Chapter 1: What is Finance?

Sole proprietorship

Advantages: Easiest to start, least regulated, single owner keeps all of the profits, and taxed once as personal income Disadvantages: Limited to life of owner, equity capital limited to owner's personal wealth, unlimited liability, and difficult to sell ownership interest.

Stock price and intrinsic value

In equilibrium, a stock's price should equal its 'true' or intrinsic value. Intrinsic value is a long-run concept. To the extent that investor perceptions are incorrect, a stock's price in the short run may deviate from its intrinsic value. Ideally, managers should avoid actions that reduce intrinsic value, even if those decisions increase the stock price in the short run.

If a client had the following needs, which would be the best business type: Flow through of expenses and profits Protection of personal assets

Limited liability company

Stockholder-manager conflicts

Managers are naturally inclined to act in their own best interests (which are not always the same as the interest of stockholders). The following factors affect managerial behavior: managerial compensation packages, direct intervention by shareholders, the threat of firing, and the threat of takeover.

Goal of Business/Corporate Finance

Maximize the current value per share of the company's existing stock. Maximize the market value of the existing owners' equity.

Financial Legislation

Sarbanes-Oxley Act - 2002 Established Public Company Accounting Oversight Board and requires enhanced auditing of public corporations. Dodd-Frank Wall Street Reform and Consumer Protection Act - 2010 Improved oversight of financial institutions and created the CFPB (Consumer Financial Protection Bureau).

Forms of Business Orginizations

Sole Proprietorship Partnership (general or limited) Corporation (limited liability company, s-corp, or c-corp)

Finance

A broad term that describes activities associated with banking, leverage or debt, credit, capital markets, money, and investments. Encompasses the oversight, creation, and study of money, banking, credit, investments, assets, and liabilities that make up financial systems.

Real Estate

Deals with the acquisition, use, and disposition of real estate (a tangible asset). Job opportunities include analysts, brokers, and developers.

Corporate Finance

Focused on maximizing shareholder value through long and short-term financial planning in corporations. Deals with how corporations' funding sources, capital structure, and investment decisions. Job opportunities include analysts and CFO

Personal Finance

Focuses on the individual and household level financial decision making in the following areas: cash flow and debt management, insurance, taxes, investments, estates planning, charitable giving. Job opportunities include financial planners or advisors, financial coaches or counselors, and financial therapists.

Corporation

Advantages: Limited liability, unlimited life, separation of ownership and management, transfer of ownership is easy, and easier to raise capital. Disadvantages: Separation of ownership and management (agency problem) and double taxation (income taxed at the corporate rate and then dividends taxed at personal rate, while dividends paid are not tax deductible).

Partnership

Advantages: Two or more owners, more capital available, relatively easy to start, and income taxed once as personal income. Disadvantages: Unlimited liability (general or limited partnership), partnership dissolves when one partner dies or wishes to sell, and difficult to transfer ownership.

Agency Problem

Agency relationship The principle is that they hire an agent to represent their interest(s). An example would be stockholders (principles) hire managers (agents) to run the company. Agency problem is the conflict of interest between principle and agent. Increases costs to manage/reduce the agency problem.

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 a 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.

Financial Managers

Attempt to answer questions around long-term investments, day-to-day financing strategies, and value creation. Capital budgeting Capital structure Working capital management

Financial Institutions

Companies that specialize in financial matters such as banks (commercial and investment, credit unions, savings, and loans), insurance companies, brokerage firms. Job opportunities include commercial bankers, bank managers, loan analysts, treasury analysts, and investment bankers.

Areas of Finance

Corporate finance Investments Financial Institutions International Finance Real Estate Personal Finance

Stockholder-debtholder conflict

Stockholders are more likely to prefer riskier projects, because they receive more of the upside if the project succeeds. By contrast, the bondholders receive fixed payments and are more interested in limiting risk. Bondholders are particularly concerned about the use of additional debt. Bondholders attempt to protect themselves by including covenants in bind agreements that limit the use of additional debt and constrain managers' actions.

Balancing shareholder interest and society interests

The primary financial goal of management is shareholder wealth maximization, which translates to maximizing stock price. Value of any asset is present value of cash flow stream to owners. Most significant decisions are evaluated in terms of their financial consequences. Stock prices change over time as conditions change and as investors obtain new information about a company's prospects. Managers recognize that being socially responsible is not inconsistent with maximizing shareholder value.

Investments

Work with financial assets such as stocks and bonds Value of financial assets, risk versus return, and asset allocation Job opportunities include stockbrokers, portfolio managers, and security analyst