Week 1-Introduction Flashcards
What is Finance? (6 aspects)
• Finance is a sub‐field of economics, but with a different focus and a different methodology
-Finance focuses on the capital markets ‐ as opposed to goods or labour markets
• It focuses on how capital markets work, how they supply
capital and how capital assets are priced
• Finance is the study of how individuals, businesses and
organisations allocate and use scarce financial resourcesacross time
• Costs and benefits occur over time, so the actual timing
and size of future cash flows are very important butuncertain, known only probabilistically
• Finance helps you evaluate those uncertain cash flowsand the associated risks
What is the law of one price?
“Law of one price”: all assets and risk must be priced consistently, so that assets with the same risk yield the same return
What is arbitrage?
Arbitrage: Undertaking financial transactions and
obtaining a net profit without incurring any risk
(If the “Law of one price” holds, no arbitrage is possible. If the “Law of one price” does NOT hold, arbitrage opportunities arise)
What is financial theory consisted of?
• Financial theory consists of:
– a set of concepts to organize thinking about how to allocate financial resources over time
– a set of quantitative models to evaluate alternave s, to make
financial decisions, and to implement them
Mention sub-fields
– Asset pricing ‐ Personal finance – Corporate finance ‐ Risk management – International finance ‐Behavioural Finance
What is the financial system?
-the set of markets and other institutions used for
financial contracting and exchange of assets
and risks
• Financial decisions are implemented through the financial system
• The financial system both constrains and
enables the decision maker
• The financial system is the “oil in the wheels”, the plumbing, of an economy
What are the 3 types of financial decisions?
1) Investment – Capital Budgeting
• Where will you get long‐term financing for your long term projects?
- The process of planning and managing a firm’s long‐ term investments.
- Identify investment opportunities that aare worth more to the firm than they cost to acquire.
- Financial managers must be concerned not only with how much cash they expect to receive, but also with when they expect to receive it and how likely they are to receive it.
2) Financing – Capital Structure
• Where will you get long‐term financing for your long term projects?
-The mixture of long‐term debt (borrowing) and
equity (owners’ investment) maintained by a firm.
-1. How much should the firm borrow?
.2. What are the least expensive sources of funds for the firm?
-the financial manager also has to decide exactly
how and where to raise the money
3)Liquidity-working capital
• How will you manage your everyday everyday activities?
-The management of a firm’s short‐term
assets and liabilities.
-How much cash and inventory should we
keep on hand?
-Should we sell on credit? If so, what terms
will we offer, and to whom will we extend
them?
-How will we obtain any needed short‐term
financing?
Financial decisions made by households
Consumption and saving decisions
Investment decisions
Financing decisions
Risk‐management decisions
What is the financial manager responsible for?
- investment decisions
- financing decisions
- short-term financial planning
- oversee accounting and audit function in firm
- ensure the financial welfare of the firm
What is the goal of financial management?
Maximise Value of Owner’s Equity / wealth
What is the financial system consisted of?
A financial system consists of the financial
instruments, financial markets and financial institutions that are used to implement the financial decisions of households, business firms, and
governments through financial contracting and exchange of assets and
risks
What are financial institutions? (give some examples)
- a firm whose primary business is to provide financial services and financial products
ex: banks, insurance companies, pension funds, investment banks, hedge funds
What are primary markets? What are secondary markets?
Primary:
- securities are sold to investors
- money that is raised goes to issuing firm
- first share issues is called an initial Public Offering
- Second share issue is called a seasoned offering
Secondary:
- investors trade securities with each other
- money that is raised goes to the seller of securities
- share prices
What are flow funds? Through what do flow funds flow? Who are involved?
-Flow of funds are the data that provide the
overall, consolidated picture of how money
flows in the economy from those (units) who are
net savers to those who are net users of funds.
-Funds (money) flow through the financial system from a surplus unit to a deficit unit • Through financial intermediaries • Through the financial markets • Directly, without intermediation
Units involved:
- households
- firms
- gov
- foreign investors
Describe Flow funds via an intermediary
• A household with surplus funds invest them in a bank saving account.
• The bank receives the surplus funds, say as 90‐day deposits, and adds them to the bank’s assets (creating a bank liability).
• The bank then provides say, loans to small businesses. Money is fungible, so the source of the corresponding
loan to the firm cannot be identified.
