Introduction to corporate finance booth cleary

Lecture Agenda•• Learning Objectives Learning Objectives •• Important Terms Important Terms •• Finance Defined Finance Defined •• Real versus Financial Assets Real versus Financial Asset

•• CHAPTER 1: CHAPTER 1: An Introduction to Finance An Introduction to Finance 03

•• CHAPTER 2: CHAPTER 2: Business (Corporate) Finance Business (Corporate) Finance 38

•• CHAPTER 3: CHAPTER 3: Financial Statements Financial Statements 80

•• CHAPTER 4: CHAPTER 4: Financial Statement Analysis and Forecasting Financial Statement Analysis and Forecasting 136

•• CHAPTER 5: Time Value of Money 221

•• CHAPTER 6: Bond Valuation and Interest Rates 281

•• CHAPTER 7: Equity Valuation 353

•• CHAPTER 8: Risk, Return, and Portfolio Theory 410

•• CHAPTER 9: The Capital Asset Pricing Model (CAPM ) 504

•• CHAPTER 10: Market Efficiency 618

•• CHAPTER 10: Market Efficiency 618

•• CHAPTER 11: Forwards, Futures, and Swaps 663

•• CHAPTER 12: Options 717

•• CHAPTER 13: Capital Budgeting, Risk Considerations and Other Special Issues 781

•• CHAPTER 14: Cash Flow Estimation and Capital Budgeting Decisions 867

•• CHAPTER 15: Mergers and Acquisitions 937

•• CHAPTER 16: Leasing 992

•• CHAPTER 17: Investment Banking and Securities Laws 1015

•• CHAPTER 18: Debt Instruments 1042

•• CHAPTER 19: Equity and Hybrid Instruments 1088

•• CHAPTER 20: Cost of Capital 1153

•• CHAPTER 21: Capital Structure Decisions 1288

•• CHAPTER 22: Dividend Policy 1383

•• CHAPTER 23: Working Capital Management: General Issues 1457

CHAPTER 1

An Introduction to Finance

Lecture Agenda

•• Learning Objectives Learning Objectives

•• Important Terms Important Terms

•• Finance Defined Finance Defined

•• Real versus Financial Assets Real versus Financial Assets

•• Real versus Financial Assets Real versus Financial Assets

•• The Financial System The Financial System

•• Financial Instruments and Markets Financial Instruments and Markets

•• The Global Financial Community The Global Financial Community

•• Summary and Conclusions Summary and Conclusions

–– Concept Review QuestionsConcept Review Questions

Learning Objectives

1 What finance is and what is involved in the study of finance.

2 How financial securities can be used to provide financing for

borrowers and simultaneously to provide investment opportunities for lenders.

3 How financial systems work in general.

3 How financial systems work in general.

4 The channels of intermediation and the role played by

market and financial intermediaries within this system.

5 The basic types of financial instruments that are available

and how they are traded.

6 The importance of the global financial system.

Key Terms

•• Bourse de Montréal

•• brokers

•• Canadian Trading and Quotation System Inc (CNQ)

•• capital market securities

Key Terms

•• market capitalization

•• market intermediary

•• marketable financial assets

•• money market securities

•• New York Stock Exchange (NYSE)

•• non non marketable financial assets marketable financial assets

•• Ontario Securities Commission

•• Ontario Securities Commission

What Is Finance?

•• Finance is the study of how and under what Finance is the study of how and under what

terms savings (money) are allocated between lenders and borrowers.

–

– Finance is distinct from economics in that it Finance is distinct from economics in that it addresses not only how resources are allocated but

addresses not only how resources are allocated but

•• Financial contracts or Financial contracts or securities securities occur whenever occur whenever funds are transferred from issuer to buyer.

The Study of Finance

•• The study of finance requires a basic The study of finance requires a basic

understanding of:

– – Securities Securities –

– Corporate law Corporate law –

– Corporate law Corporate law –

– Financial institutions and markets Financial institutions and markets

Real Versus Financial Assets

•• Real assets are tangible things owned by Real assets are tangible things owned by

persons and businesses

– – Residential structures and property Residential structures and property –

– Major appliances and automobiles Major appliances and automobiles –

– Office towers, factories, mines Office towers, factories, mines –

– Office towers, factories, mines Office towers, factories, mines –

– Machinery and equipment Machinery and equipment

•• Financial assets are what one individual has lent Financial assets are what one individual has lent

to another

– – Consumer credit Consumer credit –

– Loans Loans –

– Mortgages Mortgages

Assets and Liabilities of Households,

2005

Assets $ Billion Liabilities $ Billion

Real Assets 2,348 Total Liabilities 979

Table 1-2 Assets and Liabilities of Households, 2005

Real Assets 2,348 Total Liabilities 979

So urce: Statistics Canada Natio nal B alance Sheet A cco unts, Quarterly Estimates, Fo urth

Quarter 2005 Ottawa: M inister o f Industry, 2006 (Catalo gue No 13-214-XIE).

The Financial System

Overview

•• The household is the primary provider of funds to The household is the primary provider of funds to

businesses and government.

•• Households must accumulate financial resources throughout their Households must accumulate financial resources throughout their working life times to have enough savings (pension) to live on in their retirement years

•• Financial intermediaries transform the nature of the Financial intermediaries transform the nature of the

•• Financial intermediaries transform the nature of the Financial intermediaries transform the nature of the

securities they issue and invest in

•• Banks, trust companies, credit unions, insurance firms, mutual Banks, trust companies, credit unions, insurance firms, mutual funds

•• Market intermediaries simply help make markets work Market intermediaries simply help make markets work

•• Investment dealers Investment dealers

•• Brokers Brokers

The Financial System

FIGURE 1-2

The Financial System

–

– Indirect claims through a financial intermediary Indirect claims through a financial intermediary (where the financial intermediary such as a bank offers deposit

offers deposit taking services and ultimately lends taking services and ultimately lends those deposits out as mortgages or loans)

Channels of Intermediation

FIGURE 1-3

The Financial System

Financial Intermediaries

•• Banks and other deposit Banks and other deposit taking institutions taking institutions

•• Insurance companies Insurance companies

•• Pension Funds Pension Funds

•• Pension Funds Pension Funds

•• Mutual Funds Mutual Funds

Financial Intermediaries

Canadian Chartered Banks

•• Banks take deposits from numerous depositors from across Canada

•• The deposits are ‘pooled’ in the Bank

•• The bank takes these pooled funds and lends them out to households and businesses in the form of mortgages and loans

•• The bank transforms the original nature of the savers (depositors) money:

•• Borrowed for long periods of time

•• Borrowed for risky purposes.

•• Banks can perform this transformation function because they become

experts at risk assessment, financial contracting (pricing the risk) and

monitoring the activities of borrowers.

Financial Intermediaries

Canadian Chartered Banks

Bank

Revenue ($ million)

Assets ($ million)

Profits ($ million)

Royal Bank of Canada 29,403 469,521 3,387 Canadian Imperial Bank of Commerce

Table 1-3 Chartered Banks: Financial Statistics, 2005

Canadian Imperial Bank of Commerce

Bank of Nova Scotia 18,332 314,025 3,209

TD Canada Trust 18,665 365,210 2,229 Bank of Montreal 15,138 297,532 2,400

So urce: B M O Investo rLine website: www.bmo investo rline.co m, Octo ber 31, 2006.

Financial Intermediaries

Insurance Companies

–– Insurers sell policies and collect premiums from customers Insurers sell policies and collect premiums from customers based on the pricing of those policies given the probability of a claim and the size the policy and administrative fees

–– They invest the premiums so that the accumulated value in the They invest the premiums so that the accumulated value in the future will grow to meet the anticipated claims of the

future will grow to meet the anticipated claims of the policyholders

–– In this way, unsupportable risks (such as the death of wage In this way, unsupportable risks (such as the death of wage earner or the burning down of a business) are shared among a large number of policyholders through the insurance company.–

– Insurance allows households, business and government to Insurance allows households, business and government to engage in risky activities without having to bear the entire risk of loss themselves

Financial Intermediaries

Insurance Companies

Insurer

Revenue ($ million)

Assets ($ million)

Profits ($ million)

Manulife Financial 32,187 322,171 3,294

Table 1-4 Insurance Companies: Financial Statistics, 2005

Manulife Financial 32,187 322,171 3,294 Sun Life Financial 21,871 171,850 1,867 Great-West Lifeco 23,883 102,161 1,775

So urce: Data fro m B M O Investo rLine website: www.bmo investo rline.co m, Octo ber 31, 2006.

– Ultimately, the accumulated value in the pension can Ultimately, the accumulated value in the pension can

be used by the person in retirement.

– – Pension plans accumulate considerable sums of Pension plans accumulate considerable sums of –

– Pension plans accumulate considerable sums of Pension plans accumulate considerable sums of money, and their managers invest those funds with long

long term investment time horizons in diversified term investment time horizons in diversified portfolios of investments These investments are a major source of capital, fuelling investment in

research and development, capital equipment, resource exploration and ultimately contributing in a substantial way to growth in the economy.

Financial Intermediaries

Pension Plan Assets

Pension Plan Managers

Net Assets ($ billion)

Table 1-5 Pension Plan Assets, 2005

Pension Plan Managers ($ billion)

Caisse de depot et placement du Quebec 216.1

Ontario Teachers (Teachers) 96.1 Ontario Municipal Employees (OMERS) 41.6

* The Caisse manages the investments o f several pensio n plans.

Financial Intermediaries

Canadian Mutual Fund Assets

•• Mutual funds give small investors access to diversified, Mutual funds give small investors access to diversified, professionally

professionally managed portfolios of securities managed portfolios of securities.

•• Small investors often do not have the funds necessary to Small investors often do not have the funds necessary to invest directly into market

invest directly into market traded stocks and bonds traded stocks and bonds.

•• This is called denomination intermediation because the This is called denomination intermediation because the mutual fund makes investments available in smaller,

mutual fund makes investments available in smaller,

more affordable amounts of money.

•• Canadian indirect investment in the markets through Canadian indirect investment in the markets through

managed products such as mutual funds and segregated funds has grown exponentially

(see Figure 1 (see Figure 1 4 on the next slide) 4 on the next slide)

Financial Intermediaries

Canadian Mutual Fund Assets

FIGURE 1-4

The Financial System

The Major Borrowers

•• Public Debt Public Debt

– – Governments Governments

•• FederalFederal

•• ProvincialProvincial

•• MunicipalMunicipal

•• MunicipalMunicipal

•• Crown CorporationsCrown Corporations

•• Private Debt Private Debt

– – Households Households –

– Non Non financial Corporations financial Corporations

The Financial System

Largest Non Largest Non financial Companies financial Companies

Non-financial Companies

Revenue ($ million)

Assets ($ million)

General Motors of Canada Ltd 34,991 n/a Loblaw Companies Ltd 27,812 13,761 Magna International Inc 22,873 12,321

Table 1-6 Non-Financial Canadian Companies: Financial Statistics, 2005

Magna International Inc 22,873 12,321 Imperial Oil Ltd 26,936 15,582

Financial Instruments

Non Non marketable marketable

•• Characteristics of non Characteristics of non marketable securities marketable securities

between the borrower and the lender)

Financial Instruments

Marketable

issue in public markets and before they mature or expire

the market price per share

shareper

Priceshares

ofNumber tion

Capitaliza

Financial Instruments

Marketable

Markets can be categorized by the time to maturity:

•• Money Market Securities Money Market Securities (for short (for short term debt securities that are term debt securities that are

pure discount notes) – Bankers’ acceptances – Commercial Paper – Treasury Bills

– Treasury Bills

•• Capital Market SecuritiesCapital Market Securities (for long(for long term debt or equity term debt or equity

securities with maturities greater than 1 year)

– Debentures – Common Stock – Preferred Stock

•• Secondary Market Secondary Market

•• Secondary Market Secondary Market

–

– Markets that involve buyers and sellers of existing Markets that involve buyers and sellers of existing securities Funds flow from buyer to seller Seller becomes the new owner of the security (No capital formation occurs)

Financial Markets

Types of Secondary Markets

•• Exchanges or Auction Markets Exchanges or Auction Markets

•• Secondary markets that involve a bidding process that takes Secondary markets that involve a bidding process that takes place in specific location

•• For example TSX, NYSEFor example TSX, NYSE

•• Dealer or Over Dealer or Over the the counter (OTC) Markets counter (OTC) Markets

•• Secondary markets that do not have a physical location and Secondary markets that do not have a physical location and consist of a network of dealers who trade directly with one another

•• For example the bond marketFor example the bond market

Financial Markets

Other Markets

•• Third Market Third Market

•• Trading of securities that are listed on organized exchanges Trading of securities that are listed on organized exchanges

in the Over

in the Over thethe counter marketcounter market

•• Fourth Market Fourth Market

•• Fourth Market Fourth Market

•• Trading of securities directly between investors (usually Trading of securities directly between investors (usually between two large institutions) without the involvement of brokers or dealers

•• Operates through the use of privately owned automated Operates through the use of privately owned automated systems such as

systems such as Instinet Instinet

The Global Financial Community

•• Represents an important source of funds for Represents an important source of funds for

borrowers

•• Provides investors with important alternatives as Provides investors with important alternatives as

•• Provides investors with important alternatives as Provides investors with important alternatives as they seek to build wealth through diversified

portfolios

The Global Financial Community

Total Assets

($ million) 1,016,031

Canadian direct investments abroad 465,058 Canadian portfolio investments 284,604 Portfolio foreign bonds 82,374

Portfolio foreign stocks 189,175 Other portfolio investments 13,055 Other Canadian investments 266,369

Table 1-7 Canada's International Investments, 2005

Allowances Deposits 120,694 Official international reserves 38,030 Other assets 59,319

Foreign direct investments in Canada 415,561 Foreign portfolio investments 508,398 Portfolio Canadian bonds 380,017

Portfolio Canadian stocks 107,598 Portfolio Canadian money market instruments 20,783 Other foreign investments 260,575

Deposits 201,639 Other liabilities 22,829

Canada's Net International Investment Position -168,503

– Major participants in the Canadian financial system, Major participants in the Canadian financial system, including the different types of financial securities and financial markets

INTRODUCTION TOCORPORATE FINANCE

CHAPTER 2

Business (Corporate)

Finance

Lecture Agenda

•• Learning Objectives Learning Objectives

•• Important Terms Important Terms

•• Types of Business Organizations Types of Business Organizations

•• Goals of the Corporation Goals of the Corporation

•• Role of Management and Agency Issues Role of Management and Agency Issues

•• Role of Management and Agency Issues Role of Management and Agency Issues

•• Corporate Finance Corporate Finance

•• Finance Careers Finance Careers

•• Organization of the Finance Function Organization of the Finance Function

•• Sample Problems Sample Problems

financial management of their real and financial assets, as well as the associated corporate financing decisions

and nonand non financial companiesfinancial companies