Business Finance
Chapter 1
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Financial management is concerned with
managing a corporation’s money
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Where to invest money
Whether or not to replace an asset
When to issue new stocks or bonds
How to raise money
Functions of Financial Management
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Allocate funds to current and fixed assets
Obtain best mix of financing
Develop an appropriate dividend policy
Acquire new funds
Credit management
Inventory control
Receipt and disbursements of funds
Possible Goals of Financial
Management
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Earn the highest profit
Increase the value of the firm
Maximize shareholder wealth
Maximize management wealth
Act in a socially responsible or ethical
manner
Forms of Business Organization
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Sole proprietorship
Partnership
Corporation
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Subchapter S
Sole Proprietorship
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Single person ownership
Unlimited liability for owner
Profits/losses taxed as though they belong to
owner
Partnership
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Two or more owners
Unlimited liability for owners
Articles of partnership specify ownership
interest, methods of distributing
profits/losses, and means of withdrawal
Losses/profits allocated directly to partners
Corporation
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Legal entity
Formed through articles of incorporation
Owned by shareholders whose liability is
limited to investment
Continual life
Easy division/transfer of ownership
Managed by a Board of Directors
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Pays taxes on its income
Remaining income is paid to shareholders as
dividends
Shareholders pay taxes on dividends leading
to double taxation
May form a Subchapter S Corporation to
prevent double taxation
How will we see the difference?
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Balance sheet – ownership
Raising funds
Dividends paid
Cash flow – owner’s draw
Agency Theory
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Agents act on behalf of others
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Ex: Real estate agents, sports agents
Relationship between the owners and
managers of a firm
Two different groups in a public corporation
May cause conflicts of interests in running the
company
Sarbanes-Oxley Act
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2002 response to corporate scandals
Federal law drafted that increased regulation
of corporations’ accounting practices and
governance
Focus is to make sure that corporations
present financial information accurately
Creates an Oversight Board that increases
standards for auditing
Current Issues in Finance
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Risk vs. return
Short–term vs. long-term
Raising money through stocks or bonds
Financial Markets
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Meeting place for people, corporations, and
institutions what need money or have money
to lend or invest
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Public financial markets – government that is
borrowing for highways, education, welfare or
other public activities
Corporate financial markets – corporations raising
money
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What is bought or sold is called a “security”
An investment instrument issued by a
corporation, government, or other
organization which offers evidence of debt or
equity
Securities include stocks, bonds, notes,
options, calls, and leases
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Money markets – deals with short-term
securities that have a life of one year or less
(ex: CD sold by a bank)
Capital market – deals with long-term
securities that have a life over one year
Who are the primary participants in the
capital markets?
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U.S. Treasury, other agencies of the federal,
state and local gov’t, and corporations
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The international capital markets are rapidly
increasing in importance.
Influenced by:
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Iron curtain "collapse."
Reunification of East and West Germany.
A more competitive and tariff-free Europe.
The North American Free Trade Agreement
(NAFTA).
Economic growth of Asian countries led by China.
Competition for Funds in the U.S. Capital
Markets
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U.S. Treasury sells short/long term securities
for financing
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Treasury bills (or T-bills) -short-term securities
that mature in one year or less from their issue
date.
Interest paid as difference between purchase
price and payment at maturity
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For example, if you bought a $10,000 26-week Treasury
bill for $9,750 and held it until maturity, your interest
would be $250
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Treasury notes and bonds - securities that pay
fixed rate of interest every six months until
maturity
Difference between them is length until maturity.
Treasury notes mature in 1-10 years from their
issue date. Bonds mature in more than 10 years
from their issue date.
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Treasury bonds
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http://finance.yahoo.com/bonds
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Corporations sell securities for funds also
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Common stock – company sells ownership
interest with voting rights to control company for
capital
Preferred stocks - usually have a fixed dividend
and carry no voting rights. They have priority over
common stocks in the case of bankruptcy and
with regard to dividends. They technically have an
unlimited life but often are redeemable.
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Common stock is sold in two ways by
corporation
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Initial Public offering (IPO)
Secondary offering
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Securities are later traded by owners in
security markets
Primary markets in the U.S. the New York
Stock Exchange (NYSE) and the NASDAQ American Stock Exchange (AMEX).
Exchanges of lesser importance include the
Chicago, Pacific, Detroit, Boston, Cincinnati,
and PBW (Philadelphia, Baltimore, and
Washington) exchanges.
NASDAQ is electronic
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http://finance.yahoo.com/
Regulation
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Organized securities markets are regulated
by the Securities and Exchange
Commission (SEC) and through selfregulation.
Laws governing securities trading
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Securities Act of 1933: Requires full
disclosure of all pertinent investment
information on new corporate security issues.
Securities Exchange Act of 1934 - created
the Securities and Exchange Commission
(SEC) and empowered it to regulate
securities markets.
Securities Acts Amendments of 1975 Directed SEC to supervise development of
national securities market
Which is most popular?
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Corporations tend to raise funds through debt
more often than equity