Chapter: 01

1. Chapter: 01 The Role & Environment of Managerial Finance

2. What is Finance? • Finance is the art & science of managing money. Finance is concerned with the process, institutions, markets & instruments involved in the transfer of money among individuals, businesses & governments. )

3. Role of Finance in a Typical Business Organization

4. Responsibility of the Financial Staff/Manager • Maximize stock value by: • Forecasting and planning • Investment and financing decisions • Coordination and control • Transactions in the financial markets • Managing risk

5. Goal of the Firm • Stockholder wealth maximization. • Profit maximization. • Managerial reward maximization. • Behavioral goals. • Social responsibility.

6. Goal of the Firm…………………..contd. • Modern managerial finance theory operates on the assumption that the primary goal of the firm is to maximize the wealth of its stockholders, which translates into maximizing the price of the firm’s common stock.

7. Profit Maximization VS Stockholder Wealth Maximization • Profit maximization is basically a single-period or short-term goal which is usually interpreted to mean the maximization of profits within given a given period of time. A firm may maximize its profits at the expense of its long-term profitability & still realize this goal.

8. Profit Maximization VS Stockholder Wealth Maximization……contd. • Stockholder wealth maximization is along-term goal, since stockholders are interested in future as well as present profits. This concept is preferred because it considers: • Wealth for the long term, • Risk or uncertainty, • The timing of returns, & • The stockholders return.

9. Profit Maximization

10. Stockholder Wealth Maximization

11. The Modern Corporation There exists a SEPARATION between owners and managers. Modern Corporation Shareholders Management

12. Agency Theory • Jensen and Meckling developed a theory of the firm based on agency theory. • Principals must provide incentivesso that management acts in the principals’ best interests and then monitorresults.

13. Agency relationships • An agency relationship exists whenever a principal hires an agent to act on their behalf. • Within a corporation, agency relationships exist between: • Shareholders and managers • Shareholders and creditors

14. Shareholders versus Managers • Managers are naturally inclined to act in their own best interests. • But the following factors affect managerial behavior: • Managerial compensation plans • Direct intervention by shareholders • The threat of firing • The threat of takeover

15. Shareholders versus Creditors • Shareholders (through managers) could take actions to maximize stock price that are detrimental to creditors. • In the long run, such actions will raise the cost of debt and ultimately lower stock price.

16. How to Overcome Agency Problem? • Market Forces • Major Shareholders. • Threat of Takeover. • Agency Costs: These are the costs of monitoring management behavior, ensuring against dishonest acts of management & giving managers the financial incentives to maximize share price. )

17. Three Major Concepts • Financial Instruments. • Financial Institutions. • Financial Markets.

18. Financial Instruments. • A financial instrument is the written legal obligation of one party to transfer something of value – usually money – to another party at some future date, under certain conditions, such as stocks, loans, or insurance.

19. Financial Instruments…..Contd. • Characteristics • Standardization • Communicate Information • Classes of Financial Instruments • Primary – underlying Instruments • Derivative Instruments • Value derived from the behavior of Underlying instruments. )

20. Value of Financial Instruments 1. Size the promised payment. (Face Value) 2. When the payment will be received. (Maturity) 3. The likelihood the payment will be made (risk). 4. The conditions under which the payment will be made. (Prerogatives)

21. Examples of Financial Instruments

22. Financial Institutions • Financial institutions serve as intermediaries by channeling the savings of individuals, businesses & governments into loans or investments, i.e., they facilitate the flow of funds between surplus units & deficit units. • Role of Financial Institutions • Reduce transactions cost by specializing in the issuance of standardized securities • Reduce information costs of screening and monitoring borrowers. • Issue short term liabilities and purchase long-term loans. )

23. Financial Institutions …...contd.

24. Financial Markets • Financial Markets are the places where financial instruments are bought and sold. • Role of Financial Markets. • Offer liquidity to borrowers and savers. • Pool and communicate Information. • Allow risk sharing

25. Financial Markets……..contd. • Structure of Financial Markets • Primary vs. Secondary Markets • Money Market VS Capital Market • Centralized Exchanges vs. Over-the- counter Markets. • Debt and Equity vs. Derivative Markets • Characteristics of a well-run financial market • Low transaction costs. • Information communicated must be accurate. • Investors must be protected.