Summary sheet for entire year 1 course - Principles of Finance
From the history and origins of financial markets to the functions of finance today.
How investments work, how to maximise returns, financial calculations and formulas and so on.
Finance is concerned with decisions about money, investment decisions and funding needs.
To make sound financial decisions, remember:
• More value is preferred to less
• The sooner cash is received the more value it has
• Less risky assets are more valuable (preferred to) than risky assets
4 major areas of finance: (1) Financial Markets and Institutions, (2) Investments, (3) Financial
Services, (4) Managerial Finance
(1) i) Financial Institutions à banks, insurance companies, savings and loans, credit unions
ii) Financial Markets
• Markets are places where buyers and sellers meet (can be physical or electronic)
o i.e. New York Stock Exchange, London Stock Exchange
o Non-physical markets: NASDAQ (AAPL stocks traded)
• Used to be private corporations owned by brokers, now mostly public companies
• Primary markets à new issues raising capital
• Secondary markets à subsequent exchanges
• Clearing Houses organize the settlement of trades and takes on the counterparty
risk
• Securities are dematerialized and registered with a Central Securities Depository
(DTCC, Clearstream, Euroclear)
(2) Investments
• Major functions
o Determining the values, risks and returns of financial assets (through VRS
analysis)
o The higher the risk, the higher the likely return
o Determining the optimal mix of securities that should be held in a
portfolio
(3) Financial Services
• Deal with the management of money
• Help individuals and companies determine how to invest money
• One of the largest industries in the world
o i.e. Goldman Sachs, deals with financial markets and provides financial
services to customers
(4) Managerial Finance
1
, • Important in all areas of business
• Decisions made by financial managers:
o The credit terms under which customers can buy
o How much inventory the firm should carry
o How much cash to keep on hand (if you lose investments how much of a
base do you have?)
o Whether to acquire other firms
§ Mergers and acquisition fields
§ Microsoft acquired Activision and Blizzard
§ Which companies and how much money
o How much earnings to reinvest in business and how much to pay out in
dividends
EVOLUTION OF MODERN FINANCE
Þ Early 1900s – banks were full service financial organizations
Þ Crisis of 1907
Þ Bank failures during 1920s
Þ Great depression 1929 – 1933 (market value decrease > 80%)
Þ Legislative reform
Þ Deregulation since 1970s
o Banks made more and more risky activities – these cause financial crises and
regulators become strict, then economy begins to regress, and regulators
become more permissive (cycle)
o In the U.S., the Securities and Exchange Commission (SEC) overlooks
investments, in France it is the Autorité de Marché Financier (AMF)
History of investments
Þ Early 1900s investments dominated by a small group of wealthy investors
Þ Industrialization during WW1
Þ Growth of investment firms by 1920s
Þ Stock market crash 1929-1932; market value decreased > 80%
o Regulations of securities
o Prosperity after WWII
o Inflation and high interest in 1970s
o Increase in individual and institutional investors
History of Managerial Finance
Þ Emergence as a separate field of study in the early 1900s
Þ Wave of mergers during 1920s
Þ Bankruptcies 1930s
Þ Liquidity stressed during 1940s and 50s
Þ Analysis and maximizing value in late 1950s and 1960s
Þ Innovative risk management in 1970s
2
, o Trends of the 1990s have continued into 21st century
§ Continued globalization of business
§ Further increase in use of technology
§ Regulatory attitude of government
Globalization of Business
• Improvements in transportation and communications
• Political clout of consumers
• Cost of developing new products has decreased
• Multinational firms are able to shift production to wherever costs are lowest
Importance of Managerial Finance:
• Financial managers no longer merely fund the business needs, they coordinate decisions
• People in marketing, accounting, production and personnel need to understand finance
in order to do their job well
• Responsibilities:
o Obtain and use funds in a way that will maximize the value of the firm
o Value = the present, or current, value of the cash flows an asset is expected to
generate in the future (during its life)
Value of the firm
From the point of view of a company the interest rate is a cost, from the point of view of an
investor, the interest rate is a return.
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