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Lecture

Management and Organizational Studies 1023A/B Lecture Notes - Net Present Value, Financial Intermediary, Systematic Risk


Department
Management and Organizational Studies
Course Code
MOS 1023A/B
Professor
Kate Helsen

Page:
of 3
Feb 27 – Introduction to Finance
Under what terms is money allocated b/w lenders and borrowers?
Role of Management
Management serves as a sort of intermediary for the best interest of the
shareholder. Manager's role is to ensure conflicting interests are satisfied
Contractual claims – eg. Salary owed for working for two weeks. Under
contract that these claims will be satisfied
Function of Financial Manager
Finance function: investing funds in the right places and getting returns
back to investors. Look at longer-term decisions.
Day to day decisions: looks at current assets and liabilities – short term
investments critical to the company eg. Having the right amount of
inventory.
Financing a business: short term debt, liability. eg. Is it wiser to sell shares?
Manager must generate money by going to outside financial markets.
Investors: anyone that lends or gives a company money.
Maximizing Shareholder Wealth
Investors have expectations on return – either dividends or reselling at a
higher price
*Shareholder – shares. Stockholder – owns stocks. Both mean the same
thing.
*Stakeholder – anyone who invests in a company – creditor, employee,
government.
*Not all stakeholder are shareholders/stockholders
Profits must be considered in relation to the investment. eg. Company makes
$1000. 1000 shares outstanding. $1000/outstanding shares = $1. Profit is $1500,
but shares are doubled. $1500/2000 = $0.75. Must consider the amount of shares
to the amount of profit – often better to issue debt.
Also must consider timing
Consider risk as well – some projects are riskier than others.
Six Principles of Finance
1. Time Value of Money
Money is more valuable now because it has higher purchasing power than
later if it is the same amount
Net Present Value Method – *if it's zero, it's still acceptable – promises return
equal to required rate of return
2. Risk-Return Tradeoff
More risk = more chance of a good return
3. Diversification of Investments
Impossible to have a risk-free portfolio
Fully diversified portfolio – always will be stuck with the market or
systematic risk
4. Efficient Financial Markets
Information can be through anything - financial media reports, press
releases, accounting info. Information gets processed by investors.
No one is at an advantage – all known information is processed. However,
doesn't mean everything is correct eg. Something can be over-valued
5. Management vs. Owner Objectives
Manager works on behalf of the shareholders
Owners want maximization of their returns, but managers are looking
towards their own personal objectives. This may create bias eg. Company
owners may want to buy companies to be in charge of a large company
even if it may not be in the best interest of the shareholders. Tying manager
compensation to performance measures beneficial to owners – can be
costly. Creates information asymmetry. Can be a problem when this inside
information is used for insider trading – people who are sold stocks to will
lose out.
Agency costs reduce this risk for someone's information asymmetry
6. Reputation Matters
Ethical behaviour – eg. Laying off people – changes how people perceive a
company. People will not invest
Integrity of a company hugely impacts financial manager.
Real Versus Financial Assets
Assets – someone who lends credit to another person – it is the lender's
asset
The Functions of Money
One thing must have equal value to another, and both parties must want
what the other person has – this is how money developed.
Financial intermediary – changes the nature of the saver's security itself eg.
Putting money in a bank. The bank lends money to someone else. Insurance
companies – life insurance plan. Company invests in stocks, bonds to generate
profit and pay your benefits. You don't have a claim to the investments they
make.
Mutual funds – do not fall into exact definition of a financial intermediary – more of
a market intermediary. Investors act as a middle man.
Channels of Intermediation
Non-market – did not involve an investor, TSX etc. – between a lender and a
borrower.
Market intermediaries – eg. Call broker to buy shares in a comapny.
Financial intermediaries – bank invests using your money – person has no claim
over money they put in – all they have claim on is the savings in their account.
Financial Markets
Primary: brand new security
Secondary: b/w investors
Money: short term
Capital: long term debts
Third market: where it's listed
Fourth market: b/w investors and companies
Financial Instruments Issued by Corporations
Matching the money with what it's needed for. Companies don't want to
issue long-term debt for short-term issues
1. Commercial Paper
Very short-term debt, usually less than 270 days.
Debt is unsecured – no collateral. As an investor, you must trust the
company.
2. Bankers Acceptance
Bank is the guarantor of the payment
Bank must ensure that you can pay them back
1 and 2 both considered low risk = low returns. People invest in these things
because too much cash in a bank earns minimal interest.
3. Corporate Bonds
Bought and sold on the market. Can be short-term or long-term
Advantage – gives an active secondary market for bonds.
Bond Features – not all bonds come with these features – all dependent on the
market, competition etc.
Issuer vs Holder
Issuer* - issuing the opportunity for others to lend me
Holder* – one who holds the financial asset i.e. Lends issuer money
1. Retractable
Allows the holder (lender) to force the issuer to redeem the bond (pay them
back)
2. Convertible
Allows the holder to convert debt into shares
3. Extendable
Issuer or holder has the option to extend the bond.
4. Callable (Redeemable)
Gives the issuer the right to call back their debt. eg. Due to a market
change.
All of these features likely have an impact on the price of the bond.