CHAPTER 1

INTRODUCTION

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 CHAPTER OUTLINE

1. Definition of Finance
2. Introduction to Personal Financial Planning
3. Financial Market and Business Organization
4. Goals of the Firm
5. Function of the Financial Manager
6. Risks and Return Relationship

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 WHAT IS FINANCE?
⚫ Finance is the art and science of management of
money and other assets. It is an art and science because
in any financial decisions it will involve intuition of
decision maker and certain procedures that must be
followed before any decision are made.

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PERSONAL FINANCE
⚫ An individual or a person’s fund or money management
 Importance of
Personal Finance

Financial success – able to use

limited financial resources to gain
maximum benefits or returns.
Financial Goals
⚫ The basic financial directions of an individual.

⚫ Important in financial planning to achieve financial

success.

⚫ It should be realistic, specific/ measureable term,

have time frame and having course of actions.
Types of Financial Goals
⚫ Current consumption – goods and services that we
consume at present or now

⚫ Future consumption – goods and services to be consumed

tomorrow or in future

⚫ Savings – Amount of fund being kept or not being used

Personal Financial Planning

⚫ A process of
managing fund/
money which belongs
to an individual so
that he or she can
gain personal
economic
satisfaction.
Importance of Financial Planning
⚫ The key to financial success

⚫ A life-long process/ life-cycle planning

⚫ Can control one’s financial situation

⚫ Good financial planning can lead to enhancing

quality of life and increasing personal satisfaction
by reducing uncertainty about future needs and
resources.
Personal Financial
Planning Area
⚫ Consumption and
savings planning
⚫ Debt planning
⚫ Insurance planning
⚫ Investment planning
⚫ Retirement planning
⚫ Estate planning
⚫ Income tax planning
is an area which is
inserted in all other
financial planning
areas
 FINANCIAL MARKET
⚫ Financial market is a market for the exchange of capital and credit,
including the money markets and the capital markets.

⚫ Functions of financial market:-

- To help allocate financial resources within the economy.
- To moves money from those who have a surplus and are willing
to invest to those who have a need or a use for this money.

⚫ Financial sources are from commercial and savings bank, finance

companies, insurance companies, pension funds, investment funds,
brokers, dealers, households, other business firms and government.

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 Money
Market

Secondary Financial Capital

Market Market Market

Primary
Market
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 MONEY MARKET
⚫ Money market provides trading facilities for individuals
and institutions with temporary surpluses or shortages.

⚫ It deals with marketable securities or money market

instruments that mature within one year or less. For
example, short-term debt securities such as such as
banker’s acceptances, commercial paper, repos,
negotiable certificates of deposit and treasury bills.

⚫ This security have low defaults risks, short maturities,

high liquidity and high marketability.
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 CAPITAL MARKET

⚫ This capital market deals with transactions of long term

securities such as bonds, common stocks, preferred stocks
and convertible issues.

⚫ The existence of capital market represents an important

channel for businesses to raised needed capital to finance
the business growth and expansion to achieve its goals.

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 PRIMARY MARKET

⚫ Deals with newly issued securities that involve the issuer

and the investors.

⚫ It serves as important venue for the firms to raise funds

to finance new investment in fixed assets.

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 SECONDARY MARKET

⚫ Deals with securities previously issued.

⚫ Its provides means of liquidity to investors to acquire and

dispose shares with relative ease.

⚫ The issuer is not involved in the transaction and the

volume of trading is much larger than the primary market.

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 GOALS OF THE FIRM

To maximize the shareholder’s

wealth by maximizing the
share price.

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 WEALTH MAXIMIZATION VS PROFIT
MAXIMIZATION
• Profit maximization tends to be a short-term approach.
Time Horizon • Decisions are focus on getting as much current profit as possible
with less consideration on its impact on long –term profits.

• Profit maximization gives no considerations on the timing of

Timing of returns.
Returns • Thus time value of money.

Distributions • Profit maximization tends to ignore the owners wish to receive a

of Returns portion of earnings in the form of dividends.

• Profit maximization tends to give less consideration to risk in an

Risk attempt to maximize profits.
Orientation • Thus faces higher risks in operations.

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FINANCIAL MANAGEMENT
FRAMEWORK

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 FUNCTION OF FINANCIAL
MANAGER

Planning

Financia
Financing l Controllin
Decisions Manage g
r
Investment
Decisions
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 PLANNING
⚫ Involves the development, refinement and evaluations of
the firm goals and strategies to ensure the achievement of
the stated objectives.

⚫ It involves deciding what the firm is aiming to do?

⚫ How it proposes to do it?

⚫ When to do it?

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⚫ What strategies to be implement and what is the outcomes?
 CONTROLLING
⚫ Involve the analysis of causes and responsibilities.

⚫ Information and clues gathered will act as a guide to

reinforce current performance that conforms to the
original plans.

⚫ To modify and develop other strategies or plans for future

use.

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 INVESTMENT DECISIONS
⚫ Involve determining the appropriate mix in the asset
portfolio or asset structure held by the firm.

⚫ Determining the appropriate Ringgits to be invested in

current assets versus fixed assets.

⚫ Determining the optimal levels of investment in each type

of current assets.

⚫ Recommending the best fixed assets to acquire and know

when to replace the existing assets.
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 FINANCING DECISIONS
⚫ The determination of the financial structure of the firm.

⚫ Determining the appropriate mix of short and long term

sources of funds for financing.

⚫ Choosing the appropriate source of funds for investment in

asset portfolio.

⚫ Determining the appropriate dividend policy so that

internally generated funds are available for reinvestment.

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 RISK AND RETURN RELATIONSHIP

Risk

HIGH RISK
HIGH RETURN

Return
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 SYSTEMATIC RISK
⚫ Non-diversifiable risk and also known as market risk that
are unavoidable in an investment portfolio.

⚫ Example of systematic risks are inflation, oil embargoes,

recessions, interest rates, political attitudes and others that
affect all firms in the market simultaneously.

⚫ Its also refers to the external environment which financial

managers have no direct control or influence.

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 UNSYSTEMATIC RISK
⚫ Diversifiable risk and also known as non-market risk that
is unique to a particular firm and avoidable in an
investment portfolio.

⚫ Example of unsystematic risks are new competition,

lawsuits and others that relate to a specific firm.

⚫ Can be diversify to reduce unsystematic risk through

correlation coefficient that exists between the securities
held in portfolio.

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 CORRELATION COEFFICIENT
⚫ Describes how linear co-movement exist between two
random variables or between two securities.

• The securities involved have a direct relationship.

Positive • An increase risk in one security tends to increase
Correlation risk in another.

• The securities involved have an inverse

Negative relationship.
Correlation • An increase risk in one security tends to reduce
risk in another.

Zero • The securities involved have no relationships with

Correlation one another.
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 INDIVIDUAL ASSIGNMENT

⚫ Please find out a chart of financial institution in Malaysia.

⚫ Then, find out in details about money market and capital

market in Malaysia.

⚫ Write up in 3 to 5 pages only.

⚫ Submit next class.

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 THANK YOU

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