Finance Coperations and principles
Finance
Principle of finance
• money has a time value
• There is a risk - return trade off
• Cash glow are the source of value
Principle 1 money has a time value
• A dollar recieved to today is worth more than a dollar recieved in a year.
A firms investing decision is called its capital budgeting desicion
What is a cooperation - a company owned by shareholders.
Public or private
How are they run?
Shareholders vote to select the members of the board of directors
BOD represent the interest of shareholders and they apppoint a management such as CEO
How they raise money?
RyBank loan = debt financing
Sell stocks = equity financing
Principle 2 - There is a risk - return trade off
,rinciple
Principle 3 - Cash flows are the source of value
Cash flow is the amount of cash that can actually be tacked out of the business
What is the study of finance?
Finance refers to money related transactions and to the performance of decisions that consumers, businesses and governments make.
Two key ideas Knowledge exists to price in the consequences of decisions, and that decisions shall lead to maximize financial performance
What are corporations?
• Legal entity, owned by shareholders
• Can make contracts, carry on business, borrow, lend, sue and be sued
• Corporations can be public or private
• A Large public cooperation may have hundreds of thousands of shareholders.
• Seperation of owner ship and management
• Limited liability
• Profits taxed at cooperate or individual level
• Life potentially unlimited
• Financing not limited by owners resources
Principle 4 - individuals responds to incentives
Stakeholders respond to incentives they are given in the cooperate world
Shareholders are stakeholders but not all stakeholders are shareholders
What is cooperate governance?
• The system of rules practices and processes by which companies are directed and controlled.
• Involves balancing the interests of a company’s many stakeholders
• Sets out the rules, controls, policies and resolutions to dictate corporate behaviour.
• A key responsibility of the board of directors is to ensure that the corporation is governed appropriately
• Includes the process through which a company’s objectives are set and pursued.
Why corporate governance?
• A toolkit for management and the BOD to deal more effectively with the challenges
• Ensures to have appropriate desicion making process and controls in place so that the interest of all stakeholders (shareholders, employees, suppliers, customers and the community) are balanced.
• Set of procedures make sure that a company is run in such a way that it achieves its objectives, while keeping stakeholders confidence and trust.
Shareholders monitor, but their power can be limited…
And so additional devices help to control cooperations for stakeholders su as
The board of directors
➢The large shareholders (blockholders, these are institutions such as pension funds and insurance companies)
➢auditors (objective, external control)
➢creditors (control on cash inflow)
➢regulators (compliance of rules and regulations of the financial market and system)
The financial market itself since corporations are exposed to market effects, and ownership can be traded
Management compensation and incentives to align managerial and shareholder objectives
… And they all respond to incentives!
Agency theory - everyone acts in their own interest.
It is all about making sure that the agents act in the best interest of the principals, making sure that the interest of the principals and the agents are aligned.
If the incentives are not properly aligned managers may make decisions inconsistent to increasing shareholder value, leading to agency cost
Managers do not attempt to maximize firm value.
Shareholders incur cost to monitor managers and constrain their actions.
Role of corporate governance is to minimize the costs
Principle 5 Market prices reflect information
Investors respond to new information by buying and selling their investment.
What is a financial system
• set of actors that maintain transactions. Permit the exchange of funds
• Exists on corporate, regional and global levels
Also includes sets of rules and practices to conceptualize, control and coordinate transactions.
Role of the financial system: to maintain money flow
What is the toolset of the financial system to maintain money flow
A sophisticated payment mechanism.
• Allows individuals to make and receive payments quickly and safely over long distances
two main mechanism Borrowing and lending
• A distribution channel of savings toward investments (lenders to borrowers)
Pooling risk
• Allows individuals to share risk , insurance companies
Provides information
• Allows estimations of expected rates of return
Discount rate is r
Discount factor is 1/(1+R)t
Problem solving model
1. Picture the problem, list what you know
2. Decide on the solution strategy, list what you have
3. Apply the techniques and solve the problem
4. Conclude, interpret results
Huddle rate: minimum acceptable rate of return on investments for shareholders
Shall match opportunity cost of capital, which depends on the investments opportunities available in financial markets
FV = Co * (1+R)^t
Co is the cash flow today at time zero
Role of a financial manager
Include the following
• Financing decision - making sure the company has enough cash to run its day to day operations.
• Capital budgeting decision - choosing which companies/ projects to invest in
• Re invest additional funds
Financial asset are claims held by investors
Agency issues
Why might one expect managers to act in shareholders interest?
• Legal duty
• Receive compensation for company’s performance
• Fear reputational damage from not acting in investors interest
• Fired by BOD, who is hired by shareholders
• Shareholders sell shares creating a potential takeover.
Managers that are insulated from takeovers may be more prone to agency problems and therefor act in their own interest. A new takeover defense makes the firm seem week and shares decline as agency problems increase.