FIN CH 1

Basic areas of Finance

Corporate finance
Investments
Financial institutions
International finance
Fintech

Corporate finance

basic financial ideas and principles that apply to all types of business not just Corporations

Investments

Financial assets such as stocks and bonds.
concepts such as calculating risk versus return and asset allocation

Job opportunities:
stockbroker or financial advisor
portfolio manager
security analyst

Financial institutions

companies that specialize in financial matters
banks- commercial and investment credit unions savings and loans
insurance companies
brokerage firms

Job opportunities:
Loan Officer
Investment Analyst
Financial Advisor

Fintech

combination of technology and finance
Broad term for a company that uses the internet, mobile phones, software and or cloud services to provide a financial service
Technology can be a differentiator for financial companies

• better beater faster

International Finance

An area of specialization within each of the areas discussed so far
may allow you to work in other countries or at least travel on regular basis
Need to be familiar with exchange rates and political risk
Need to understand the customs of other countries; speaking a foreign language fluently is also helpful

some important questions that are answered using finance:

What long-term investments should the firm take on?

• strategic planning

Where will we get the long-term financing to pay for the investments?

• borrow (bonds) or sell equity (stocks)

How will we manage the everyday financial activities of the firm?

• treasury / cash management

Financial manager

The top financial manager within a firm is usually the Chief Financial Officer (CFO)

• Treasurer

• Controller

Treasurer

oversees cash management credit management capital expenditures and financial planning

Controller

oversees taxes cost accounting financial accounting and data processing

Financial management decisions

capital budgeting

• what long-term investments or projects should the business take on?

capital structure

• how should we pay for our assets?

• should we use debt or equity?

working capital management

• how do we manage the day-today finances of the firm?

3 major forms of business organizations in the US

Sole proprietorship

Partnership

• general

• limited

Corporation

• limited liability company (LLC)

• subchapter S corporation (pass-through corporation)

• benefit corporation (B Corp)

Sole proprietorship

business owned by one person

advantages:

• easiest to start

• least regulated

• single owner keepers all of the profits

• taxed once as personal income

disadvantages

• limited to life of owner

• equity capital limited to owner’s personal wealth

• unlimited liability

• difficult to sell ownership interest

partnership

business owned by two or more persons

advantages:

• two or more owners

• more capital available

• relatively easy to start

• income taxed once as personal income

disadvantages:

• unlimited liability

• general partnership

• limited partnership (has limited liability)

Partnership dissolves when one partner dies or wishes to sell. Difficult to transfer ownership

corporation

a legal “person” distinct from owners and a resident of a state

advantages:

• limited liability

• unlimited life

• separation of ownership and management

• transfer of ownership is easy

• easier to raise capital

disadvantages:

• separation of ownership and management (agency problem)

• double taxation (income taxed at the corporate rate and then dividends taxed at personal rate while dividends paid are not tax deductible)

S corporation (Tax Efficiency)

Core purpose:

maximize tax savings for small-to-medium businesses

Taxation:

pass-through entity; business income losses deductions and credits pass directly to shareholders’ personal tax returns

Ownership restrictions:

shareholders must be U.S. citizens or permanent residents

allowed only one class of stock

Best for:

privately held profit-focused companies looking to reduce self-employement taxes

B corporation (purpose & impact)

core purpose: expand fiduciary duty to balance profit with purpose (people planet profit)

legal vs. certified:

• Benefit Corporation: a legal corporate entity recognized by most U.S. states requiring directors to consider environmental and social stakeholders

• Certified B Corp: a private designation awarded by the non-profit B Lab based on performance and transparency audits

Taxation: taxed as a standard C Corp by default but can elect S corp tax status if qualified

Best for: mission-driven companies seeking public accountability, ESG investor alignment, and brand differentiation

Goal of Financial management

maximize the market value of the existing owners’ equity

Sarbanes-Oxley Act (SOX 2002)

driven by corporate scandals

• enron tyco worldcom adelphia

Intended to strength production against accounting fraud malpractice

compliance very costly

firms driven to:

• go public outside the US

• go private (“go dark”)

Agency relationship

Principal hires an agent to represent its interests
Stockholders (principals) hire managers (agents) to run the company

Agency problem

conflict of interest between principal and agent

management goals and agency costs

do managers act in the shareholders’ interests?

managerial compensation

• incentives can be used to align management and stockholder interests

• incentives need to be carefully structured to ensure that they achieve their goal

Corporate control

• threat of a takeover may result in better management

Other stakeholders

primary market

original sale of securities by governments and corporations

the corporation is the seller and the transaction raises money for the corporation

2 types of primary market transactions:

public offerings and private placements

secondary market

securities are bought and sold after the original sale
involves one owner or creditor selling to another (transferring ownership of corporate securities)

2 types of secondary markets: auction markets and dealer markets

dealer markets

dealers buy and sell for themselves at their own risk

dealer markets in stocks and long-term debt are called over-the-counter (OTC) markets

many dealers are connected electronically

auction markets

has a physical location
the primary purpose of an auction market is to match those who wish to sell with those who wish to buy
dealers play a limited role

The largest auction market in US

New York Stock Exchange (NYSE) which accounts for more than 85% of all shares traded in auction markets

Large OTC market for stocks

Nasdaq (NASD Automated Quotations system)

there are more companies listed on here than on nyse but they tend to be smaller in size and trade less actively