Finance

Course objectives
to give an introduction to corporate finance, providing a pre-requisite for Corporate Finance course
to provide an understanding of the most important concepts and issues of corporate finance at a level that is approachable for a wide audience
to develop basic skills of making financial decisions in accordance with the concept of time value of money.

Schedule of classes
Class 1. Tuesday, September, 4th, 13.00-16.15
Class 2. Wednesday, September, 5th, 13.00-16.15
Class 3. Friday, September, 7th, 13.00-16.15
Class 4. Saturday, September, 15th, 14.45 -16.30
Final exam: Saturday, September, 15th, 16.30 – 17.15

Individual consultation
Friday, September, 7th, 16.30-17.30 (room TBA)

Course content
Topic 1. Introduction to Finance. Overview of Сorporate Financial Decisions.
Topic 2. Financial Statements and Cash Flows.
Topic 3. Discounted Cash Flow Analysis and Present Value Concept.
Topic 4. Essentials of Investment Evaluation.

Grading system

Required textbook
S. A. Ross, R. W. Westerfield, B. D. Jordan. Essentials of Corporate Finance. 6-th or 7-th ed. McGraw Hill, 2008 or 2010.
Additional textbook
F. J. Fabozzi, P. Peterson Drake. Basics of Finance: An Introduction to Financial Markets, Business Finance, and Portfolio Management. Ch. 1, 2, 4, 5, 10, 12, 13. (available online in EBRARY Academic Complete database).

Introduction to Finance. Overview of Сorporate Financial Decisions.
Topic 1

Content
Introduction.
Areas of finance.
Corporation and financial manager. The goal of financial management. Corporate financial decisions.
Financial system and financial markets.
Money and capital markets.
Types of financial instruments.
Financial instruments issued by a corporation: commercial papers, bonds and stocks.

Origin of the word “finance”
Two versions:
medieval Latin language (XIII-XIV centuries) contained words finatio, financia meaning “obligatory payment”;
in English language the word is alleged to be derived from the word fine (XI century) which was the synonym of tax.

Finance: evolution of meaning
XVIII century – mid-XX century – “finance” meant
funds of the state;
since mid-XX century – “finance” also covers the area of financial decisions made by corporations and individuals.
.

What is finance?
Finance can be defined as the art and science of managing money [Gitman, 1989].
Finance is concerned with the process, institutions, markets, and instruments involved in the transfer of money among individuals, businesses and governments.
.

Main areas of finance
Public
Corporate or business
Personal
.

Basic types of business organization
Sole proprietorship
Partnership
general partnership
limited partnership
Corporation
.

Basic types of business organization: sole proprietorship
Strengths:
Easy to create
Owner receives all profits
Low organizational costs
Flexible
Weaknesses:
Owner has unlimited liability for proprietorship’s debts
Limited life cycle
Low fund-raising power
.

Basic types of business organization: partnership
Strengths:
Easy and inexpensive to form
Weaknesses:
Owners (general partners) have unlimited liability for partnership’s debts
Limited life cycle due to difficulties to transfer ownership
.

Characteristics of corporation
Separate legal entity
The shareholders have a limited liability for the business debts
It’s difficult to create:
Articles of incorporation
Set of bylaws
Separation of ownership and management
ownership can be relatively easily transferred
Provides an ample opportunity to raise capital
Main disadvantage: possible mismatch between objectives of managers and shareholders (agency problem).
.

Corporate financial decisions
Financing decision – where is money going to come from
Investment decision – how much to invest and in what assets
Operations
Investors
Financial Manager
Investments
Financing

Functions of Financial Manager
Operations (plants, equipment, projects)
Financial Manager
Investors
1b.Raising funds
2.Investments
3.Cash from operational activities
4.Reinvesting
1a.Obligations (stocks, debt securities)
5.Dividends or interest payments
Finance function – managing the cash flow

Finance function in corporation
.

Financial management decisions (problem areas)
Capital budgeting decisions: what long-term investments should we take on?
Capital structure decisions: what are the sources of long-term financing? (equity, loans)
Working capital management decisions: how should we manage everyday activities? (collecting receivables, paying suppliers etc.)

What is the goal of financial management?

The goal of financial management
Maximizing shareholder’s wealth
Maximizing stock prices

Objectives for financial manager
Maximizing earnings and earnings growth
Maximizing return on assets and return on equity

Financing decisions

Financial markets
The main goal of financial markets:
Take savings from those who do not wish to consume (savings surplus units) and to channel them to those who wish to invest more than they have presently (saving deficit units)

Financial markets and financial system

The example of financial intermediary work: the case of commercial bank
Deposits
Loans
Commercial bank
Kd
Kl
Bank reward = Kl - Kd

Financial markets

Primary and secondary markets
Primary market – primary issues of securities are sold, allows governments, banks, corporations to raise money by directly selling financial instruments to the public.
Secondary market – allows investors to trade financial instruments between themselves. Secondary transactions take place.

Money and capital markets
Money markets – short-term assets (maturity less than 1 year) are traded:
Certificates of deposits (CDs)
Treasury bills
Commercial papers (CPs)
Capital markets – long-term assets (maturity longer than 1 year) are traded:
Stocks
Corporate bonds
Long-term government bonds

Organized exchanges and over-the-counter
Organized exchange – most of stocks, bonds and derivatives are traded. Has a trading floor where floor traders execute transactions in the secondary market for their clients.
Stocks not listed on the organized exchanges are traded in the over-the-counter (OTC) market. Facilitates secondary market transactions. Unlike the organized exchanges, the OTC market doesn’t have a trading floor. The buy and sell orders are completed through a telecommunications network.

Types of financial instruments

Types of financial instruments

Types of financial instruments

Financial instruments issued by corporations: goals
To finance operations
To invest in new projects
To expand their business
To repay debt

Commercial paper – short-term debt with maturity of not more than 270 days
Issued by larger, known corporations (GE – $80 bln)
Issued at discount
Higher rates than comparable treasury bills because of higher default risk than government securities
Financial instruments issued by corporations: commercial paper

Corporate bond – long-term debt security, promising a bondholder interest payments on a regular basis and payback of a par (face) value at maturity.
Maturities
Short-term: 1-5 years
Intermediate-term: 5-10 years
Long-term: 10-20 years
Interest is quoted as a percentage from face value
Financial instruments issued by corporations: bonds

Zero-coupon corporate bonds
Bonds that pay face value at maturity and no payment until then
Sell today at a discount from face value

Corporate bonds
Secured debt (mortgage debt) – secured by specific assets
Debentures - unsecured debt. Backed only by the general assets of the issuing corporation

Financial instruments issued by corporations: common stocks
The common stockholders are the owners of the corporation’s equity
Do not have a specified maturity date and the firm is not obliged to pay dividends to shareholders
Returns come from dividends and capital gains

Common stockholders are called the residual claimants of the firm
Stockholders have only limited liabilities
Financial instruments issued by corporations: common stocks

Hybrid securities: has characteristics of debt and equity
Have face value, predetermined periodical (dividend) payments with priority over common stockholders
If dividend payment is not made, preferred stockholders may get voting rights
Financial instruments issued by corporations: preferred stocks