,CHAPTER 1 Overview of Corporate Finance and the Financial Environment,Corporate finance Forms of business organization Objective of the firm: Maximize wealth Determinants of stock pricing The financial environment Financial instruments, markets and institutions Interest rates and yield curves,Why is corporate finance important to all managers?,Corporate finance provides the skills managers need to: Identify and select the corporate strategies and individual projects that add value to their firm. Forecast the funding requirements of their company, and devise strategies for acquiring those funds.,Sole proprietorship Partnership Corporation,What are some forms of business organization?,Advantages: Ease of formation Subject to few regulations No corporate income taxes Disadvantages: Limited life Unlimited liability Difficult to raise capital,Sole Proprietorship,A partnership has roughly the same advantages and disadvantages as a sole proprietorship.,Partnership,Advantages: Unlimited life Easy transfer of ownership Limited liability Ease of raising capital Disadvantages: Double taxation Cost of set-up and report filing,Corporation,The primary objective should be shareholder wealth maximization, which translates to maximizing stock price. Should firms behave ethically? YES! Do firms have any responsibilities to society at large? YES! Shareholders are also members of society.,What should managements primary objective be?,Is maximizing stock price good for society, employees, and customers?,Employment growth is higher in firms that try to maximize stock price. On average, employment goes up in: firms that make managers into owners (such as LBO firms) firms that were owned by the government but that have been sold to private investors,Consumer welfare is higher in capitalist free market economies than in communist or socialist economies. Fortune lists the most admired firms. In addition to high stock returns, these firms have: high quality from customers view employees who like working there,Amount of cash flows expected by shareholders Timing of the cash flow stream Risk of the cash flows,What three factors affect stock prices?,Sales revenues Current level Short-term growth rate in sales Long-term sustainable growth rate in sales Operating expenses (e.g., raw materials, labor, etc.) Necessary investments in operating capital (e.g., buildings, machines, inventory, etc.),What factors determine of cash flows?,What factors affect the level and risk of cash flows?,Decisions made by financial managers: Investment decisions (product lines, production processes, geographic market, use of technology, marketing strategy, etc.) Financing decisions (choice of debt policy and dividend policy) The external environment (taxes, regulation, etc.),What are financial assets?,A financial asset is a contract that entitles the owner to some type of payoff. Debt Equity Derivatives In general, each financial asset involves two parties, a provider of cash (i.e., capital) and a user of cash.,What are some financial instruments?,Instrument Rate (9/01) U.S. T-bills 2.3% Bankers acceptances 2.6 Commercial paper 2.4 Negotiable CDs 2.5 Eurodollar deposits 2.5 Commercial loans Tied to prime (6.0%) or LIBOR (2.6%),(More . .),Financial Instruments (Continued),Instrument Rate (9/01) U.S. T-notes and T-bonds 5.5% Mortgages 6.8 Municipal bonds 5.1 Corporate (AAA) bonds 7.2 Preferred stocks 7 to 9% Common stocks (expected) 10 to 15%,Who are the providers (savers) and users (borrowers) of capital?,Households: Net savers Non-financial corporations: Net users (borrowers) Governments: Net borrowers Financial corporations: Slightly net borrowers, but almost breakeven,Direct transfer (e.g., corporation issues commercial paper to insurance company) Through an investment banking house (e.g., IPO, seasoned equity offering, or debt placement) Through a financial intermediary (e.g., individual deposits money in bank, bank makes commercial loan to a company),What are three ways that capital is transferred between savers and borrowers?,Commercial banks Savings & Loans, mutual savings banks, and credit unions Life insurance companies Mutual funds Pension funds,What are some financial intermediaries?,The Top 5 Banking Companies in the World, 12/1999,What are some types of markets?,A market is a method of exchanging one asset (usually cash) for another asset. Physical assets vs. financial assets Spot versus future markets Money versus capital markets Primary versus secondary markets,How are secondary markets organized?,By “location” Physical location exchanges Computer/telephone networks By the way that orders from buyers and sellers are matched Open outcry auction Dealers (i.e., market makers) Electronic communications networks (ECNs),Physical Location vs. Computer/telephone Networks,Physical location exchanges: e.g., NYSE, AMEX, CBOT, Tokyo Stock Exchange Computer/telephone: e.g., Nasdaq, government bond markets, foreign exchange markets,