Financial Management Focus - 3 Decisions

Chapter 1.

Finance: science and arte of managing money. Decisions on how to spend, save and invest money.

Financial management focuses in 3 decisions:

Chapter 2

Well-functioning econ, capital flows efficiently from who supply capital - to who demand it and from who have it to those who use it. Suppliers of capital:  indiv. and inst. with “excess funds.” They save money. Look for a rate of return on their investment. Demanders of capital:  indiv. and inst. who raise funds to finance their investment opportunities. Pay a fee for capital.

Capital is transferred from suppliers to demanders in one of three ways. Direct transfers: Business sells stocks or bonds directly to savers. Not through financial institution. Small firm. Insignificant dollar volume. Indirect transfers: firms sell to investment bankers who then sells them to investors. Investment banker = the underwriter. Financial intermediaries: Intermediaries sell securities or services to savers then take the proceeds from their sales and purchase securities from business firms.

A market is a venue where goods and services are exchanged. A financial market is where indiv. and orgs. that to access funds are brought together with those who have a surplus of funds. Well-functioning financial markets facilitate the flow of capital. Markets provide money saved/invested this provides money in the future. Also, the necessary funds to finance their investment projects and economic growth. Economies with well-developed markets > poorly-functioning markets.

Types of markets.1.Physical vs. Financial assets. Physical assets: real or tangible assets. Actual product is involved. Financial assets: exchange of promises (Future payments).

Sometimes a financial asset’s promise to pay will be contingent on the outcome of some event or the price of another financial asset.  Such assets are referred to as derivatives because they derive their value from the outcome of an event or the price of another asset.2. Spot vs. Futures Markets. Spot Markets: delivery of the item being exchanged takes place immediately. Futures Markets: participants agree to trade today at a specific price, but delivery is on future date. Long position: buy an asset today and will receive delivery in the future (oil refinery buys oil today that they don’t need until next year. Short position: sell an asset today and you will be required to make delivery in the future (farmer sells a crop before they actually grow it).3.Money vs. Capital Markets. Money markets: short-term financial assets are traded(short maturities, Low risk & low return expectation, High denominations).Capital Markets: long-term financial assets are traded (Longer maturities, lots of risk & return expectations, Small denominations).

4.Primary vs Secondary Markets. Primary markets: new securities are issued for the first time. The issuer receives the proceeds from the sale. Primary market transactions frequently involve investment bankers. Securities only trade in the primary market one time. Secondary Markets: existing owners of securities trade among themselves.

The original issuer is not involved and receives nothing from these transactions. Most financial transactions take place in the secondary market.5.Private vs Public Markets.

Private markets: individual firms or investors negotiate and transact directly.  The public is simply not involved or invited to participate in private market transactions. Public Markets: anyone may engage in transactions. Securities tend to be fairly standardized when offered in public markets.

Trends: 1.Globalization of Banking and Commerce: Technology link world’s financial markets. More complex financial instruments and competition.2. Need for Increased Regulation: Financial market regulations at the international level have not kept pace with the changes in the financial markets. Regulating international markets requires cooperation from many competing interests. Some blame the international financial crisis of 2008 on a lack of continuity from regulators.3. Derivatives: intended to be used as a hedge or to reduce risk.  For example, an importer, whose profit falls when the dollar loses value, could purchase currency futures that do well when the dollar weakens. Today, more and more speculators use derivatives to bet on the direction of future stock prices, interest rates, exchange rates, and commodity prices.  

Financial Institutions: 1. Investment Banks: Assist corporations in the design of securities that will appeal to potential investors. Underwriting the offering: investment banks buy securities from issuing firms. Sell the new securities to the investing public. If the investment bank underwrites the offering, their profit motive encourages selling at the highest possible price. If it does not underwrite the offering, they pledge their best efforts in order to obtain the highest possible price for the issuing firm.2.Commercial banks:

“department store of finance”= they offer a full range of financial services to indiv. and business firms. Inflows are received in the form of checking, savings, and time deposits that pay a small rate of interest. Deposits are then used to make loans to borrowers that will charge a higher rate of interest than that being paid to depositors.3.Financial Services Corporations: A combination of financial institutions operating as one corporation. Specific type of institution that evolves through acquisitions (investment banking, brokerage, insurance, real estate).4.Credit Unions: Cooperative associations (not-for-profit, owned by depositors) members have common bond sought in order to minimize risk. Pay higher rates of interest to depositors and charge lower rates of interest to borrowers.5.Pension Funds: Retirement plans funded by employees and employers. Contributions to the fund occur while the employee is working and withdrawals begin when the employee retires. Long-term investments such as stocks, bonds, mortgage loans, and real estate.6.Life Insurance Companies: Receive premium payments from the insured party in exchange for a death benefit to be paid to a designated beneficiary.