SESSION 1:

OVERVIEW OF FINANCE

N. K. Chidambaran
Corporate Finance
 Overview
 Finance
 Financial markets
 Three “angles”
 Investments
 Financial Intermediation
 Corporate Finance
 The goal of the firm
 What is a firm
 What is value?
 Should firms maximize value
Primary & Secondary Markets

Investments: How to build

a portfolio, Pricing of assets
 The three angles

Investments: How to build a portfolio, Pricing of assets

Financial Intermediaries:
Commercial, Investment Banks
Mutual Funds, Pension Funds, Hedge Funds
Exchanges (NYSE, NASDAQ, NSE, BSE), Brokers
Some common securities – a stock
Specifies
one share of
ownership of
Walt Disney

Specifies owner
details and
certificate
number

Investor buys
the share for a
price and holds
it till they sell.
In the interim
they receive
dividends
 Some common securities – a bond
The
“Maturity”

The “Face”
Value

The
“Coupon”
$30 every
Jan and
July upto
Maturity
 Some common securities – savings bond
The “Face” The
Value “Maturity”

Interest details on
Govt website. Price
paid today much
lower than $100
 Some common securities – a mortgage
loan Specifies the
Amount interest rate.
borrowed Payment
frequency
MONTHLY

Usually re-
paid in equal
monthly
payments
CFIN1: WHERE SHOULD FIRMS INVEST
CFIN2: RAISING CAPITAL & PAYOUTS
 TYPES OF FIRMS
 Proprietorships
 Usually small \mom and pop store" type of
businesses, single owner
 Partnerships
 Larger than proprietorships, multiple owners
 Multiple owner "partners" { general and limited
partners.
 Corporation
 Shareholders own the  rm, have limited liability,
i.e., can't lose
 more than initial investment.
 Shareholders are subject to double taxation (next
slide)
 DOUBLE TAXATION OF SHAREHOLDERS

 Proprietorships, partnerships: profits taxed at personal rates

 Shareholders of corporations face double taxation
 Taxes on corporate income
 Taxes on dividends received by shareholders.
 Example: Compute effective tax rates if personal, corporate,
and dividend income are taxed at 40%, 26% and 18%.
 Partnerships, proprietorships: tax rate = personal rate =
40%
 Corporate shareholders: corporate plus dividend taxes
 Tax on $1 profit = 0.26   $1 + ($1-0.26)*0.18 = 39.32%
 Why corporations?

 How should one organize firms?

 Basic choice is whether to be a corporate or not
 Corporate structure gives limited liability for
shareholders.
 Corporates face different tax rules
 Choose based on preference for limited liability and tax
rates.
 What does the market say?
 Corporate structures dominate for large-scale
economic activities Likely shows a strong preference
for limited liability where shareholders losses are
limited to invested capital.
 Thus, the name “corporate" finance, i.e., financial
decisions of corporations.
Types of firms
What is firm value?
 Maximizing Firm Value
 We will assume that managers maximize firm value
This may or may not be true due to “agency problems”.
 Examples of “agency" problems:
 Give favorable contracts to group companies
 Take up pet projects of controlling shareholders
(Google + wind; Tesla + solar panels))
 Managers engage in empire building (Kingfisher
Airlines?)
 Modern debates -- consider, for an all equity  rm
 What about ESG?
 Should these norms be followed if they destroy value? See
https://tinyurl.com/r94786un
AGENCY PROBLEMS
 Myths About Maximize Value
 Myth #1: It creates short-term orientation.
Does it?
 Value usually depends on long-term cash ows.
Value focus is probably long-termism.
 What about meme stock bubble? Consider AMC's
response: https://tinyurl.com/37p325jw
 Is issuing shares short-termism?"
 Myth #2: It ignores other goals, e.g., CSR.
 Not really. Increasing value (through legal
activities) creates more $ for other things such
as CSR.
 Bottom Line
 Corporate finance studies how firms
should (a) raise capital, (b) invest capital,
and (c) distribute excess capital.
 We assess these decisions assuming that
firms maximize value. It is a reasonable
guidepost for major decisions though
perhaps not for all decisions.
 Our job
 Develop models for  rm value
 Use them in understanding how to invest
scarce capital