INTERMEDITE ENGLISH FOR ECONOMICS

(Patahuddin, S.Pd., M.Pd)

FINANCE
arranged by:
Yudi hardiansa
(NIM: 220210005)
MODERN FINANCE THEORY
Strategic Financial Management (SFM henceforth) with an idealised picture
of shareholders as wealth maximising individuals, to whom management are
ultimately responsible.
We also noted the theoretical assumption that shareholders should be
rational, risk-averse individuals who demand higher returns to compensate for
the higher risk strategies of management.
 ADVANCED…
Then steps sho uld be taken is termed normative theory.

The over-arching, normative objective of strategic financial management should be an

optimum combination of investment and financing policies which maximise shareholders’ wealth
as measured by the overall return on ordinary shares (dividends plus capital gains).
ADVANCED…
As a benchmark, you recall from SFM how Fisher (1930)
neatly resolved this dilemma. In perfect markets, where all
participants can borrow or lend at the same market rate of
interest, management can maximise shareholders’ wealth
irrespective of their consumption preferences, providing that:
The return on new corporate investment at least equals
the shareholders’ cost of borrowing, or their desired
return earned elsewhere on comparable investments of
equivalent risk.
1. FISHER’S SEPARATION
THEOREM
In corporate economies where ownership is divorced
from control, firms that satisfy consumer demand should
generate money profits that create value, increase equity
prices and hence shareholder wealth.

Fisher (1930) states that in perfect markets a company’s

investment decisions can be made independently of its shareholders’
financial decisions without compromising their wealth, providing that
returns on investment at least equal the shareholders’ opportunity cost
of capital.
2. IMPERFECT MARKETS AND
EFFICIENCY
We know that capital markets are not perfect but are
they reasonably efficient? If so, profitable investment
undertaken by management on behalf of their shareholders
(the agency principle supported by corporate governance)
will be communicated to market participants and the current
price of shares in issue should rise.

So, conventional theory states that firms should maximise

the cash returns from all their projects to maximise the market
value of ordinary shares
3. CAPITAL MARKET THEORY
Modern capital market theory is based on three
normative concepts that are also pragmatic because they
were accepted without any empirical foundation.
- Rational investors
- Efficient markets
- Random walks
 4. THE EFFICIENT MARKET
HYPOTHESIS (EMH)
Anticipating the need for this development, Eugene - Current share prices reflect all the
Fama (1965 ff.) developed the Efficient Market information used by the market.
Hypothesis (EMH) over forty years ago in three forms
- Share prices only change when new
(weak, semi-strong and strong). Irrespective of the form
of market efficiency, he explained how: information becomes available.

5. The EMH as “Bad Science”

Financial models premised on rationality, efficiency and random walks, which are the bedrock of modern finance,
therefore attract legitimate criticism concerning their real world applicability
SUMMARY AND CONCLUSIONS
The implosion of the global free-market banking system
(and the domino effect throughout world-wide corporate
sectors starved of finance) required consideration of the
assumptions that underscore modern financial theory still
adhere to the traditional objective of shareholder wealth
maximisation, based on agency theory and corporate
governance, whereby the owners of a company entrust
management with their money, who then act on their behalf
in their best long-term interests. But remember, too many
financial managers have long abused this trust for personal
gain.
THANKS
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