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01 Introduction

Finance

Finance is the field that deals with value; finance is not about money

Financial system helps transfer money from savers to consumers.

Finance is a child of Economics.

Financial Management is a study of a corporation’s finances. Hence, it is also called as Corporate Finance, Business Finance.

2 variables involed are

  • Time
  • Risk

Goal

Maximize value of company

This is measure by the price of the stock

Financial Decisions (in order of importance)

  • Capital budgeting decisions (most important)
  • Long term investments
  • Purchase of real assets
  • Captial structure decisions
  • Financing decisiosn
  • Sale of financial assets
  • Working capital decisions
  • Liquidity vs Profitability
  • Dividend decisions (Residual of budgeting and structure - not very important)
  • Pay/Retain

Risk vs Uncertainity

For risk, we have known probabilities. For eg, we can estimate inflation, etc

Uncertainity means we have no information.

Usually,

\[ \text{Trade Return} \propto \text{Risk} \]

Securities

is a tradeable asset that gives you claim over something.

Risk-Free
(Future cash flows guaranteed)
Tradeable
Loan ✅ ❌
Bond âś… âś…
Share ❌ ✅

Ownership Forms

Form Sole Proprietorship Partnership Company/
Corporation/
Limited Liability Company
No of owners 1 \(\ge 2\) \(n\)
(includes shareholders)
Ease of starting Easy Intermediate Difficult
Regulations Low Low High
Keeping profits All Part Partial
Ease of Valuation Difficult Difficult Easy
Life length life of owner life of owners Unlimited
Equity capital Limited to owner’s personal wealth Limited to owners’ personal wealth
Liability Unlimited Unlimited Limited to investment of investor
Ease for transfer of ownership Difficult Difficult Easy
Ownership separate from Management ❌ ❌ ✅
Agency Problems ❌ ❌ ✅
Taxation Single* Single* Double

*Taxed only once as personal income (corporate tax is higher than personal)

Agency Problems

Goals of managers different from owners

The manager will be more short-term oriented, in order to boost their portfolio, so that they can move on to a better company

Last Updated: 2024-05-14 ; Contributors: AhmedThahir

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