CHAPTER 1:

INTRODUCTION OF
FINANCIAL
MANAGEMENT

FUNDAMENTAL OF FINANCE FIN242 2021

 CHAPTER OUTLINE
Financial markets and business organization

Goals of the firm

Functions of the financial manager

Risks and return relationship

 What is Finance?
To obtained and
Maintenance and
allocated financial
creation of
resources
economic value and
effectively and
wealth
efficiently

Deal with financial

Integrate with other
decision (e.g. new
department (i.e..
product, new asset,
Marketing,
borrowing, issue
operations
stocks & debts)
 Forms of Organization
Sole
Partnership Corporation
Proprietorship

“An association of two “An entity that legally

“A business owned
by single individual”
Advantages:
◼ Ease of formation
◼ Belongs to only one
person
◼ Manager and owner is
the same person
or more individuals functions separate from
joined as coowners of its owner”
business for profit”
Advantages:
Advantages: ◼ Ease of transfer of
ownership
◼ Ease of formation
◼ Shareholders are co-
◼ Belongs by more one
owner
person
◼ Limited liability
◼ Share liabilities
◼ Ease of raising capital

Disadvantages: Disadvantages: Disadvantages:

◼ Limited life ◼ Limited life ◼ Double taxation
◼ Unlimited liability ◼ Unlimited liability ◼ Cost of set-up and
◼ Difficult to raise capital report filing
◼ Difficult to raise capital
 Goals of the Corporation

Profit Maximization of Benefits to

Maximization Shareholder Value society
• To obtain Profit • The primary • Efficient and low
as much as goal is cost operations
possible shareholder (i.e. low price)
• Reasons: wealth • New product
• Maintain its maximization, development (i.e.
operating stability which translates consumer choice)
• Maintain growth to maximizing • Provide efficient
stock price. and courteous
• Reward to
stakeholders (i.e. service (door to
contributors of door service)
idea, capital etc)
Functions of Financial Management

Controlling (i.e. to
conform actual
performance with
stated plan)
Financial Decisions:
Planning (i.e. ways
- Investment &
to achieve firms
Financing
goals and
strategies) - Both decision affect
the Risk and Return

To ensure the
maximization of
shareholder value,
financial manager need
to:
 What is Financial Market?
Institutions and procedures
To allocate financial
that facilitate transactions in
resources within the
all type of securities (i.e.
economy
financial assets)

Firms receive money from

it, while investors (i.e. Firms
Provide Sources of Funds or Individual) made
(suppliers) to Deficit investment (i.e. shares,
(demanders) Units bonds, marketable
securities, government
securities)
 Financial Market

Capital Market Money Market

• Market in which long-term • Market short-term debt

securities issued by firms instruments (i.e. less than
and government are 1-year)
exchanged • Issued by firms, &
• Equity and Debt (i.e. government
corporate and govt ) • Low risk and liquid
instruments traded in • Instruments such as
capital market commercial paper, NCDs,
• Carries greater risks but etc (also known as
higher in returns (i.e. Marketable Securities)
market risk)
 Risk and Return Relationship
• Risk can be referred as the chances of having an unexpected or
negative outcome. Any action or activity that leads to loss of any type
can be termed as risk.
• Typically, investment returns are not known with certainty.

Risk • Investment risk pertains to the probability of earning a return less than
that expected.
• The greater the chance of a return far below the expected return, the
greater the risk

• Investment returns measure the financial results of an investment (i.e.

ROI).
• Returns may be historical or prospective
• Returns can be expressed in dollar and percentage term

Return
 Categories of Risk
Non-Business Risk
Not under the control of
firms such as political
and economic
Financial Risk
Business Risk imbalances
Due to instability and
Eg: Companies
losses in the financial
undertake high cost risks
market caused by
in marketing to launch
movements in stock
new product in order to
prices, currencies,
gain higher sales
interest rates

Risk
 Risk and Return Relationship
⮚Risk and return trade – offs play a major role in
influencing the investment decision made.
⮚The basic rule states that; higher risk associates with
higher returns and vice versa
⮚Risk is unavoidable, thus, the key strategy is seek
investment opportunities that offer the highest return with
the least risk
⮚Bonds and Equities are the instruments that pose
Higher Risks and gives Higher Returns, and there are
Less Liquid (i.e. long-term securities) while Marketable
Securities pose Lower Risk, result to Low in Returns,
but High in Liquidity
 Risk and Return Relationship

Risk Common
Stocks
Preferred SML
Stocks
Bond

Risk free asset

 Risk and Return Relationship
Systematic Unsystematic
(Market Risk) (Firm Specific Risk)
• Risk that is • Risk that can be
unavoidable and eliminated by
cannot be eliminated diversification
by diversification • For example
• For example management,
inflation, interest operations, profit
rate, political and
more
 How to Managing Risk
Diversification in an investment
portfolio can reduce unsystematic
risk to some extend, dependent upon
Diversification the correlation coefficient that
exists between the securities held in
the portfolio (i.e. stocks, corporate
bonds, government bonds)

Correlation coefficient
describes how much linear co
– movement exists between
two random variables or
between two securities.
Possible correlation which
consist of positive, negative
and zero correlation.