PRINCIPLES OF

FINANCE
TCH 302
Lecturer: Chu Mai Linh, Ms.

Email: chumailinh.cs2@ftu.edu.vn

Introduction to Finance 1
 ASSIGNMENTS &
ASSESSMENTS
• ATTENDANCE

Attendance is compulsory in accordance with FTU regulations. Students

are strongly advised not to miss lecture hours since success is closely
related with attendance.

• ASSIGNMENTS & ASSESSMENTS

% Contribution Form of Size of the assessment Feedback method
Assessment Duration

10% of the final mark Attendance

30% of the final mark Examination 45 minutes (4 pages) Correct answers
Multiple Choices and Short
answer questions

60% of the final mark Examination 60 Minutes Correct answers

Introduction to Finance 2
 TEXTBOOKS

1. The Economics of Money, Banking, and Financial

Markets, Frederic S. Mishkin, 11th edition, 2016

2. Money, Banking and Financial Markets, Stephen G.

Cecchetti and Kermit L. Schoenholtz, 5th edition,
2017

3. Finance: Applications and Theory, Marcia M. Cornett,

2nd edition, 2012

Introduction to Finance 3
 SYLLABUS PLAN
Modules Compulsory readings
1 Mishkin, Chapter 1
Introduction to Finance Cecchetti, Chapters 1,2 & 3
Cornett, Chapter 1
2
Financial Statements Bodie, Chapter 3
3 Cornett, Chapters 2 & 3
Analyzing financial statements

Bodie, Chapters 4 & 5,8 & 9

4
Mishkin, Chapter 4
Time Value of Money
Cornett, Chapters 4 & 5

5 Mishkin, Chapters 1,2,3 & 8

Understanding Financial Markets and Cecetti, Chapter 11
Institutions Cornett, Chapter 6,7 & 8

Introduction to Finance 4
INTRODUCTION TO FINANCE

Mishkin, Chapter 1
Cecchetti, Chapters 1,2 & 3
Cornett, Chapter 1

Introduction to Finance 5
 Content
1. Defining Finance

2. Why study Finance?

3. Financial Functions

4. Business Organization

5. Firm Goals

6. Financial Markets, Intermediaries and the Firm

7. The Financial System

8. Six Parts of the Financial System

9. Flows of Funds through the Financial System

Introduction to Finance 6
 Finance in Business and in Life
Example #1

• Lucas has a plan to provide an online learning platform for

students. He has finally designed the websites and feels that he is
offering a perfect educational service, combining tutorial and self-
learning. As the result, his business runs well and starts bringing
some profits. Lucas would like to invest more in this website and
expand the customer base. Lucas needs more money to upgrade
the technology and hire and train more people.

• How can he get the capital he needs to expand?

Introduction to Finance 7
 Finance in Business and in Life
Example #2

• Song is interested in finance and would like to invest some

money in stocks. However, she has heard about loss and failure of
the corporations. In the past years, Song learned about the
delisting of CotecLand (2021), the bankruptcy cases of Lehman
Brothers (2008). These firm stockholders lost their entire money in
these firms.

• Song would like to know what guarantee she has as an investor

against losing her investment.

Introduction to Finance 8
 Defining Finance

• Type 2 = individual investors

• Type 3 = corporations or other types of companies

Introduction to Finance 9
 Defining Finance
• Return of
capital to investors

------------------------------------------------------------------
• Not all of the cash
will return to the investors

Introduction to Finance 10
 Defining Finance
• Investments

----------------------------------------------------------------
• Financial managements

Introduction to Finance 11
 Defining Finance
Investments

• methods and techniques for making decisions

about:
• what kinds of securities to own, which firms’ securities to buy,

• and how to pay the investor back in the form that the investors

wishes (e.g., the timing and certainty of the promised

cashflows).

Introduction to Finance 12
 Defining Finance
Financial Management

• deals with a firm’s decisions in acquiring and

using the cash that is received from investors or

from retained earnings.

Introduction to Finance 13
 Defining Finance
Financial Management

1. How to or organize the firm in a manner that will attract

capital

2. How to raise capital (e.g., bonds versus stocks).

3. Which projects to fund.

4. How much capital to retain for ongoing operations and

new projects.

5. How to minimize taxation.

6. How to pay back capital providers.

Introduction to Finance 14
 Defining Finance
Financial Institutions and Markets

• The organization that

facilitate the flow of
capital between investors
and companies.
• e.g.: banks, insurance
companies, stock
companies, mutual funds

Introduction to Finance 15
 Defining Finance
International Finance

The use of finance

theory in a global
business environment.
e.g.: law, risks and
business relationships
across different countries

Introduction to Finance 16
 Defining Finance

• Finance is the study of applying specific value to

things we own, services we use, and decision we
make.

• E.g.: shares of stock in a company, payments on a

home mortgage, the purchase of an entire firms..

• In finance, cash flow is the term that describes the

process of paying and receiving money.

Introduction to Finance 17
 Cash flows are not guaranteed!

• Future cash flows are uncertain in term of timing

and size, and we refer to this uncertainty as risk.

• E.g.: investors experience risk about the return of

the capital.

• Comparing rewards with risks involves assessing

the value today of cash flows that we expcect to
receive in the future.

Introduction to Finance 18
 Finance vs Accounting

• In the most companies, the financial function is

usually closely associated with the accounting
function.
Accountant’s job Finance job
what happened in the past historical figures + current
information  what should happen
now and in the future with the
firm’s money.

Introduction to Finance 19
 Why study Finance?
Example #3
• Suppose you have some savings money. What
kinds of financial assets should you choose these
days?

Introduction to Finance 20
 Why study Finance?
1. To manage your personal resources (e.g. to
borrow money to buy a new car, to refinance your
shop house at a lower rate…)

2. To deal with the world of business

3. To pursue interesting and rewarding career

opportunities

4. To make informed public choices as a citizen

5. To expand your mind

Introduction to Finance 21
 Financial Decisions

1. Financial decisions of households

2. Financial decision of firms
3. Financial decision of government

Introduction to Finance 22
 Financial decisions of households

Households face 4 basic types of financial decision:

• 1. Consumption and saving decisions

• 2. Investment decisions

• 3. Financing decisions (if they borrow, they incur a

liability = debt,

• Their wealth or net worth = assets – liabilities)

• 4. Risk-management decisions

Introduction to Finance 23
 Financial decision of firms

The branch of finance dealing with financial decisions of

firms is called business finance or corporate finance.

• Capital budgeting process such as whether to build a

plant or produce a new product.

• Capital structure decision such as how much debt and

how much equity it should have in its capital structure.

• Working capital management, such as whether it should

extend credit to customer or demand cash on delivery.

Introduction to Finance 24
 Financial decision of government

• A government budget is a government document presenting the

government's proposed revenues and spending for a financial year that is
often passed by the legislature (parliament", "congress", and "assembly“)- -
Government budgets are of three types:

• Balanced Budget: when government revenue and expenditure are equal.

• Surplus Budget: when anticipated revenues exceed expenditure.

• Deficit Budget: when anticipated expenditure is greater than revenues.

Introduction to Finance 25
 The Financial Function
• How the financial function fits in and interacts
with other areas of the firm?

Introduction to Finance 26
 The Financial Function

• Finance affects the firm in many ways and

throughout all levels of a company’s
organizational chart, providing guidance for both
strategic and day-to-day decisions of the firm
and collecting information for control and
feedback about the firm’s financial decisions.

Introduction to Finance 27
 Financial Manager
(CFO)
• Both the company
treasurer and the
controller report to
the chief financial
officer.

Introduction to Finance 28
 Business Organization

• The number of owners is the key to how business

structures are classified.

• Who controls the firm.

• Who owns the firm.

• What the owners’ risks are

• What access to capital exists.

• What the tax ramifications are.

Introduction to Finance 29
Business Organization

Introduction to Finance 30
 Business Organization
Types of U.S firms

Source: www.irs.gov, 2017

Introduction to Finance 31
 Business Organization
Corporations

• A public corporation is legally independent entity

that completely separate from its owners.

Limited liability

Double taxation

Introduction to Finance 32
 Business Organization
Corporations

• Double taxation

You are a shareholder in a corporation. The corporation

earns $5 per share before taxes. After it has paid taxes, it
will distribute the rest of its earnings to you as a dividend.
The dividend is income to you, so you will then pay taxes
on these earnings. The corporate tax rate is 40% and
your tax rate on dividend income is 15%. How much of
the earnings remains after all taxes are paid?

Introduction to Finance 33
 Business Organization
Puzzles

1. Why must an entrepreneur give up some control

of the business as it grows into a public
corporation?

2. What advantages doe the corporate form of

organization hold over a sole proprietorship?

Introduction to Finance 34
 Firm Goals

• To maximize shareholder wealth vs to maximize

total satisfaction of all stakeholders in a business.

• Maximizing owners’ equity can also stated as

maximizing the current value per share, or
stock price of existing shares.

• Common alternatives goals are:

o income or profit
o costs
o market share.
Introduction to Finance 35
 Firm Goals
Puzzles
• Are these the same goals? Please explain your
answer.

Introduction to Finance 36
 Agency Theory

• Whenever one party (the principal) hires someone

else (the agent) to work for him/her, their
interaction is called an agency relationship.

Introduction to Finance 37
 Agency Problem
• Because of the separation of ownership and control in
a corporation, managers have little incentive to work in
the interests of the shareholders when this means
working against their own self-interest.

• Solutions:
o To ignore it.

o To monitor managers’ actions

Corporate
Governance o To align managers’ personal interest with those of
owners (e.g.: options, employee stock options plan
ESOP)
Introduction to Finance 38
 Corporate Governance

• A set of laws, policies,

incentives, and monitors
designed to handle the
issues arising from the
separation of ownership
and control.
• CG balances the needs
of shareholders and
managers.

Introduction to Finance 39
Financial markets, Intermediaries and the Firm

Introduction to Finance 40
 Financial System
• Financial system is defined as the set of markets
and other institutions used for financial
contracting and exchange of assets and risks.

• The financial system includes markets, stocks,

bonds and other financial instruments, financial
intermediaries and the regulatory bodies that
govern all of these institutions.

Introduction to Finance 41
 Six Parts of the Financial System

1.Money
2.Financial Instruments
3.Financial Markets
4.Financial Institutions
5.Regulatory Agencies
6.Central Bank

Introduction to Finance 42
 Money

• Money is the medium of exchange and to

store value

• Money is at the heart of the payments

system.
……………………………………………………………….

• What is the difference between wealth and income?

• What about liquidity?

Introduction to Finance 43
 Financial Instruments
• The written legal obligation of one party to
transfer something of value, usually money, to
another party at some future date, under certain
conditions.

Introduction to Finance 44
 Financial Instruments

1. Financial instruments act as a means of payment (like money).

Employees take stock options as payment for working.
2. Financial instruments act as stores of value (like money).
Financial instruments generate increases in wealth that are larger than
from holding money.

Financial instruments can be used to transfer purchasing power into

the future.
3. Financial instruments allow for the transfer of risk (unlike money).
Examples: Insurance contracts, future contracts.

Introduction to Finance 45
 Examples of financial
instruments
• The basic types of financial assets are debt, equity and derivatives.

• Debt instruments are issued by anyone who borrows money: corporate

bonds, government bonds, residential and commercial mortgages and
consumer loans.

• Derivative instrument are those where their value and payoffs are
“derived” from the behaviors of the underlying.

• Underlying instruments are used by saver/lenders to transfer resources

directly to investors/borrowers.

Introduction to Finance 46
 Features of Financial Instruments

• These contracts are very complex.

This complexity is costly, and people do not want
to bear these costs.
• Standardization of financial instruments
overcomes potential costs of complexity.
Most mortgages feature a standard application
with standardized terms.

•
Introduction to Finance 47
 Features of Financial Instruments

• Financial instruments also communicate

information, summarizing certain details about the
issuer.

• Financial instruments are designed to handle the

problem of asymmetric information.

Introduction to Finance 48
 Financial Markets

Financial markets are places where financial instruments are bought and sold.
• These markets are the economy’s central nervous system.
• These markets enable both firms an individuals to find financing for their
activities.
• These markets promote economic efficiency.
They ensure resources are available to those who put them to their best use.
They keep transactions costs low.

Introduction to Finance 49
Stock Market Indexes

Introduction to Finance 50
 Financial Institutions
• Firms that provide access to the financial
markets, both to savers who wish to purchase
financial instruments directly and to borrowers
who want to issue them.
• Also known as financial intermediaries.
▫ Examples: commercial banks, investment
banks, insurance companies,
securities firms, and pension funds.
Introduction to Finance 51
 Government regulatory agencies

• Government regulatory agencies provide

wide-ranging financial regulation – rules
and supervision.
Increasing Information Available to Investors

Ensuring the Soundness of Financial Intermediaries (Restrictions on

Entry, Disclosure, Restrictions on Assets and Activities, Deposit
Insurance, Limits on Competition, Restrictions on Interest Rates)

Introduction to Finance 52
Government regulatory agencies

Introduction to Finance 53
 Central banks
• Central banks began as large private banks to
finance wars.
• Central banks control the availability of
money and credit to ensure low inflation,
high growth and stability of financial
system

Introduction to Finance 54
Flow of Funds Through the
Financial System

Introduction to Finance 55
Flow of Funds Through the
Financial System

Introduction to Finance 56
 Summary
A healthy and constantly evolving financial system is the
foundation for economic efficiency and economic growth. It has
six parts:
1. Money is used to pay for purchases and to store wealth.
2. Financial instruments are used to transfer resources and risk.
3. Financial markets allow people to buy and sell financial
instruments.
4. Financial institutions provide access to the financial markets,
collect information and provide a variety of other services.
5. Government regulatory agencies aim to make the financial
system operate safely and reliably.
6. Central banks stabilize the economy.

Introduction to Finance 57
 SYLLABUS PLAN
Modules Compulsory readings
1 Mishkin, Chapter 1
Introduction to Finance Cecchetti, Chapters 1,2 & 3
Cornett, Chapter 1
2
Financial Statements Bodie, Chapter 3
3 Cornett, Chapters 2 & 3
Analyzing financial statements
4 Bodie, Chapters 4 & 5,8 & 9
Time Value of Money Mishkin, Chapter 4
Cornett, Chapters 4 & 5
5
Mishkin, Chapters 1,2,3 & 8
Understanding Financial Markets Cecetti, Chapter 11
and Institutions Cornett, Chapter 6,7 & 8

Financial Statements 1
REVIEWING FINANCIAL STATEMENTS

Bodie, Chapter 3
Cornett, Chapters 2 & 3

Financial Statements 2
 Content

1.Balance Sheet

2.Income Statement

3.Statement of Cash Flows

4.Free Cash Flow

5.Statement of Retained Earnings

Financial Statements 3
 • Song wants to invest in DPH Tree
Farm Inc. Song has a set of recent
Looking financial statements from DPH Tree
Farm’s annual report but is not sure
for a perfect
how to read them or what are the
company meanings of all these numbers and
reports.
• What are the four financial statements?
• What information can she gets from
these statements?

Financial Statements 4
 An annual report
• Four basic financial statements:
1. The balance sheet
2. The income statement
3. The statement of cash flows
4. The statement of retained earnings
• A financial statement provides an accounting-
based picture of a firm’s financial position.

Financial Statements 5
 The balance sheet
• Assets = Liabilities + Equity

Financial Statements 6
 7
Balance
Sheet
Financial Statements
 Net working capital

• Net working capital = Current assets – Current liabilities

Financial Statements 8
 Book vs Market Value

• Balance Sheet shows its

book (or historical cost) value
based on generally accepted
accounting principles.
• Because of inflation and
market forces, many assets
are more worth now thatn
they were worth when the
firm bought them.
• Book values can differ widely from market
values for the same assets.
Financial Statements 9
 Computing Book vs Market Value
• D2K Inc. lists fixed assets and current assets
of $25 million and $10 million respectively on
its balance sheet. The firm’s fixed assets and
current assets were recently appraised at $32
and $ 11 million respectively.
• The current liabilities’ book and market values
stand at $6 million and the firm’s long-term
debt is $15 million.
• What are the book value and market value of
the firm’s shareholders equity? Construct the
book value and market value balance sheet for
D2K Inc.
Financial Statements 10
Income Statement

Financial Statements 11
 Some equations
1. EPS

2. DPS

3. BVPS

4. MVPS = Market price of the firms’ common stock

Financial Statements 12
 13
Statement
Income
Financial Statements
 Corporate Income Taxes
• Corporate Tax Rates as of 2012

• The U.S tax structure is progressive, meaning

that the larger the income, the higher the taxes
assessed.
Financial Statements 14
 Average Tax Rate
vs Marginal Tax Rate

• Average tax rate =

• Marginal tax rate is the additional
taxes a firm must pay out for every
additional dollar of taxable income it
earns.

Financial Statements 15
 Calulating the tax rate
• E.g: Antonio Inc. earned $17 mill taxable
income (EBT) in 2012. Use the tax schedule to
compute the firm’s 2012 tax liability, its average
tax rate and its marginal tax rate.

Financial Statements 16
 Effect of Debt vs Equity Financing on Returns

• Supposed you wonder between two alternative

investments (in Firm A or Firm B). Both are active
in the same industry and have identical operating
incomes of $10 million. Firm A finances its $24
million in assets with $22 million in debt (on which
it pays 10% interest) and $2 million in equity. Firm
B finances its $24 million in assets with $24 million
in equity and no debt. Both firm has pay 30% tax
on their taxable income.
• Calculate the income that each firm has available
to pay its debt and shareholders and the ROEs.

Financial Statements 17
 The
Statement of
Cash Flow
• Financial managers
and investors are far
more interested in
actual cash flows than
in the backward-
looking profit listed on
the income statement.
• A financial statement
that shows the firm’s
cash flows over a
given period of time.

Financial Statements 18
The Statement of Cash Flow

Financial Statements 19
The Statement of Cash Flow

Financial Statements 20
 Statement
Financial Statements

of Cash
Flows

21
 Free Cash Flow
• The cash that is actually available for
distribution to the investors in the firm after the
investments that are necessary sustain the
firm’s ongoing operations are made.

Financial Statements 22
 Computing FCF
• What was DPH Tree Farm’s free cash flow for
2012?

Financial Statements 23
 Statement of Retained Earnings
• Increases in retained earnings occur not just
because a firm has net income, but also
because the firm’s common shareholders
agree to let management reinvest net income
back into the firm rather than pay it out as
dividends.
• Reinvesting net income back into retained
earnings allows the firm to grow by providing
additional funds that can be spent on plant and
equipment, inventory, and other assets needed
to generate even more profit.

Financial Statements 24
 Statement
Financial Statements

of
Retained
Earnings

25