Finance can be through of as the study of the following 3 questions: 1. In what long-term assets should the firm invest? (Capital budgeting) 2. How can the firm raise cash for required capital expenditures? (Capital structure) 3. How should short-term operation cash flows be managed? (Working capital management)
Forms of business organization:
Proprietorship- single owner
Partnership- more than one owner
Corporation- legal entity separate and distinct form its owners and managers.
Unlimited life- independent of owners
Ease transfer of ownership
Ease of raising capital
Cost of set-up and report filing
Limited liability- the lower the risk the higher the value, all else equal Growth opportunities: corporations can raise capital easier to take advantage of these opportunities. Liquidity: an asset value also depends on how easy it is to sell it.
Management’s primary goal
Our focus: profit, publicity held companies
Management’s goal: maximize shareholder wealth, which translates into maximizing the stock price.
Maximizing shareholder value:
A company’s shareholder wealth is equal to the number of shrares outstanding times market value per share. We need to know what factors affect the stock price.
The value of a share of stock is the present value of the cash flows an “average investor” expects to receive in the future id he or she bought the stock. Long-term view important.
Market price VS intrinsic value
Stock’s market price: actual market price of the share of stock. Value based on perceived returns and risk. (could be wrong)
Intrinsic value: what a fully informed analyst would estimate as the “true” value of a stock based on “true” risk and return data. Analyst’s estimates of the intrinsic value of a stock vary. A firm’s management has the best information.
Take actions that are designed to maximize the firm’s intrinsic value. Not it’s current market value. Maximizing intrinsic value will maximize the average price over long run, not current price at each point in time.
The capital allocation process
In a well functioning economy, capital flows efficiently from those who supply capital to those who demand it. Suppliers of capital – Excess funds
Income greater than their current expenditures
Saving for future use (ex. retirement)
Demanders or users of capital
Need funds now
2. Go through an investment bank (iBank) such as Morgan Stanley, which underwrites the issue. An underwriter serves as a middleman and facilitates the issuance of securities. The company sells its stocks or bonds to the investment bank, which then sells these same securities to savers 3. Transfers can also be made through a financial intermediary such as a bank, an insurance company, or a mutual fund. Here the intermediary obtains funds from savers in exchange for its securities. The intermediary uses this money to buy and hold businesses’ securities, while the savers hold the intermediary’s securities.
The importance of financial markets
Well functioning financial markets facilitate the flow of capital from investors to
Types of markets:
1. Physical asset markets: (also called “tangible” or “real” asset markets) are for products such as wheat, autos, real estate, computers, and machinery. 2. Financial asset markets. Financial asset markets, deal with stocks, bonds, notes, and mortgages. Financial markets also deal with derivative securities whose values are derived from changes in the prices of other assets. 3. Spot markets: Spot markets are markets in which assets are bought or sold for “on-the-spot” delivery (literally, within a few days). 4. Futures markets: markets in which participants agree today to buy or sell an asset at some future date. 5. Money markets: money markets are the markets for short-term, highly liquid debt securities 6. Capital markets: Capital...
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