Chapter 1LEARNING OBJECTIVESDefinition of FinanceDefinition of Financial Management1.1 The Financial Intermediary Function1.1 The Cycle of Money1.2 Overview of Finance Areas1.3 The Financial Markets1.4 The Finance Manager and Financial ManagementSlide 111.5 Objective of the Finance Manager1.6 Internal and External Players1.7 The Legal Forms of Business1.7 The Legal Forms of BusinessSlide 16Slide 171.8 The Financial Management Setting: The Agency Model1.9 Corporate Governance and Business Ethics1.10 Why Study Finance?Financial Management1. Describe the cycle of money, the participants in the cycle, and the common objective of borrowing and lending.2. Distinguish the four main areas of finance and briefly explain the financial activities that each encompasses.3. Explain the different ways of classifying financial markets.4. Discuss the three main categories of financial management.LEARNING OBJECTIVESLEARNING OBJECTIVES5. Identify the main objective of the finance manager and how that objective might be achieved.6. Explain how the finance manager interacts with both internal and external players.7. Delineate the three main types of business organizations and their respective advantages and disadvantages.8. Illustrate agency theory and the principal-agent problem. 9. Review issues in corporate governance and business ethics.Definition of Finance Finance is the art and science of managing wealth.  It is about making decisions regarding what assets to buy/sell and when to buy/sell these assets. Its main objective is to make individuals and their businesses better off.Definition of Financial ManagementFinancial management is generally defined as those activities that create or preserve the economic value of the assets of an individual, small business, or corporation. Financial management comes down to making sound financial decisions.1.1 The Financial Intermediary Function Financial intermediaries assist in the movement of money from lenders to borrowers and back again. This process is termed the cycle of money and its main objective is to make all the participants better off1.1 The Cycle of MoneyThe movement of money from lender to borrower and back to lender from borrower (see page 4 of textbook)Example: A mutual fund issues shares, which are bought by individualsThe pooled funds are invested by the mutual fund company in shares that are issued by firmsThe firms pay dividends periodically, which are received by the mutual fund and passed through to their shareholders, or reinvested in additional shares, and the cycle of money starts again. The mutual fund managers earn feesThe firms whose securities are bought are able to raise capital for growth and future returnsThe mutual fund shareholders earn dividends and capital gains Thus, all participants are generally better off.1.2 Overview of Finance AreasFour main interconnected and interrelated areas:Corporate FinanceInvestmentsFinancial Institutions and MarketsInternational Finance1.3 The Financial MarketsForums where buyers and sellers of financial assets and commodities meet. Financial markets can be classified by:The Type of Asset TradedThe Maturity of the Financial Assetmoney marketcapital marketThe Owner of the Financial Assetprimary marketsecondary marketThe Nature of the Transactiondealer markets auction markets1.4 The Finance Manager and Financial Management The Finance Manager Determines the best repayment structure for borrowed funds Ensures that debt obligations are met on timeEnsures that sufficient funds are available for carrying out daily operations1.4 The Finance Manager and Financial Management Financial management involves three main functions:Capital BudgetingCapital StructureWorking Capital Management1.5 Objective of the Finance ManagerTo make investment and financing decisions that increase the cash flow of the firm, thereby maximizing the current stock price Profit maximization vs. Stock price maximizationWhy are they not the same?Which one is more important?1.6 Internal and External Players•Financial managers have to interact with various internal and external stakeholders•Internal players include all the departmental managers and other employees•External parties include:CustomersSuppliersGovernmentCreditors1.7 The Legal Forms of BusinessThere are three main legal categories of business organizations: 9Sole proprietorshipPartnershipCorporation9Besides these three main forms, some other forms of business organizations include:Hybrid CorporationsNot-for-Profit Corporations1.7 The Legal Forms of BusinessSole Proprietorship•Advantages1.Simplest and easiest form of business2.Least amount of legal documentation3.Least regulated4.Owner keeps all profits9•Disadvantages1.Owner pays personal tax rate on profits2.Obligations of the business are sole responsibility of owner, and personal assets may be necessary to pay obligations (personal and business assets are commingled)3.Business entity limited to life of owner4.Can have limited access to outside funding for the business1.7 The Legal Forms of BusinessPartnership •Advantages1. Agreements between partners may be easily formed2. Involves more individuals as owners and therefore usually more expertise3. Larger amount of capital usually available to the business (compared to proprietorship)•Disadvantages1. Assets of general partners are commingled with assets of the business2. Profits treated as personal income for tax purposes3. Difficult to transfer ownership91.7 The Legal Forms of BusinessCorporationAdvantages1. Business is legal, separate entity from owners2. Owners have limited liability to obligations of the business3. Easy to transfer ownership4. Usually greater access to capital for business5. Owners do not have any personal liability for defaultDisadvantages1. Most difficult business operation to form2. Double taxation of company profits3. Most regulated91.8 The Financial Management Setting: The Agency ModelAgency relationship Agency conflictWhy does it arise?How can it be minimized?Principal-agent problemAgency theoryAgency costs1.9 Corporate Governance and Business Ethics•Corporate governance deals with….–how a company conducts its business and implements controls to ensure proper procedures and ethical behavior.•The Sarbanes-Oxley