Finance as the science and art of managing money .
setting general policy, guiding corporate affairs, and approving
 How much they save.
 How they invest their savings .
 How firms raise money from investors.
 How firms invest money in an attempt to earn profit.
2 Career Opportunities in Finance
 Financial Services
 Managerial Finance
Financial Services is the area of finance concerned with the design
and delivery of advice and financial products to individuals ,
business and governments
Managerial Finance concern the duties of the financial manager
in a business.
Financial Manager actively manages the financial affairs of all
types of business , whether private or public , large or small ,
profit seeking or not for profit.
Legal Forms of Business Organization
Sole Partnership a business owned by one person and operated
for his or her own profit.
Unlimited liability condition of sole proprietorship (or
general partnership) , giving creditors the right to make claims
against the owner’s personal assets to recover debts owed by the
business.
Partnership a business owned by two or more people and
operated for profit.
Articles of partnership the written contract used to
formally establish a business partnership.
Corporations an entity created by law.
The Role of Management Finance
Stockholders the owners of a corporation , whose ownership , or
equity , takes the form of either common stock or preferred stock.
Limited liability a legal provision that limits stockholders liability
for a corporation’s debt to the amount they initially invested in
the firm by purchasing stock.
Common Stock the purest and most basic form of corporate
ownership.
Dividends periodic distributions of cash to the stockholders of a
firm.
Board Of Directors Group elected by the firm’s stockholders and
typically responsible for approving strategic goals and plans,
major expenditures.
President or Chief Executive Officer (CEO) corporate
official responsible for managing the firm’s day-today operations
and carrying out the policies established by the board of directors.
 Limited Partnership (LP)
 S Corporation (S corp)
 LImited Liability Company (LLC)
 Limited Liability Partnership (LLP)
MAXIMIZE SHAREHOLDER WEALTH
Maximize the wealth of the owners for whom it is being
operated, or equivalently, to maximize the stock price.
MAXIMIZE PROFIT
Earnings Per Share (EPS)
The amount earned during the period on behalf of
each outstanding share of common stock, calculated by dividing
the period’s total earnings available for the firm’s common
stockholders by the number of shares of common stock
outstanding.
Timing the receipt of funds sooner rather than later is preferred.
Cash Flows not necessarily result in cash flows available to the
stockholders.
Risk the chance that actual outcomes may differ from those
expected.
Return and risk are, in fact, the key determinants of
share price, which represents the wealth of the owners in the firm.
Risk Averse requiring compensation to bear risk.
Stakeholders groups such as employees, customers, suppliers,
creditors, owners, and others who have a direct economic link to
the firm.
THE ROLE OF BUSINESS ETHICS
Business Ethics standards of conduct or moral judgment that
apply to persons engaged in commerce.
Ethics and Share Price
Ethical behavior is therefore viewed as necessary for achieving
the firm’s goal of owner wealth maximization.
ORGANIZATION OF THE FINANCE FUNCTION
Treasurer the firm’s chief financial manager, who manages the
firm’s cash, oversees its pension plans, and manages key risks.
Controller the firm’s chief accountant, who is responsible for the
firm’s accounting activities, such as corporate accounting, tax
management, financial accounting, and cost accounting.
Foreign Exchange Manager the manager responsible for
managing and monitoring the firm’s exposure to loss from
currency fluctuations.
RELATIONSHIP TO ECONOMICS
Marginal Cost–benefit Analysis economic principle that states
that financial decisions should be made and actions taken only
when the added benefits exceed the added costs.
Emphasis on Cash Flows
Accrual Basis in preparation of financial statements, recognizes
revenue at the time of sale and recognizes expenses when they
are incurred.
Cash Basis recognizes revenues and expenses only with respect to
actual inflows and outflows of cash.
Decision Making accountants devote most of their attention to
the collection and presentation of financial data.
statements, develop additional data, and make
decisions on the basis of their assessment of the associated
returns and risks.
CORPORATE GOVERNANCE
Corporate Governance the rules, processes, and laws by which
companies are operated, controlled, and regulated.
Individual versus Institutional Investors
Individual Investors who own relatively small quantities of shares
so as to meet personal investment goals.
Institutional investors investment professionals, such as banks,
insurance companies, mutual funds, and pension funds, that are
paid to manage and hold large quantities of securities on behalf of
others.
Government Regulation
Sarbanes-Oxley Act of 2002 (SOX) an act aimed at eliminating
corporate disclosure and conflict of interest problems. Contains
provisions about corporate financial disclosures and the
relationships among corporations, analysts, auditors, attorneys,
directors, officers, and shareholders.
THE AGENCY ISSUE
Principal–agent Relationship an arrangement in which an agent
acts on the behalf of a principal. For example, shareholders of a
company (principals) elect management (agents) to act on their
behalf.
The Agency Problem
Agency problems problems that arise when managers place
personal goals ahead of the goals of shareholders.
Agency costs arising from agency problems that are borne by
shareholders and represent a loss of shareholder wealth.
Management Compensation Plans
Incentive plans management compensation plans that tie
management compensation to share price; one example involves
the granting of stock options.
Stock Options extended by the firm that allow management to
benefit from increases in stock prices over time.
Performance Plans that tie management compensation to
measures such as EPS or growth in EPS. Performance shares
and/or cash bonuses are used as compensation under these plans.
Performance Shares of stock given to management for meeting
stated performance goals.
Cash bonuses paid to management for achieving certain
performance goals.
CHAPTER 2 : The Financial Market Environment
Financial institution an intermediary that channels the savings of
individuals, businesses, and governments into loans or
investments.
COMMERCIAL BANKS, INVESTMENT BANKS, AND THE SHADOW
BANKING SYSTEM
Commercial banks institutions that provide savers with a secure
place to invest their funds and that offer loans to individual and
business borrowers.
Investment banks that assist companies in raising capital, advise
firms on major transactions such as mergers or financial
restructurings, and engage in trading and market making
activities.
Glass-Steagall Act An act of Congress in 1933 that created the
federal deposit insurance program and separated the activities of
commercial and investment banks.
Shadow banking system a group of institutions that engage in
lending activities, much like traditional banks, but do not accept
deposits and therefore are not subject to the same regulations as
traditional banks.
FINANCIAL MARKETS
Financial markets Forums in which suppliers of funds and
demanders of funds can transact business directly.
Private placement the sale of a new security directly to an
investor or group of investors.
Public offering the sale of either bonds or stocks to the general
public.
Primary market Financial market in which securities are initially
issued; the only market in which the issuer is directly involved in
the transaction.
Secondary market Financial market in which pre owned securities
(those that are not new issues) are traded.
THE MONEY MARKET
Money market A financial relationship created between suppliers
and demanders of short-term funds.
Marketable securities Short-term debt instruments, such as U.S.
Treasury bills, commercial paper, and negotiable certificates of
deposit issued by government, business, and financial institutions,
respectively.
Eurocurrency market International equivalent of the domestic
money market.
THE CAPITAL MARKET
Capital market A market that enables suppliers and demanders of
long-term funds to make transactions.
Bond Long-term debt instrument used by business and
government to raise large sums of money, generally from a
diverse group of lenders.
Preferred stock A special form of ownership having a fixed
periodic dividend that must be paid prior to payment of any
dividends to common stockholders.
Broker market The securities exchanges on which the two sides of
a transaction, the buyer and seller, are brought together to trade
securities.
Securities exchanges organizations that provide the marketplace
in which firms can raise funds through the sale of new securities
and purchasers can resell securities.
Dealer market the market in which the buyer and seller are not
brought together directly but instead have their orders executed
by securities dealers that “make markets” in the given security.
Market makers securities dealers who “make markets” by offering
to buy or sell certain securities at stated prices.
Nasdaq market an all-electronic trading platform used to execute
securities trades.
Over-the-counter (OTC) market where smaller, unlisted securities
are traded.
Bid price the highest price offered to purchase a security.
Ask price the lowest price at which a security is offered for sale.
International Capital Markets
Eurobond market the market in which corporations and
governments typically issue bonds denominated in dollars and sell
them to investors located outside the United States.
Foreign bond that is issued by a foreign corporation or
government and is denominated in the investor’s home currency
and sold in the investor’s home market.
International equity market a market that allows corporations to
sell blocks of shares to investors in a number of different countries
simultaneously.
The Role of Capital Markets
Efficient market a market that allocates funds to their most
productive uses as a result of competition among wealth-
maximizing investors and that determines and publicizes prices
that are believed to be close to their true value.
FINANCIAL INSTITUTIONS AND REAL ESTATE FINANCE
Securitization the process of pooling mortgages or other types of
loans and then selling claims or securities against that pool in the
secondary market.
Mortgage-backed securities that represent claims on the cash
flows generated by a pool of mortgages.
REGULATIONS GOVERNING FINANCIAL INSTITUTIONS
Federal Deposit Insurance Corporation (FDIC) An agency created
by the Glass-Steagall Act that provides insurance for deposits at
banks and monitors banks to ensure their safety and soundness.
Gramm-Leach-Bliley Act an act that allows business combinations
(that is, mergers) between commercial banks, investment banks,
and insurance companies, and thus permits these institutions to
compete in markets that prior regulations prohibited them from
entering.
REGULATIONS GOVERNING FINANCIAL MARKETS
Securities Act of 1933 An act that regulates the sale of securities
to the public via the primary market.
Securities Exchange Act of 1934 An act that regulates the trading
of securities such as stocks and bonds in the secondary market.
Securities and Exchange Commission (SEC) The primary
government agency responsible for enforcing federal securities
laws.
Ordinary Income earned through the sale of a firm’s goods or
services.
Marginal Tax Rate The rate at which additional income is taxed.
Average Tax Rate A firm’s taxes divided by its taxable income.
Interest and Dividend Income
Double Taxation Situation that occurs when after-tax corporate
earnings are distributed as cash dividends to stockholders, who
then must pay personal taxes on the dividend amount.
 Capital Gain the amount by which the sale price of an
asset exceeds the asset’s purchase price.
CHAPTER 3 : FINANCIAL STATEMENTS AND RATIO
Generally Accepted Accounting Principles (GAAP) the practice
and procedure guidelines used to prepare and maintain financial
records and reports; authorized by the Financial Accounting
Standards Board (FASB).
Financial Accounting Standards Board (FASB) The accounting
profession’s rule-setting body, which authorizes generally
accepted accounting principles (GAAP).
Public Company Accounting Oversight Board (PCAOB) A not-for-
profit corporation established by the SarbanesOxley Act of 2002 to
protect the interests of investors and further the public interest in
the preparation of informative, fair, and independent audit
reports.
Stockholders’ report Annual report that publicly owned
corporations must provide to stockholders; it summarizes and
documents the firm’s financial activities during the past year.
Letter to stockholders Typically, the first element of the annual
stockholders’ report and the primary communication from
management.
THE FOUR KEY FINANCIAL STATEMENTS
(1) the income statement,
(2) the balance sheet,
(3) the statement of stockholders’ equity, and
(4) the statement of cash flows.
Income statement Provides a financial summary of the firm’s
operating results during a specified period.
Dividend Per Share (DPS) The dollar amount of cash distributed
during the period on behalf of each outstanding share of common
stock.
Balance Sheet
Balance sheet Summary statement of the firm’s financial position
at a given point in time.
Current assets Short-term assets, expected to be converted into
cash within 1 year or less.
Current liabilities Short-term liabilities, expected to be paid within
1 year or less.
long-term debt Debt for which payment is not due in the current
year.
balance sheet Summary statement of the firm’s financial position
at a given point in time.
Current assets Short-term assets, expected to be converted into
cash within 1 year or less. current liabilities Short-term liabilities,
expected to be paid within 1 year or less.
Paid-in capital in excess of par The amount of proceeds in excess
of the par value received from the original sale of common stock.
Retained earnings The cumulative total of all earnings, net of
dividends, that have been retained and reinvested in the firm since
its inception.
Statement of stockholders’ equity Shows all equity account
transactions that occurred during a given year.
Statement of retained earnings Reconciles the net income earned
during a given year, and any cash dividends paid, with the change
in retained earnings between the start and the end of that year.
An abbreviated form of the statement of stockholders’ equity.
Statement of cash flows Provides a summary of the firm’s
operating, investment, and financing cash flows and reconciles
them with changes in its cash and marketable securities during
the period.
Notes to the financial statements Explanatory notes keyed to
relevant accounts in the statements; they provide detailed
information on the accounting policies, procedures, calculations,
and transactions underlying entries in the financial statements.
Financial Accounting Standards Board (FASB) Standard No. 52
Mandates that U.S.–based companies translate their foreign-
currency-denominated assets and liabilities into dollars, for
consolidation with the parent company’s financial statements.
This is done by using the current rate (translation) method.
Current rate (translation) method Technique used by U.S.–based
companies to translate their foreign-currency-denominated assets
and liabilities into dollars, for consolidation with the parent
company’s financial statements, using the year-end (current)
exchange rate.
Ratio analysis Involves methods of calculating and interpreting
financial ratios to analyze and monitor the firm’s performance.

Cross-sectional analysis Comparison of different firms’ financial

ratios at the same point in time; involves comparing the firm’s
ratios to those of other firms in its industry or to industry
averages.

Benchmarking A type of cross-sectional analysis in which the

firm’s ratio values are compared to those of a key competitor or
group of competitors that it wishes to emulate.

Time-series analysis Evaluation of the firm’s financial

performance over time using financial ratio analysis.

LIQUIDITY OF RATIO

Liquidity A firm’s ability to satisfy its short-term obligations as

they come due.

Current ratio A measure of liquidity calculated by dividing the

firm’s current assets by its current liabilities.

Current ratio = Current assets/ Current liabilities

Quick (acid-test) ratio A measure of liquidity calculated by

dividing the firm’s current assets minus inventory by its current
liabilities.

activity ratios Measure the speed with which various accounts are
converted into sales or cash—inflows or outflows.

inventory turnover Measures the activity, or liquidity, of a firm’s

inventory

average age of inventory Average number of days’ sales in

inventory.

average collection period The average amount of time needed to

collect accounts receivable.