Specific area of finance dealing with
financial decisions by company, tools
and analysis used to make decision.
CORPORATE FINANCE
 In what long-lived asset (NCA) should firm
invest? Its related to the investment
decision (capital budgeting)
 How firm can raise cash for required
capital expenditure? Related to the
liability and equity of co where involve
financing decision (capital structure)
 How short-term operating cash flow
(working capital) managed? CA – CL
where how much money u need.
Short term cash flow problems:
1. Mismatch between timing of cash inflow
and cash outflow.
 U give credit to customer for 30
days but u have to pay ur supplier
within 20 days. Thus, cash inflow n CONTINGENT CLAIM
outflow happen not in the same
time.
2. Uncertainty of amount and timing of
operating cash flow.
 U decide to construct a new
business where u are unsure about
cost that u have to bare and turnover IMPORTANT OF FINANCIAL MGT
that u will get.
FINANCIAL MANAGER
Value creation – give investor more money
(abnormal return) than what they are supposed to
pay.
 Revenue gain (dividend)
 Capital gain (increase in share price)
 Make good investment decision
( buy asset that can generate more
cash)
 Good financing decision (sell
bond/stock that can raise more
money)
VALUE CREATION
However, it is difficult bcs :
I. Difficult to identify cash flow directly
 Acc info prepare are based on
accrual basis (SOFP & SOPL)
 VC depend on cash flow and not
accounting profit.
II. Timing of cash flow.
 Receive cash earlier bcs overtime,
time value of money will drop.
 If take info timing, choose the one
that give cash inflow every year.
III. Risk of cash flow.
 It’s all about uncertainty.
 Risk adverse will consider less risky
market.
 Risk taker will consider high return
market.
 SH claim on firm value is residual amount
after debt holder are paid.
 Debt holders will receive full amount of
loan unless firm does not have enough
money.
 Survival
 Avoid financial distress and bankruptcy
 Minimize cost
 Maximize profit
AGENCY RELATIONSHIP
 Relationship between
stockholder(principle) and mgt(agent).

CHAPTER 1
SET OF CONTRACTS
 Contracts prepared by principle and sign by
agent. ( agreement)
 Claim that managers will act in the best
interest.
How SH encourage manager act in the best interest:
i. Devise appropriate incentives
 Tie profit to share price
 Give bonus ( payment if reach certain
profit)
ii. Monitor manager behavior
Cost of resolving the conflict of
interest btween manager and SH
 Monitor mechanism :
 BOD ( act on behalf of SH)
 External auditor
FINANCIAL MARKET
 Transfer fund from those have excess
fund to those who in need of funds.
 Types of securities : 1) debt securities
2)equity securities 3) derivative
securities.
 Money market (bank)
 For short term securities
 Bank will reimburse money
 Will go to market and borrow
 Capital market ( bursa MY)
 Long term securities
 Primary market ( directly from
issuer)
 Secondary market (from third
parties)

AGENCY COST

 Direct cost ( fees, incentive)

 Indirect cost ( how manager make decision
whether it is benefit or not to SH )
 SH may experience residual loss (due to
behavior of manager) as they willing to incur
cost bcs if not, they will get greater losses
and co will go into liquidation.

CONTROL DEVICE
a) stock option plan
 Do not really target manager.
 To achieve target performance
 Give option to managers to purchase
stock in lower price.

b) Performance share
 Earning per share (performance
indicator) increase, give share for free
to manager.
 CHAPTER 2 RISK AND RETURN
Ř P = XA Ř A + XB Ř B
EXPECTED RETURN EXPECTED RETURN OF PORTFOLIO

Variance (σ2+) =P(R

(Ř) = P(%) – ŘP(%)
P(%)A + A)
2  Weighted average of expected return on
individual security.

VARIANCE
 Difference between actual and budgeting
SD =√ VARIANCE
VARIANCE PORTFOLIO

σ2P= XA2σA2 + 2XAXBσAB + XB2σB2

STANDARD DEVIATION
 Variance and SD measure risk.
SD OF PORTFOLIO

COVARIANCE AND CORRELATION
 Measure interrelationship between two
securities.
Covariance (σAB) = P(RA-ŘA)(RB –ŘB)
Correlation (ρAB) = Covariance / (SDA) (SDB)
 Positive cov – opposite relationship between
stock
 Negative cov – positive relationship between
stock
 Zero cov – no relationship between stock
 Same applied to correlation
SD = √ σ2
DIVERSIFICATION EFFECT
 Takes place as long as there is less than
perfect correlation ( p < 1)
 Positive cov – increase variance of entire
portfolio. Risk will be larger.
 Negative cov – decrease variance of
portfolio. Negative relationship will reduce
risk as they setoff (hedging)
PORTFOLIO RISK
1) Systematic risk
 Cannot be eliminate
 Related to all co in the market

2) Unsystematic risk
 Can be eliminate
 Associate with risk of 1 particular co
EFFICEINT SET OF 2 RISKY ASSETS
PROBLEMS OF IDENTIFYING OPTIMAL
 Unrealistic to assume investor borrow at
risk-free rate.
 Require knowledge of the risk and return
of risk investment.
 Expensive related to transaction cot
point( need professional view)
 Market portfolio change over time.

MARKET EQUILIBRIUM PORTFOLIO

 All investor assume to hold well diverse
portfolio.
 Investors have same info, therefore
probably will have same expected return,
variance and covariance.
Efficient portfolio :
 Offer higher expected return for a given DEFINITION OF RISK WHEN INVESTOR
SD HOLD MARKET PORTFOLIO
 Offer lower risk.
 Best to measure risk in large security =
RISKLESS BORROWING AND LENDING BETA
2 2
 Large and diversified portfolio only have
VARIANCE
 Can = Xinvestment
combine 1 risky A σA
and 1 systematic risk.
risk-free investment.  Beta only measure systematic risk.

Řp = XAŘA + XFŘF

 SD and covariance of risk-free is 0

ŘM = RF + Market Risk Premium

CAPM
 Relationship btween risk and required
 Relationship between expected return and return
risk for 1 risky asset and 1 risk-free is  Expected return on market :
straight line  Expected return on individual security :
 If borrow at higher borrowing rate,
expected return will be lower.
Ři = RF+ βi (RM –RF)