What is finance

FINANCIAL MANAGEMENT Part 1: An introduction to finance Lecture 1: What is finance? Lecture 1: What is finance? 1.1 Introduction 1.2 Defining finance 1.3 The Firm: a sistemic approach 1.4 Corporate Finance: the financial function 1.5 The financial objective: value creation 1.6 Financial main principles 1.7 Finance: historic evolution 1.8 Main programmes in Finance Lecture 1: What is finance? 1.1 Introduction (1)  I am saving for retirement Should I use a pension fund, mutual fund, direct stock market investment ?  I want that new car Should I use my cash saving, lease, borrow? Which is the best way to pay for my holidays, for my house?  I’m thinking about starting a new business Will it reward me adequately? Marocco has asked for major project financing Should my organization provide the funds? Lecture 1: What is finance? 1.1 Introduction (2) Why study finance? To manage your personal resources To deal with the world of business To pursue interesting and rewarding career opportunities To make informed public choices as a citizen For the intellectual challenge Lecture 1: What is finance? Introduction: Macroeconomic/Spending Sectors • • • • Household Business Firms Government Foreign Sector SURPLUS SPENDING UNITS DEFICIT SPENDING UNITS Lecture 1: What is finance? 1.1 Introduction: Surplus Spending Unit (1) • Has more cash income flow than expenditure on consumption and real investments in a period of time The surplus is then allocated to the financial sector • Other terms for surplus unit are saver, lender, buyer of financial assets, financial investor, supplier of loanable funds, buyer of securities Lecture 1: What is finance? 1.1 Introduction: Surplus Spending Unit (2) • The surplus unit may buy financial assets, hold more money, or pay off financial liabilities issued earlier when in a deficit situation • The household and foreign sectors are usually a surplus sector Lecture 1: What is finance? 1.1 Introduction:Deficit Spending Unit (1) • Has more expenditures on consumption and real goods (investment) in the real sector than income during a period of time • The deficit unit must participate (borrow) in the financial sector to balance cash inflows with outflows Lecture 1: What is finance? 1.1 Introduction:Deficit Spending Unit (2) • Other terms for deficit expending unit are borrower, demander of loanable funds, and seller of securities • The deficit spending unit may issue financial liabilities, reduce money balances, and sell financial assets acquired previously when in a surplus situation Lecture 1: What is finance? 1.1 Introduction:Financial Claims (1) • Contracts related to the transfer of funds from surplus to deficit budget units • Financial claims are also called financial assets and liabilities, securities, loans, and financial investments • For every financial asset, there is an offsetting financial liability • Total receivable equal total payable in the financial system • Loans outstanding match borrowers’ liabilities Lecture 1: What is finance? 1.2 Defining Finance: a new paradigm Definition Finance is the process of transforming existing assets into new, contractual forms, as well as the analytical techniques needed to support this process, for the purpose of wealth creation in modern, capitalistic economies Norton y Scott, “A new Paradigm: the value creation function of finance”, january 2001 Lecture 1: What is finance? 1.2 Defining Finance: the three primary areas of finance • Financial management (Corporate finance) deals with how firms raise and use funds to make short-term and long-term investments • Investment deals with how the securities markets work and how to evaluate and manage investments in stocks and bonds • Financial Markets and Institutions includes the study of the banking system and markets Peterson and Fabozzi FINANCIAL MANAGEMENT Part 1: An introduction to finance Lecture 1: What is finance? (II) Lecture 1: What is finance? (II) 1.1 Introduction 1.2 Defining finance 1.3 The Firm: a sistemic approach 1.4 Corporate Finance: the financial function 1.5 The financial objective: value creation 1.6 Financial main principles 1.7 Finance: historic evolution 1.8 Main programmes in Finance Lecture 1: What is finance? (II) 1.3 The Firm: a sistemic approach Bienes y servicios Commercial Subsistema comercial Subsystem Goods and Services s ce ur o es alr oann s m r PHeu Goods and Services Operations Subsistema de operaciones Subsystem es alr oann s m r Peu H Human Subsistema Resources de recursos Subsystem humanos ou rc Resourses es Subsistema de Management dirección Subsystem y gestión Personnel Personal Subsistema Finance Subsystem de dirección y gestión Resourses Expenses Sales Incomes Dinero Funds Dinero Funds Human PersonalResources Lecture 1: What is finance? (II) 1.4 The Firm: a sistemic approach FINANCIAL SUBSYTEM Planificación Financial Planning Financiera Planificación Financiera Subsistema Management deSubsytem dirección y gestión FINANCING FINANCIACIĨN Demanda Debt de créditos E N T V OI R N O N O M E N T Financiación External Externa Financing INVERSIÓN INVESTMENT Funds Dinero Subsistema Human deRecourses recursos Subsystem humanos Empoloyees Financiación Fixed en activo Assetfijo Subsistema Operations de operaciones Subsystem Securities Valores Financial Mercados Financieros Market es s sroc r u scou Re Autofinanciación Retained earnings Inversión Current en activo circulante Assets Resources Dividendos Dividends Reservas Reserves Impuestos Taxes In Income Benefit Beneficio Amortización Depreciation Subsistema Commercial Subsystem comercial Costs Costes Expenses Lecture 1: What is finance? (II) 1.5 Corporate Finance: the financial function • Corporations face two broad financial questions: - What investments should the firm make? - How should it pay for those investments? Financial managers are concerned with : • Investment Decisions (use of funds): – The buying, holding or selling of types of assets • Financing Decisions (acquisitions of funds) Lecture 1: What is finance? (II) 1.6 Corporate Finance: the financial function INVESTMENT / FINANCIAL SUBSYTEM REAL SYSTEM r FINANCIAL SYSTEM (r>k) INVESTMENT FIRM OPERATIONS (Real goods & services RETURN k FINANCING FINANCIAL MANAGEMENT (CORPORATE FINANCE) FINANCIAL MARKETS REPAYMENT AND RETURN Lecture 1: What is finance? (II) 1.7 The Financial objective: value creation • Goal of management: maximize the economic well-being, or wealth, of the owners (current shareholders) => maximize the price of the stock • Share price today = Present value of all future expected dividends at required return  Max.Share Pr ice max  i 1 di i   1 k   Lecture 1: What is finance? (II) 1.8 The Financial objective: value creation • Financial managers must create or generate value for their shareholders • Economic Value Added (EVA) is a measure of a company's financial performance based on the residual wealth calculated by deducting cost of capital from its operating profit (adjusted for taxes on a cash basis) • The formula for calculating EVA is as follows: EVA = Net Operating Profit After Taxes - (Capital * Cost of Capital) Lecture 1: What is finance? (II) 1.9 Financial main principles • • • • • • • • • • • Rational Financial behavior Risk aversion Budgetary diversification Existence of two parts in all financial transaction Measurement by cash flows Signaling and informative asymmetry Efficiency of financial markets Direct relation of risk and return Existence of valuable ideas Financial conduct initiative The Time Value of the money and value additivity Lecture 1: What is finance? (II) 1.10 Finance: historic evolution Principles of century XX: Beginning of the research in finance EVENTS - Expansion of the Years 20 - The 29 Crises - Economy military of the 40 - Expansion of the 50 - Crises of the petroleum of the 73 Finance at the present Lecture 1: What is finance? (II) 1.10 Finance: historic evolution 2000- 1980- 1970- 1950- A p p r o a c h Markets Efficiency Paradigm years 70 1990- M o d e r n Financial Innovation Chaos Theory, Non Linear Dynamics Methods based on Fuzzy Sets Theory (Kaufmann y Gil, 1986-87) y Options Valuation Models (Black y Scholes, 1973) eor h T y nc ion Age ormat APT Model y r In f o CAPM (widening and reformulation) (Ross, 1970) Efficient T he Market Financial Structure Capital Assets Pricing Theory (Modigliani, Miller, Model (CAPM) (Sharpe, 1958) (Fama, 1963-4, Lintner, 1965) Portfolio selection 1970) Dividends Policy (Modigliani, Miller, Theory (Markowitz, 1952,1959) 1963) Classical Approach 1900- Behavioral finance Lecture 1: What is finance? (II) 1.11 Main programmes in finance • • • • • • • • Managements of Investments- Capital Budgeting Capital Structure and Dividend Policy Market Efficiency The Capital Asset Pricing Model Options Theory Agency Theory Financial Planning Small Firms Lecture 1: What is finance? Bibliography • Kidwell, Peterson, Blackwell, Whidbee: Financial Institutions, Markets, and Money, Eighth Edition, John Wiley & Sons, 2003 • Fabozzi, Modigliani: Capital Markets Institutions and Instruments Prentice Hall, 2003 • Bodie, Zvi and Merton, Robert C.: Finance Prentice Hall, 1999 • Pamela P Peterson and Frank Fabozzi: Financial Management and Analysis, 2nd Edition, John Wiley & Sons, 2003 ... 1: What is finance? 1.2 Defining Finance • Finance is analytical • Finance is based on economic principles • Finance uses accounting information as an input for decision-making • Finance is international... Issue Lecture 1: What is finance? 1.2 Defining Finance • What is Finance? • Types of Finance definitions – – – – Lack of any specific definition Raising and spending funds Economic decisions with... introduction to finance Lecture 1: What is finance? (II) Lecture 1: What is finance? (II) 1.1 Introduction 1.2 Defining finance 1.3 The Firm: a sistemic approach 1.4 Corporate Finance: the financial