8 27 Corporate Finance Finance management of money generating cash investing cash managing financial resources 3 Areas of Finance 1 Corporate Finance 2 Institutions Markets 3 Investments Financial Tool Box 1 accounting statements and ratios 2 present value 3 risk and return models 4 spread sheet modeling The importance of financial markets corn is a commodity so it s price elastic price of energy oil has gold prices during the crisis as people were scared so they bought gold to store value currencies fluctuate Debt capital markets raising by issuing bonds interest rates reflect the base cost of capital in economy 30 year treasury rate Equity capital markets raising by issuing stocks allocator of risk capital in economy essential to financial growth barometer of economic health The role of capital markets 1 Capitalism markets allocate capital 2 Government regulator investor market control 3 Stock prices reflect stock values operating efficiency info price efficiency 4 Creating shareholder value 4 Current market issues financial crisis insider trading high frequency trading Free market 1 Hong Kong 2 Singapore Government controlled 1 NK 2 Zimbabwe Financial crises from housing and mortgage crisis to subprime credit crunch and recession Tulip bulb mania Netherlands luxury item and symbol of status price dramatically then when no one bought them dramatic South sea company England to reduce government debt and politicians trade rumors to push price up Tech Stock bubble US tech stocks declined 80 I na year Asian market collapse large values of currency became expensive as investors flock to market large investments by Asian funds Four elements of Financial Crisis 1 Overinvesting in asset class 2 Easy financing 3 Government bailout 4 People don t learn 8 29 Ten Principles of Finance Buffett Berkshire Hathaway insurance 172k share 20 annual return ROE and PE 1 Likes to buy companies over stocks 2 Management act like owners 3 Companies has barriers to entry big brand names 4 No tech companies 5 Generates a lot of cash flows 2 1 Higher returns require taking more risk Annual rate of return of stock market 10 change in price dividend initial price 2 2 Efficient capital markets are tough to beat current stock prices reflect all publicly available information and prices react completely correctly and instantaneously to incorporate the receipt of new information 2 3 Rational investors are risk averse Risk aversion means that a rational investor prefers less risk to more risk Stock A mean return 10 STD 10 VS Stock B mean return 10 STD 20 Stock B is more risky 2 4 Supply and demand drive stock prices in the short run Short run a stock s price may be influenced by temporary and extreme supply and demand imbalance OR by the stock market s reaction to new information may not affect the true long term value RANDOM WALK Long run stock prices are driven by EARNINGS 2 5 Corporate finance and governance corporate managers should make decisions that maximize shareholder value Buffett managers have fiduciary responsibility to act in shareholder s interests 2 6 Transaction cost taxes and inflation are the ENEMIES Transaction costs and the effects of taxes and inflation can greatly reduce the real returns on your investments 2 7 Time and the value of money A dollar today is worth more than a dollar tomorrow Compounding Value Future Value Present Value mostly used fin tools FV PV 1 r n 2 8 Asset allocation is a very important decision Asset allocation involves dividing investments funds among different asset classes the asset allocation decision reflects beliefs about the anticipated risk and return of asset classes over 90 in fund performance is due to asset allocation Basic cash stock bonds 2 9 Asset diversification will reduce risk Diversify holdings spread wealth among a number of different investments Goal to diverse is to invest in a group of assets that provides you with the best return possible given a level of risk MORE STOCKS LOWER STD LOWER RISK 2 10 An asset pricing be used to value investments CAPM Capital Asset pricing model simple model that estimates the rate of return an investor should expect to receive on a risky asset its principal purpose is to determine the discount rate to use for valuation of assets POSITIVE relationship between beta and expected return Mind Over Money Traditional vs Behavioral Finance Mutual funds try to find opportunity to beat the market Behavioral Equity traders what s happening on second to second basis Emotions Traditional Financial Professors CFOs Investment Bankers how they make money by issuing stocks Greed vs Fear behavioral finance lead to financial crisis 9 03 Corporate Finance Creating shareholder value and corporate governance Microsoft bought Nokia Verizon bought Vodafone CFO vice president Treasurer financial planning capital budgets ST LT capital requirements cash management working capital Controller accounting financial statements and reports financial systems operating budgets audits and taxes The Financial Environment from 1960 2000 The New Corporate Finance Elements of the New Environment Advances in Technology Growth in Investments Growth in Global Markets Greater Economic Volatility and Risk New Complex financial instruments Institutionalization of markets Academic Advances in Finance from 1960 2000 more tools available to use financial engineering etc The CFO as Financial Engineer Traditional roles controller treasurer Expanded roles Corporate strategist assist in strategy formulation Financing and Capitalization the capital can fund strategic plan Risk Management hedge risks in markets when appropriate Growth and Acquisitions provide for the growth opportunities 2012 CFOs Lougbridge IBM moving forward Tome Home Depot redirected capital spending upgraded stores Hoguet Macy s saved Macy s Smith Intel went through fin crisis capital intensive Clancy Biogen Idec deploy capital bent off Icahn Strategic Financial Management Working capital short term financial positions of the firm Capital budgeting investments in long term assets Capital structure financing mix between debt and equity Creating shareholder value decisions aimed at increasing the value of the firm and increase stock prices Gordon Gekko s Greed Speech based on Boesky Basic Management Tenets 1 Efficiency don t need VPs 2 Accountability management must be accountable to stockholders 3 Stake in company management must have stake in company act as owners 4 Role of liberator Danny DaVito