Introduction to Finance: Key Areas and Concepts
Chapter 1: Introduction to Finance
Four Main Areas of Finance
Corporate Finance
Financial management involves three main functions:
Capital Budgeting
Determining long-term investments and asset allocation.
Capital Structure
Choosing financing sources for investments, including debt and equity.
Working Capital Management
Managing daily financial activities related to investments.
Investments
Analyzing financial assets like stocks and bonds, including valuation, risk assessment, and asset allocation.
Job opportunities include:
- Stockbroker or financial advisor
- Portfolio manager
- Security analyst
Financial Institutions and Markets
Companies specializing in financial matters, such as banks, insurance companies, and brokerage firms.
Job opportunities include:
- Loan officer
- Insurance agent
- Foreign exchange dealer
International Finance
Specialization within other areas, involving exchange rates, political risk, and cultural understanding.
Financial Markets
Forums where buyers and sellers of financial assets and commodities meet.
Classifications:
- Type of asset traded: Money market vs. Capital market
- Maturity of the financial asset: Short-term vs. Long-term
- Owner of the financial asset: Primary market (new issues) vs. Secondary market (existing securities)
- Nature of transaction: Dealer markets (OTC, NASDAQ) vs. Auction markets (NYSE, AMEX)
Objectives of Finance Manager
The primary goal is to maximize the current value of the company’s stock, aligning with shareholder wealth maximization.
Business Structures
Sole Proprietorship
A business owned by one person.
Advantages:
- Simple and easy to form
- Minimal legal documentation and regulation
- Owner keeps all profits
- Taxed once as personal income
Disadvantages:
- Unlimited liability (personal assets at risk)
- Limited lifespan (tied to owner’s life)
- Limited access to funding
Partnership
A business owned by two or more people.
Advantages:
- Easy formation
- More expertise and capital
- Taxed once as personal income
Disadvantages:
- Unlimited liability for general partners
- Challenges in dissolving, transferring ownership, or raising funds
Corporation
A legal entity separate from its owners (shareholders).
Advantages:
- Limited liability for owners
- Easy transfer of ownership
- Greater access to capital
- Unlimited lifespan
- Separation of ownership and management
Disadvantages:
- Complex formation and regulation
- Double taxation of profits
- Potential agency problems
The Agency Model
Describes the relationship between principals (shareholders) and agents (managers).
Agency problems arise from conflicts of interest, where managers may prioritize personal benefits over shareholder value.