49 1 5MB
PRINCIPLES OF FINANCE TCH 302
Lecturer: Chu Mai Linh, Ms. Email: [email protected]
Introduction to Finance
1
ASSIGNMENTS & ASSESSMENTS • ATTENDANCE Attendance is compulsory in accordance with FTU regulations. Students are strongly advised not to miss lecture hours since success is closely related with attendance. • ASSIGNMENTS & ASSESSMENTS % Contribution
Form of Assessment
10% of the final mark 30% of the final mark
Attendance Examination
60% of the final mark
Examination
Size of the assessment Duration
Feedback method
45 minutes (4 pages) Multiple Choices and Short answer questions
Correct answers
60 Minutes
Correct answers
Introduction to Finance
2
TEXTBOOKS 1. The Economics of Money, Banking, and Financial Markets, Frederic S. Mishkin, 11th edition, 2016
2. Money, Banking and Financial Markets, Stephen G. Cecchetti and Kermit L. Schoenholtz, 5th edition, 2017
3. Finance: Applications and Theory, Marcia M. Cornett, 2nd edition, 2012
Introduction to Finance
3
SYLLABUS PLAN Modules
Compulsory readings
1 Introduction to Finance
Mishkin, Chapter 1 Cecchetti, Chapters 1,2 & 3 Cornett, Chapter 1
2 Financial Statements 3 Analyzing financial statements
Bodie, Chapter 3 Cornett, Chapters 2 & 3 Bodie, Chapters 4 & 5,8 & 9 Mishkin, Chapter 4 Cornett, Chapters 4 & 5
4 Time Value of Money 5 Understanding Financial Markets and Institutions
Mishkin, Chapters 1,2,3 & 8 Cecetti, Chapter 11 Cornett, Chapter 6,7 & 8
Introduction to Finance
4
INTRODUCTION TO FINANCE
Mishkin, Chapter 1 Cecchetti, Chapters 1,2 & 3 Cornett, Chapter 1 Introduction to Finance
5
Content 1. Defining Finance 2. Why study Finance? 3. Financial Functions 4. Business Organization 5. Firm Goals 6. Financial Markets, Intermediaries and the Firm 7. The Financial System 8. Six Parts of the Financial System 9. Flows of Funds through the Financial System
Introduction to Finance
6
Finance in Business and in Life Example #1 • Lucas has a plan to provide an online learning platform for students. He has finally designed the websites and feels that he is offering a perfect educational service, combining tutorial and selflearning. As the result, his business runs well and starts bringing some profits. Lucas would like to invest more in this website and expand the customer base. Lucas needs more money to upgrade the technology and hire and train more people. • How can he get the capital he needs to expand?
Introduction to Finance
7
Finance in Business and in Life Example #2 • Song is interested in finance and would like to invest some money in stocks. However, she has heard about loss and failure of the corporations. In the past years, Song learned about the delisting of CotecLand (2021), the bankruptcy cases of Lehman Brothers (2008). These firm stockholders lost their entire money in these firms. • Song would like to know what guarantee she has as an investor against losing her investment.
Introduction to Finance
8
Defining Finance
• Type 2 = individual investors • Type 3 = corporations or other types of companies
Introduction to Finance
9
Defining Finance • Return of capital to investors
-----------------------------------------------------------------• Not all of the cash will return to the investors
Introduction to Finance
10
Defining Finance • Investments
---------------------------------------------------------------• Financial managements
Introduction to Finance
11
Defining Finance
Investments
• methods and techniques for making decisions about: • what kinds of securities to own, which firms’ securities to buy, • and how to pay the investor back in the form that the investors wishes (e.g., the timing and certainty of the promised cashflows).
Introduction to Finance
12
Defining Finance
Financial Management • deals with a firm’s decisions in acquiring and using the cash that is received from investors or from retained earnings.
Introduction to Finance
13
Defining Finance
Financial Management 1. How to or organize the firm in a manner that will attract capital 2. How to raise capital (e.g., bonds versus stocks). 3. Which projects to fund. 4. How much capital to retain for ongoing operations and new projects. 5. How to minimize taxation. 6. How to pay back capital providers. Introduction to Finance
14
Defining Finance
Financial Institutions and Markets • The organization that facilitate the flow of capital between investors and companies. • e.g.: banks, insurance companies, stock companies, mutual funds
Introduction to Finance
15
Defining Finance
International Finance The use of finance theory in a global business environment. e.g.: law, risks and business relationships across different countries
Introduction to Finance
16
Defining Finance • Finance is the study of applying specific value to things we own, services we use, and decision we make. • E.g.: shares of stock in a company, payments on a home mortgage, the purchase of an entire firms.. • In finance, cash flow is the term that describes the process of paying and receiving money.
Introduction to Finance
17
Cash flows are not guaranteed! • Future cash flows are uncertain in term of timing and size, and we refer to this uncertainty as risk. • E.g.: investors experience risk about the return of the capital. • Comparing rewards with risks involves assessing the value today of cash flows that we expcect to receive in the future.
Introduction to Finance
18
Finance vs Accounting • In the most companies, the financial function is usually closely associated with the accounting function. Accountant’s job what happened in the past
Finance job historical figures + current information what should happen now and in the future with the firm’s money.
Introduction to Finance
19
Why study Finance? Example #3 • Suppose you have some savings money. What kinds of financial assets should you choose these days?
Introduction to Finance
20
Why study Finance? 1. To manage your personal resources (e.g. to borrow money to buy a new car, to refinance your shop house at a lower rate…) 2. To deal with the world of business 3. To pursue interesting and rewarding career opportunities 4. To make informed public choices as a citizen 5. To expand your mind Introduction to Finance
21
Financial Decisions
1. Financial decisions of households 2. Financial decision of firms 3. Financial decision of government
Introduction to Finance
22
Financial decisions of households Households face 4 basic types of financial decision: • 1. Consumption and saving decisions • 2. Investment decisions • 3. Financing decisions (if they borrow, they incur a liability = debt, • Their wealth or net worth = assets – liabilities) • 4. Risk-management decisions
Introduction to Finance
23
Financial decision of firms The branch of finance dealing with financial decisions of firms is called business finance or corporate finance. • Capital budgeting process such as whether to build a plant or produce a new product. • Capital structure decision such as how much debt and how much equity it should have in its capital structure. • Working capital management, such as whether it should extend credit to customer or demand cash on delivery. Introduction to Finance
24
Financial decision of government • A government budget is a government document presenting the government's proposed revenues and spending for a financial year that is often passed by the legislature (parliament", "congress", and "assembly“)- Government budgets are of three types: • Balanced Budget: when government revenue and expenditure are equal. • Surplus Budget: when anticipated revenues exceed expenditure. • Deficit Budget: when anticipated expenditure is greater than revenues.
Introduction to Finance
25
The Financial Function • How the financial function fits in and interacts with other areas of the firm?
Introduction to Finance
26
The Financial Function • Finance affects the firm in many ways and throughout all levels of a company’s organizational chart, providing guidance for both strategic and day-to-day decisions of the firm and collecting information for control and feedback about the firm’s financial decisions.
Introduction to Finance
27
Financial Manager (CFO) • Both the company treasurer and the controller report to the chief financial officer.
Introduction to Finance
28
Business Organization • The number of owners is the key to how business structures are classified. • Who controls the firm. • Who owns the firm. • What the owners’ risks are • What access to capital exists. • What the tax ramifications are. Introduction to Finance
29
Business Organization
Introduction to Finance
30
Business Organization
Types of U.S firms
Source: www.irs.gov, 2017
Introduction to Finance
31
Business Organization
Corporations
• A public corporation is legally independent entity that completely separate from its owners. Limited liability Double taxation
Introduction to Finance
32
Business Organization
Corporations
• Double taxation You are a shareholder in a corporation. The corporation earns $5 per share before taxes. After it has paid taxes, it will distribute the rest of its earnings to you as a dividend. The dividend is income to you, so you will then pay taxes on these earnings. The corporate tax rate is 40% and your tax rate on dividend income is 15%. How much of the earnings remains after all taxes are paid?
Introduction to Finance
33
Business Organization
Puzzles
1. Why must an entrepreneur give up some control of the business as it grows into a public corporation? 2. What advantages doe the corporate form of organization hold over a sole proprietorship?
Introduction to Finance
34
Firm Goals • To maximize shareholder wealth vs to maximize total satisfaction of all stakeholders in a business. • Maximizing owners’ equity can also stated as maximizing the current value per share, or stock price of existing shares. • Common alternatives goals are: o income or profit o costs o market share. Introduction to Finance
35
Firm Goals
Puzzles
• Are these the same goals? Please explain your answer.
Introduction to Finance
36
Agency Theory • Whenever one party (the principal) hires someone else (the agent) to work for him/her, their interaction is called an agency relationship.
Introduction to Finance
37
Agency Problem • Because of the separation of ownership and control in a corporation, managers have little incentive to work in the interests of the shareholders when this means working against their own self-interest.
• Solutions: o To ignore it. Corporate Governance
o To monitor managers’ actions o To align managers’ personal interest with those of owners (e.g.: options, employee stock options plan ESOP) Introduction to Finance
38
Corporate Governance • A set of laws, policies, incentives, and monitors designed to handle the issues arising from the separation of ownership and control. • CG balances the needs of shareholders and managers.
Introduction to Finance
39
Financial markets, Intermediaries and the Firm
Introduction to Finance
40
Financial System • Financial system is defined as the set of markets and other institutions used for financial contracting and exchange of assets and risks. • The financial system includes markets, stocks, bonds and other financial instruments, financial intermediaries and the regulatory bodies that govern all of these institutions.
Introduction to Finance
41
Six Parts of the Financial System 1.Money 2.Financial Instruments 3.Financial Markets 4.Financial Institutions 5.Regulatory Agencies 6.Central Bank
Introduction to Finance
42
Money • Money is the medium of exchange and to store value • Money is at the heart of the payments system. ………………………………………………………………. • What is the difference between wealth and income? • What about liquidity? Introduction to Finance
43
Financial Instruments • The written legal obligation of one party to transfer something of value, usually money, to another party at some future date, under certain conditions.
Introduction to Finance
44
Financial Instruments 1. Financial instruments act as a means of payment (like money). Employees take stock options as payment for working. 2. Financial instruments act as stores of value (like money). Financial instruments generate increases in wealth that are larger than from holding money. Financial instruments can be used to transfer purchasing power into the future. 3. Financial instruments allow for the transfer of risk (unlike money). Examples: Insurance contracts, future contracts.
Introduction to Finance
45
Examples of financial instruments • The basic types of financial assets are debt, equity and derivatives. • Debt instruments are issued by anyone who borrows money: corporate bonds, government bonds, residential and commercial mortgages and consumer loans. • Derivative instrument are those where their value and payoffs are “derived” from the behaviors of the underlying. • Underlying instruments are used by saver/lenders to transfer resources directly to investors/borrowers.
Introduction to Finance
46
Features of Financial Instruments • These contracts are very complex. This complexity is costly, and people do not want to bear these costs. • Standardization of financial instruments overcomes potential costs of complexity. Most mortgages feature a standard application with standardized terms. • Introduction to Finance
47
Features of Financial Instruments • Financial instruments also communicate information, summarizing certain details about the issuer. • Financial instruments are designed to handle the problem of asymmetric information.
Introduction to Finance
48
Financial Markets Financial markets are places where financial instruments are bought and sold. • These markets are the economy’s central nervous system. • These markets enable both firms an individuals to find financing for their activities. • These markets promote economic efficiency. They ensure resources are available to those who put them to their best use. They keep transactions costs low.
Introduction to Finance
49
Stock Market Indexes
Introduction to Finance
50
Financial Institutions • Firms that provide access to the financial markets, both to savers who wish to purchase financial instruments directly and to borrowers who want to issue them. • Also known as financial intermediaries. ▫ Examples: commercial banks, investment banks, insurance companies, securities firms, and pension funds. Introduction to Finance
51
Government regulatory agencies • Government regulatory agencies provide wide-ranging financial regulation – rules and supervision. Increasing Information Available to Investors Ensuring the Soundness of Financial Intermediaries (Restrictions on Entry, Disclosure, Restrictions on Assets and Activities, Deposit Insurance, Limits on Competition, Restrictions on Interest Rates)
Introduction to Finance
52
Government regulatory agencies
Introduction to Finance
53
Central banks • Central banks began as large private banks to finance wars. • Central banks control the availability of money and credit to ensure low inflation, high growth and stability of financial system
Introduction to Finance
54
Flow of Funds Through the Financial System
Introduction to Finance
55
Flow of Funds Through the Financial System
Introduction to Finance
56
Summary A healthy and constantly evolving financial system is the foundation for economic efficiency and economic growth. It has six parts: 1. Money is used to pay for purchases and to store wealth. 2. Financial instruments are used to transfer resources and risk. 3. Financial markets allow people to buy and sell financial instruments. 4. Financial institutions provide access to the financial markets, collect information and provide a variety of other services. 5. Government regulatory agencies aim to make the financial system operate safely and reliably. 6. Central banks stabilize the economy.
Introduction to Finance
57
SYLLABUS PLAN Modules
Compulsory readings
1 Introduction to Finance
Mishkin, Chapter 1 Cecchetti, Chapters 1,2 & 3 Cornett, Chapter 1
2 Financial Statements 3 Analyzing financial statements
Bodie, Chapter 3 Cornett, Chapters 2 & 3 Bodie, Chapters 4 & 5,8 & 9 Mishkin, Chapter 4 Cornett, Chapters 4 & 5
4 Time Value of Money 5 Understanding Financial Markets and Institutions
Mishkin, Chapters 1,2,3 & 8 Cecetti, Chapter 11 Cornett, Chapter 6,7 & 8
Financial Statements
1
REVIEWING FINANCIAL STATEMENTS
Bodie, Chapter 3 Cornett, Chapters 2 & 3
Financial Statements
2
Content 1.Balance Sheet 2.Income Statement 3.Statement of Cash Flows 4.Free Cash Flow 5.Statement of Retained Earnings
Financial Statements
3
Looking for a perfect company
• Song wants to invest in DPH Tree Farm Inc. Song has a set of recent financial statements from DPH Tree Farm’s annual report but is not sure how to read them or what are the meanings of all these numbers and reports. • What are the four financial statements? • What information can she gets from these statements? Financial Statements
4
An annual report • Four basic financial statements: 1. The balance sheet 2. The income statement 3. The statement of cash flows 4. The statement of retained earnings • A financial statement provides an accountingbased picture of a firm’s financial position.
Financial Statements
5
The balance sheet • Assets = Liabilities + Equity
Financial Statements
6
Financial Statements
Balance Sheet
7
Net working capital
• Net working capital = Current assets – Current liabilities
Financial Statements
8
Book vs Market Value • Balance Sheet shows its book (or historical cost) value based on generally accepted accounting principles. • Because of inflation and market forces, many assets are more worth now thatn they were worth when the firm bought them. • Book values can differ widely from market values for the same assets. Financial Statements
9
Computing Book vs Market Value • D2K Inc. lists fixed assets and current assets of $25 million and $10 million respectively on its balance sheet. The firm’s fixed assets and current assets were recently appraised at $32 and $ 11 million respectively. • The current liabilities’ book and market values stand at $6 million and the firm’s long-term debt is $15 million. • What are the book value and market value of the firm’s shareholders equity? Construct the book value and market value balance sheet for D2K Inc. Financial Statements
10
Income Statement
Financial Statements
11
Some equations 1. EPS 2. DPS 3. BVPS
4. MVPS = Market price of the firms’ common stock
Financial Statements
12
Financial Statements
Income Statement
13
Corporate Income Taxes • Corporate Tax Rates as of 2012
• The U.S tax structure is progressive, meaning that the larger the income, the higher the taxes assessed. Financial Statements
14
Average Tax Rate vs Marginal Tax Rate • Average tax rate = • Marginal tax rate is the additional taxes a firm must pay out for every additional dollar of taxable income it earns.
Financial Statements
15
Calulating the tax rate • E.g: Antonio Inc. earned $17 mill taxable income (EBT) in 2012. Use the tax schedule to compute the firm’s 2012 tax liability, its average tax rate and its marginal tax rate.
Financial Statements
16
Effect of Debt vs Equity Financing on Returns • Supposed you wonder between two alternative investments (in Firm A or Firm B). Both are active in the same industry and have identical operating incomes of $10 million. Firm A finances its $24 million in assets with $22 million in debt (on which it pays 10% interest) and $2 million in equity. Firm B finances its $24 million in assets with $24 million in equity and no debt. Both firm has pay 30% tax on their taxable income. • Calculate the income that each firm has available to pay its debt and shareholders and the ROEs. Financial Statements
17
The Statement of Cash Flow • Financial managers and investors are far more interested in actual cash flows than in the backwardlooking profit listed on the income statement. • A financial statement that shows the firm’s cash flows over a given period of time.
Financial Statements
18
The Statement of Cash Flow
Financial Statements
19
The Statement of Cash Flow
Financial Statements
20
Financial Statements
Statement of Cash Flows
21
Free Cash Flow • The cash that is actually available for distribution to the investors in the firm after the investments that are necessary sustain the firm’s ongoing operations are made.
Financial Statements
22
Computing FCF • What was DPH Tree Farm’s free cash flow for 2012?
Financial Statements
23
Statement of Retained Earnings • Increases in retained earnings occur not just because a firm has net income, but also because the firm’s common shareholders agree to let management reinvest net income back into the firm rather than pay it out as dividends. • Reinvesting net income back into retained earnings allows the firm to grow by providing additional funds that can be spent on plant and equipment, inventory, and other assets needed to generate even more profit. Financial Statements
24
Financial Statements
Statement of Retained Earnings
25