Finance 311

Finance
applies specific value to things owned, services used, decisions made
Financial Management
organization’s approach to valuation AND determines what should happen with firm’s money now and in the future
Types of Economic Participants
1) No money, no ideas
2) Money, but no ideas
3) No money, but ideas
4) Money and ideas
Type 1 Participants
Do not lend or spend in business context
No direct role in financial markets
Indirect role: to provide labor and consume products
Type 4 Participants
Use financial tools
evaluate own businesses
choose highest-potential ideas
Are self-funded, so no need for financial markets
Types 2 and 3 Participants
Use financial institutions and financial markets for mutually beneficial exchange
Type 2: makes temporary loans to Type 3
Type 3: typically consists of companies engaging in R & D
Friction
Occurs when not all cash is returned to investors
Investments
Involves methods and techniques for making decisions about what kinds of securities to own
Subareas of Finance
Financial management
Financial institutions and markets
International finance
Risk
Uncertainty of future cash flows due to timing and size
Financial Asset
Ownership in cash flow represented by securities like stocks, bonds, and other assets
Real Asset
Physical property like gold, machinery, equipment, real estate
Real Market
Places/processes that facilitate real asset trading
Time Value of Money (TVM)
Theory and application of valuing cash flows at various points in time
Accounting
tracks what happened to firm’s money in the past
Chief Financial Officer
Highest level financial officer
Controller
Oversees accounting function
Treasurer
Responsible for managing cash, credit, financing, capital budgeting, risk management
Sole Proprietorships
Not legally separate from the owner

Advantages
Easy to start
Light regulatory and paperwork burden
Single taxation at the personal tax rate

Disadvantages
Unlimited liability
Limited access to capital

General Partnerships
Partners own the business together

Advantages
Relatively easy to start
Single taxation

Disadvantages
Partners jointly share unlimited liability
Personally liable for legal actions and debts of firm
Difficult to raise large amounts of capital

Public Corporations
Legally independent entity entirely separate from its owners

Advantages
Limited liability for owners
Can raise large amounts of capital
Easy to transfer ownership

Disadvantages
Double taxation (corporate level and personal level)

Hybrid Organizations
Combine attributes of several forms

Advantages
Offer single taxation and limited liability to all owners

S Corporations
Limited Liability Partnerships (LLPs)
Limited Liability Companies (LLCs)

Firm Goals
Owner seeks to maximize shareholder wealth and company’s value through

Maximizing present value of future cash flows
Maximizing owners’ equity

Decisions about
attracting additional funds
projects in which to invest
returning profits to owners over time

Corporate Goals
Maximize value of owners’ equity
Increase current value per share (stock price) of existing shares

Common methods
Maximize net income or profit
Minimize costs
Maximize market share

Agency Theory
Problems arise when principal (shareholder) hires agent (manager) to operate firm but cannot monitor the agent’s actions

Manager’s interest may not be aligned with shareholder goals

Corporate Governance
Set of laws, policies, incentives, and monitors designed to handle issues arising from the separation of ownership and control
Subprime Mortgage Borrowers
Higher-risk borrowers charged higher interest rates due to higher risk of default
Securitization
Loan originators sell the loan repayment rights to other financial institutions or investors