Financial Management

Dr.Amr Soliman
Faculty of Commerce & Business Administration
Economics Department

Certified trainer & coordinator : Pathways to Higher Education Project

Certified trainer: International Labour Organization
Know About Business (KAB) Project
 CHAPTER 1
An Overview of Financial Management
Role of financial management
Career opportunities
Forms of business organization
Goals of the corporation
Issues of the new millenium
Agency relationships
 CHAPTER 1

An Overview of the
Financial System
 Financial System

 The Financial System consists of “financial markets” and

“financial intermediaries”.

 The basic function of both is to channel funds from one

side to another in the economy. In other words, to move
funds from people who have surplus funds (savers or
lenders) to people who have shortage of funds (investors or
borrowers). This function could be undertaken directly or
indirectly.
 Financial System

 Financial Markets: they are the channel through

which funds could be provided directly from lenders
to borrowers by buying and selling securities
(financial instruments).
 Financial Intermediaries: they are the institutions
through which funds could be provided indirectly from
lenders to borrowers. These institutions borrow funds
from lenders and then lend them to borrowers.
 Financial System

Financial intermediaries include banks,

insurance companies, pension funds,
mutual funds and saving associations.
Financial intermediaries also provide
funds by buying securities in the
financial markets.
 “Indirect Finance”
Interest Rate Interest Rate
•Financial
Intermediaries
Funds (Deposits) •C. Banks Funds (Loans)

Funds

Savers Funds “Direct Finance” Funds Spenders

(Lenders): (Loans) (Shares) (Borrowers):
•Households.
Financial •Households or Individuals
•Businesses. (Firms)
•Businesses.
•Governments.
Markets Dividends
•Governments.
•Foreigners.
Interest Rate •Foreigners.
(Profits)

Bond Stock

Financial System
 Components of the Financial Markets

 A market: is a point of contact where two sides come

together to make exchange. Any market has four
components: demand (buyers), supply (sellers), good
or service, and price. The market does not
necessarily mean a location where buyers and sellers
meet.
 Like any market, the main components of the
financial system is Buyers (Demand), Sellers
(Supply), Service (or good) and Price. Therefore, the
components of financial markets are:
 Components of the Financial Markets

 Demand (Buyers): they are investors or borrowers of

money, who have shortage of funds.
 Supply (sellers): they are savers or lenders of money,
who have surplus of funds.
 Service: it is the service of money.
 (Note: savers are not giving up their money but rather
they are giving up the right of using it for a specific
period).
 Price: prices paid for the services of money are
interests (or dividends), which are returns to savers
but costs to borrowers.
 Classification of Financial Markets

 We have three types of financial markets:

Commercial banks:
 They constitute a market to exchange money
between lenders and borrowers indirectly.
They do not meet each other. This type also
includes other financial intermediaries
(insurance companies, pension funds, mutual
funds and saving associations)
 Classification of Financial Markets

Security Market (Stock Exchange):

It is a center place where all buyers and
sellers of securities (bonds and equities)
meet together to exchange their
securities. Exchange is usually done
through brokers. The major security
markets in the world are in New York,
London and Tokyo.
 Classification of Financial Markets

Foreign Exchange Market:

It is the market where buyers and
sellers meet to exchange foreign
currencies.
 Structure of Financial Markets

 We can also classify financial markets into

four classifications:
Debt and Equity markets.
Primary and Secondary Markets.
Exchange and over-the-counter markets.
Money and Capital markets.
 Primary and Secondary Markets

 Primary Markets
 Primary markets are the financial markets
where securities are sold to initial buyers.
This means, they deal with securities (bonds
and stocks) when they are issued for the first
time. In these markets, securities are sold
only at their face values (value written on the
bond).
 Primary and Secondary Markets

 Secondary Markets
 Secondary Markets are markets where
previously-issued securities are resold. In
such markets, securities are traded at their
market value, which may be higher or lower
than the face value depending on the
demand and supply forces, which in turn
depends on the financial position of the
company.
 Exchanges and Over-The-Counter Markets

 The secondary markets can be organized in two ways: exchange

markets and Over-The-Counter (OTC) markets.
 Exchanges:
 Exchanges are markets where buyers and sellers (or their brokers)
meet together in a central location to trade securities at market prices.
 Over-The-Counter (OTC) Markets:
 They are markets where dealers at different locations declare prices of
their securities and stand ready to buy and sell securities “over the
counter” at these prices to anyone who comes to them. This means,
prices are not set by demand and supply forces.
 Because OTC dealers are in computer contact and know the prices set
by one another, the OTC market is very competitive and not very
different from a market with an organized exchange.
 Money and Capital Markets

 Money Markets:
 Money market is the financial market where
only short-term debt instruments are traded.
 Capital Markets:
 Capital market is the financial market
where longer-term (with maturity of
more than one year) debt and equity
instruments are traded.
 Debt and Equity Markets
Debt Markets:
 Debt markets are the financial markets concerned with
financing through issuing debt instrument, such as bonds.
 A bond is a “contractual agreement by the borrower to pay the
holder of the instrument a fixed payment periodically (interest
payment) until a specified date (maturity date), when a final
payment of the face value is made.
 Maturity date is the expiration date of the debt instrument.
According to their maturity, debt instruments may be:
 Short term: if maturity is less than one year.
 Intermediate term: if maturity is between one year and ten
years
 Long term: if maturity is ten years or longer.
 Debt and Equity Markets
Debt Markets:
 Bonds involve no risk. This is because it does not matter
whether the corporation made losses or profits. A fixed interest
is paid periodically, and the face value will be repaid at the
maturity date, in all cases.
 Bond holders are lenders, so they are the first claimants to the
issuing company in cases of liquidation or bankruptcy.
 At the maturity date, the relationship between the bond-holder
and the bond-issuer will end.
 Bonds are issued by corporations or governments.
 Debt and Equity Markets
Equity Markets
 Equity Markets are the financial markets concerned with
financing through issuing equities such as common stocks
(shares).
 Common stocks (shares): are claims to share in the net
income and assets of a business. (For example, if a company
issued one million shares and you own one share; you are
entitled to one-millionth of the firm's net income and one-
millionth of the firm's assets).
 Equities (or stocks) give periodic payments to their holders.
These payments are called dividends. These dividends are a
specific percentage of the corporation’s net income (or profits),
which means that it is not fixed.
 Debt and Equity Markets
Equity Markets
 Equities involve no maturity, as they do not have a
maturity date. The relationship between the
shareholder and the issuing company will never end
until the former sells his shares or the company is
liquidated or bankrupt. However, equities are
considered long term securities.
 Equities involve risks, because firms might achieve
profits or losses.
 Equities holders are the last claimants to the issuing
company in cases of liquidation or bankruptcy.
 Equities are issued by corporations only.
What three questions does financial
management seek to answer?

What causes a company to have a

particular stock value?
How can managers make choices
that add value to their companies?
How can managers ensure that
their companies don’t run out of
cash while executing their plans?
 Career Opportunities in Finance

Institutions and capital markets

Investments
Financial management
 Alternative Forms of
Business Organization

Sole proprietorship
Partnership
Corporation
 Sole Proprietorship

Advantages:
Ease of formation
Subject to few regulations
No corporate income taxes
Disadvantages:
Limited life
Unlimited liability
Difficult to raise capital
 Partnership

A partnership has roughly the same

advantages and disadvantages as a
sole proprietorship.
 Corporation

Advantages:
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages:
Double taxation
Cost of set-up and report filing
 Goals of the Corporation

 The primary goal is shareholder wealth maximization,

which translates to maximizing stock
price.
Should firms behave ethically?
YES!
Do firms have any responsibilities to
society at large?
YES! Shareholders are also members of
society.
 Is maximizing stock price good for
society, employees, and customers?

Employment growth is higher in firms

that try to maximize stock price. On
average, employment goes up in:
firms that make managers into
owners
firms that were owned by the
government but that have been sold
to private investors
Consumer welfare is higher in
capitalist free market economies
than in communist or socialist
economies.
 Fortune lists the most admired firms.
In addition to high stock returns,
these firms have:
high quality from customers’ view
employees who like working there
 Factors that Affect Stock Price

Amount of cash flows expected by

shareholders
Timing of the cash flow stream
Risk of the cash flows
Three Determinants of Cash Flows

Sales
Current level
Short-term growth rate in sales
Long-term sustainable growth rate in
sales
Operating expenses
Capital expenses
 Factors that Affect the Level and
Risk of Cash Flows
Decisions made by financial
managers:
Investment decisions (product
lines, production processes,
geographic market, use of
technology, marketing strategy)
Financing decisions (choice of debt
policy and dividend policy)
The external environment
 Financial Management
Issues of the New Millenium

Use of computers and electronic

transfers of information
The globalization of business
 Agency Relationships

An agency relationship exists

whenever a principal hires an agent
to act on his or her behalf.
Within a corporation, agency
relationships exist between:
Shareholders and managers
Shareholders and creditors
 Shareholders versus Managers

Managers are naturally inclined to act

in their own best interests.
But the following factors affect
managerial behavior:
Managerial compensation plans
Direct intervention by shareholders
The threat of firing
The threat of takeover
 Shareholders versus Creditors

Shareholders (through managers)

could take actions to maximize
stock price that are detrimental to
creditors.
In the long run, such actions will
raise the cost of debt and
ultimately lower stock price.