Finance Exam 1 Finance management of money principles related to investing money and how money should be raised for investments Cash related criteria investments 1 Amount of money received from investment 2 Timing when you expect to receive cash flows from investment 3 Risk associated with receiving money Three Area s in Finance 1 Corporate Finance how companies raise money invest money and how they manage their financial resources 2 Capital Markets and Institutions role of financial institutions structure of capital markets process of financial intermediation and how money flows in the economy Investments uses valuation techniques to value alternative investment opportunities provided through financial markets and institutions 3 1 Investment Decision corporate mangers make sure money is invested in projects that will be worth more than they cost 2 Financing Decision corporate mangers need to decide what combination of debt and equity they should use to raise funds 3 Dividend Decision corporate managers need to decide what percent of the company s profits should be paid to shareholders and what percentage should be reinvested into the company Financial Toolbox Financial Statements and Ratio Analysis ratios used to establish relationships between variables and financial statements Present Value and Future Value time value of money Models of Risk and Return investors require higher rates of return for taking on more risk Spreadsheet Modeling Methods spreadsheet programs excel The Ten Principles of Finance Principle 1 Return v Risk higher returns higher risk positive relationship want higher returns Higher standard deviation higher risk Treasury Bills lowest risk Small company stock highest risk Ibbotson Sinquefield Study showed direct relationship between expected return of asset class and risk associated with receiving that return Stock Return P1 P2 D P2 Principle 2 Efficient Capital Markets are tough to beat prices of stocks and bonds react instantaneously and very quickly incorporate new information Random walk stock prices random CAPM trade off between risk and expected return Unsystematic risk specific to firm Systematic risk specific to market Principle 3 Risk Preference Rational investors are risk averse individual investors prefer less risk Principle 4 Supply Demand drive prices in short run Fundamentals drive stock prices in long run Market Capital current stock price x amount of shares outstanding Principle 5 Corporate managers should make decisions to maximize shareholder value Invest in projects that create positive net present value value associated with investing in a project or venue If positive project creates value If negative project should not be invested Capital budgeting valuation planning and managing of corporate investments for a firm investments for growth Cost of Capital cost of raising debt and equity for firm Capital Structure Decision minimizing cost of capital by using right mix of debt and equity debt equity for financial investments Working Capital Management managing a firms short term assets and short term liabilities daily activities Short Term Assets accounts receivable inventory Short Term Liabilities loans due within one year accounts payable Principle 6 Transaction costs taxes and inflation are enemies can greatly reduce the real return on your investments as they increase return on investment decreases Investors should work to minimize tax liability Principle 7 Time and Value of money are inversely related a dollar today is worth more than a dollar tomorrow FV PV 1 r n PV stock is worth r rate n years Principle 8 Asset allocation is a very important decision decision to invest in stocks bonds or cash is critical in determining your range of expect returns Brinson Study asset allocation Principle 9 Asset Diversification Reduces Risk spread your wealth Goal invest in a group of assets that will provide you with the best return possible given a level of risk If risk averse diversification way to go Principle 10 Valuation Asset pricing use to value investments used to put a price on risk CAPM Capital Asset Pricing Model estimate rate of return investor should expect to receive on risky asset Corporate Finance Creating Shareholder Value Corporate Governance Choice Decisions Traditional Finance Expected utility maximization Rational expectation Prices Markets Market Corrections Arbitrageurs correct mispricing Reflect expected outcomes Prices reflect value Behavioral Finance Flaws in utility function Not always rational emotions and biases rules of thumb Reflect emotions and biases Market efficiency Limits to arbitrage CFO Chief Financial Officer head financial manager in company who oversees financing activities Responsibilities work with bankers advisors and participants in financial market fulfill capital needs financial spokesperson Traditional Role controller and treasurer Expanded Role Corporate Strategist assist in strategy formation Financing and capitalization insure capital available to fund strategic plan Risk Management Growth and Acquisitions provide for growth opportunities Communicator with markets Treasurer finance Controller accounting books 1 Gathering auditing reporting financial results 2 Managing financial systems 3 Computing paying taxes 4 Producing operating budgets 1 Capital budgeting long term investment decisions 2 Capital structure decision where how raise funds to finance investments 3 Capital management decisions manage day to day finance activities Cash inventory management Credit collection policy Paying suppliers 4 Working capital 5 Capital budgets financial planning Command Control controlled financial information but was not accountable for company s overall performance Corporate Cop oversaw company spending and made sure company s books were closed by deadline Competitive Team new model individuals that made up finance function act as business advocates and assigned to individual business units Generate and share financial information to help in decision making All members of financial function accountable for business unit performance Command Control Corporate cops Financial planning controlling Budgeting Capital allocation Control financial information Not accountable for performance Competitive Team new model Business advocates Understanding business units and achieving targets Sharing financial information Accountable for performance Elements in New Corporate Finance Technology advancements in