FINA 2010

Lecture 1

Introduction to Financial Management

Financial Markets and Institutions

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 Chapter 1
Introduction to Financial
Management
 Forms of Business Organization
 Goals of Corporation
 Stock Prices and Intrinsic Value
 Conflicts Between Managers and
Stockholders
 Recent Trends 1-2
Forms of Business Organization

 Proprietorship
 An unincorporated business owned by 1
individual
 Partnership
 An unincorporated business owned by two or
more persons
 Corporation
 An incorporated business owned by many
shareholders
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Proprietorships and Partnerships

 Advantages
 Ease of formation
 Subject to few regulations
 No corporate income taxes
 Disadvantages
 Difficult to raise capital
 Unlimited liability
 Limited life
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Corporation

 Advantages
 Unlimited life
 Easy transfer of ownership
 Limited liability
 Ease of raising capital
 Disadvantages
 Double taxation
 Cost of set-up and report filing
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Tax Rates of Profits Tax in HK

 Tax Rates Applicable to Corporations

Year of Assessment Tax Rate
2008/09 onwards 16.5%
2003/04 to 2007/08 17.5%
2002/03 16%

 Tax Rates Applicable to Unincorporated

businesses
Year of Assessment Tax Rate
2008/09 onwards 15%
2004/05 to 2007/08 16%
2003/04 15.5%
2002/03 15%

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Financial Goals of the Corporation

 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.
 Is stock price maximization good or bad for
society?
 Do firms have responsibilities to society at large?
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Stock Prices 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.

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 Determinants of Intrinsic Values and
Stock Prices
Managerial Actions, the Economic
Environment, Taxes, and the Political Climate

“True” Investor “True” “Perceived” “Perceived”

Returns Risk Investor Returns Risk

Stock’s Stock’s
Intrinsic Value Market Price

Market Equilibrium:
Intrinsic Value = Stock Price
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Conflicts Between Managers and
Stockholders
 Managers are naturally inclined to act in their
own best interests (which are not always the
same as the interest of stockholders).
 But the following factors affect managerial
behavior:
 Managerial compensation packages
 Direct intervention by shareholders
 The threat of firing
 The threat of takeover
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Some Important Business Trends

 Recent corporate scandals have reinforced

the importance of business ethics, and have
spurred additional regulations and corporate
oversight.
 Issue of corporate governance.
 Increased globalization of business.
 The effects of ever-improving information
technology have had a profound effect on all
aspects of business finance.

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 Chapter 2
Financial Markets and
Institutions
 The Capital Allocation Process
 Financial Markets
 Sections 2-1 to 2-6

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The Capital Allocation Process
 In a well-functioning economy, capital flows
efficiently from those who supply capital to
those who demand it.
 Suppliers of capital – individuals and
institutions with “excess funds.” These groups
are saving money and looking for a rate of
return on their investment.
 Demanders or users of capital – individuals and
institutions who need to raise funds to finance
their investment opportunities. These groups
are willing to pay a rate of return on the capital
they borrow. 1-14
What is a market?

 A market is a venue where goods and

services are exchanged.
 A financial market is a place where individuals
and organizations wanting to borrow funds
are brought together with those having a
surplus of funds.

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Types of Financial Markets

 Physical assets vs. Financial assets

 Spot vs. Futures
 Money vs. Capital
 Primary vs. Secondary
 Public vs. Private

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Stock Market Transactions

 Apple Computer decides to issue additional

stock with the assistance of its investment
banker. An investor purchases some of the
newly issued shares. Is this a primary market
transaction or a secondary market transaction?
 Since new shares of stock are being issued, this is a
primary market transaction.
 What if instead an investor buys existing shares
of Apple stock in the open market – is this a
primary or secondary market transaction?
 Since no new shares are created, this is a secondary
market transaction.
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What is an IPO?

 An initial public offering (IPO) occurs when a

company issues stock in the public market for
the first time.
 “Going public” enables a company’s owners to
raise capital from a wide variety of outside
investors. Once issued, the stock trades in
the secondary market.
 Public companies are subject to additional
regulations and reporting requirements.

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S&P 500 Index, Total Returns: Dividend Yield
+ Capital Gain or Loss, 1993-2022 (30 years)

Source: Data taken from https://www.macrotrends.net/2526/sp-500-

historical-annual-returns.
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Where can you find a stock quote, and
what does one look like?
 Stock quotes can be found in a variety of print sources (The
Wall Street Journal or the local newspaper) and online
sources (Yahoo!Finance, CNNMoney, or MSN MoneyCentral).
Stock Quote for Apple Inc., Dec 14, 2022

Source: Apple Inc. (AAPL), finance.yahoo.com.

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The Importance of Financial Markets

 Well-functioning financial markets facilitate the

flow of capital from investors to the users of
capital.
 Markets provide savers with returns on their money
saved/invested, which provides them money in the
future.
 Markets provide users of capital with the necessary
funds to finance their investment projects.
 Well-functioning markets promote economic
growth.
 Economies with well-developed markets
perform better than economies with poorly-
functioning markets. 1-21
 World Top 10 Stock Exchanges in 2022

Monthly trade 
Market cap Open Close
Rank Stock exchange Region Market place volume
(USD tn) (USD bn) (local) (local)
United 
1 New York Stock Exchange New York City 26.2 1,452 9:30 16:00
States
United 
2 Nasdaq New York City 19.4 1,262 9:30 16:00
States
3 Shanghai Stock Exchange China Shanghai 7.37 536 9:30 15:00
Amsterdam
Brussels
Dublin
4 Euronext Europe Lisbon 6.41 174 9:00 17:30
Milan
Oslo
Paris
5 Shenzhen Stock Exchange China Shenzhen 5.74 763 9:30 15:00
6 Japan Exchange Group Japan Tokyo 5.16 481 9:00 15:00
7 Hong Kong Stock Exchange Hong Kong Hong Kong 4.97 182 9:30 16:00
8 Bombay Stock Exchange India Mumbai 3.96 9:15 15:30
9 National Stock Exchange India Mumbai 3.4 9:15 15:30
10 Toronto Stock Exchange Canada Toronto 3.25 97 9:30 16:00

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Where do we stand?

 Goal of a corporation  shareholder wealth

maximization  maximizing stock price
 Difference between intrinsic value and stock
prices
 Financial markets aid in the allocation of
funds
 Different types of institutions and markets
 Concept of time value of money
 Future value of a stream of cash flows
 Present value of a stream of cash flows 1-23