• Equity market
Financial management: Lecture 2
Financial markets (continue)
• By maturity of claim• Money market
• Capital market
Financial management: Lecture 2
The functions of financial markets
1. Conducting exchange
2. Providing liquidity
3. Pooling money to fund large corporations
4. Transferring money across time and distance
5. Risk management (hedge, diversify)
6. Providing information
7. Providing efficient allocation of money
Financial management: Lecture 2
Pooling money to fund large corporation investments
What does this mean? Examples
Financial management: Lecture 2
Transferring money across time and distance
What does this mean? Examples
Financial management: Lecture 2
Providing efficient allocation of money
What does this mean? Examples
Financial management: Lecture 2
The cost of capital
The cost of capital is a very important concept in capital budgeting.
It links investment opportunities in financial markets and investment opportunities in real assets markets.
Financial management: Lecture 2
What is the cost of capital?
Cash
Investment opportunity (real
asset)Firm Shareholder
Investment opportunities
(financial assets)
Invest Alternative: pay dividend to shareholders
Shareholders invest for themselves