Management and Organizational Studies 1023A/B Lecture Notes - September 11 Attacks, Western Standard, Ethical Movement

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Finance Lecture 1: Intro To Finance
What is Finance?
The science or study of the management of funds.
Role of management
Management serves as an arbitrator and moderator between conflicting
interest groups or stakeholders and objectives.
Creditors, managers, employees and customers hold contractual claims
against the firm’s revenues.
Shareholders have residual claims against the company.
Function of a Financial Manager
Maximizing Shareholder Wealth
The objective of financial management is to maximize shareholder
wealth.
Six Principles of Finance
1. Time Value of Money
Money in hand today is worth more than the promise of receiving
the same amount of money in the future.
Time value of money exists because a sum of money today could
be invested and “grow” over time.
Computation of Present Value
An investment can be viewed in two ways its future value or its present
value.
Present Value Future Value
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The Theory of Interest
Assume a bank pays 8% interest on a $100 deposit made today. How much
will the $100 be worth in one year?
Present Value an example
If a bond will pay $100 in two years, what is the present value of the $100 if
an investor can earn a return of 12% on investments?
The Process is called discounting. We have discounted the $100 to its present
value of $79.72. The interest rate used to find the present value is called discount
rate.
To Verify:
Lets verify that if we put $79.72 in the bank today at 12% interest that it
would grow to $100 at the end of two years.
If $79.72 is put in the bank today and earns 12%, it will be worth $100 in two years.
2. Risk-Return Tradeoff
Risk is the uncertainty about the outcome or payoff of an investment in the
future.
Rational Investors would choose a riskier investment only if they feel the
expected return is high enough to justify the greater risk.
Periods
8% 10% 12%
1 1.080 1.100 1.120
2 1.166 1.210 1.254
3 1.260 1.331 1.405
4 1.360 1.464 1.574
5 1.469 1.611 1.762
Future Value of $1
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3. Diversification of Investments
All investment risk is not the same
Some risk can be removed or diversified by investing in several different
assets or securities.
o Firm Specific (unsystematic)
o Market (systematic)
4. Efficient Financial Markets
A financial market is “information efficient” if at any point in time the prices
of securities reflect all information available to the public
When new information becomes available, prices quickly change to reflect
that information
Information efficient markets provide liquidity and fair prices.
5. Management vs. Owner Objectives
Management objectives may differ from owner objectives (called principle-
agent problem)
Owners or equity investors want to maximize the returns on their
investments.
Managers may seek to emphasize the size of firm sales, assets, or other perks.
Solution: tie manager compensation to performance measures beneficial to
owners.
6. Reputation Matters!
Ethical Behavior:
o How an individual or organization treats others legally, fairly, and
honestly.
o High reputation value reflects high quality ethical behavior, so
employing high ethical standards is the “right” thing to do.
Real Vs. Financial Assets
Real Assets are tangible things owned by persons and businesses
o Residential structures and property
o Major appliances and automobiles
o Office towers, factories, mines
o Machinery and equipment
Financial Assets are what one individual has lent to another
o Consumer credit
o Loans
o Mortgages
The Functions of Money
Medium of Exchange
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Document Summary

The science or study of the management of funds. Management serves as an arbitrator and moderator between conflicting interest groups or stakeholders and objectives. Creditors, managers, employees and customers hold contractual claims against the firm"s revenues. Shareholders have residual claims against the company. Six principles of finance: time value of money. The objective of financial management is to maximize shareholder. Money in hand today is worth more than the promise of receiving the same amount of money in the future. Time value of money exists because a sum of money today could be invested and grow over time. An investment can be viewed in two ways its future value or its present value. Assume a bank pays 8% interest on a deposit made today. If a bond will pay in two years, what is the present value of the if. We have discounted the to its present value of . 72.

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