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FINC 5133 Intro 2008 - FINC 5133 Financial Policy...

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1 FINC 5133: Financial Policy Introduction to Finance and Review of Principles Finance: What is it? Formally – The study of how to move wealth over time Combines economics and accounting to make decisions Areas Corporate Finance: management and investment within firms Investments Financial Institutions & Markets Commercial Banking Investment Banking (including broker/dealers) Risk Management: hedging, compliance Real Estate Insurance
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2 Corporate Finance: A Review Forms of Organization Sole proprietorship Partnership Corporation Benefits: unlimited life limited liability for owners easy access to capital Two forms of Capital Debt: a contractual obligation of the firm Risky to the firm, requires payment Cheap for the firm, because of guarantee Equity: ownership, a residual claim Safe for the firm, because no payment is required Expensive, because it is risky to the holder The Firm as a Nexus of Contracts What does the corporation represent? A Nexus of Contracts There are many stakeholders Employees/Managers Society Government Customers Suppliers Creditors Owners/Shareholders Ownership: What is it? Get the right to vote Get the opportunity to increase your wealth Get the opportunity to lose your entire investment, but no more
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3 What should be management’s goal? Given the special nature of the shareholder’s contract, managers should strive to Maximize Shareholder Wealth which is the same* as saying that they should Maximize Stock Price *as long as markets are efficient (next page) Without this goal in place, and pursued, folks won’t take risk Pursuit must be credible Is this a narrow objective? A Cornerstone: Efficient Markets One of the most important beliefs in Financial Economics Markets are efficient , which usually means that A stock’s price quickly adjusts to reflect all available and relevant information about that firm That’s a simplification, but where we’re going What is a market? A mechanism for exchange, providing immediacy and price continuity They arise when individuals find it advantageous to invest the necessary infrastructure (creating institutions )
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4 Markets, and Efficiency (2) What infrastructure is needed? 1. legal system (contracts & securities) [property rights] 2. physical markets & networked markets (fixed costs) 3. information investment 4. reputation investment (safety) 5. inventory investment (immediacy): dealers vs. brokers Market Efficiency There are three types of market efficiency : 1. Operational Efficiency : Are transactions quick and cheap? 2. Informational Efficiency : One realm of academic finance Does the price of an asset quickly adjust to reflect all available and relevant information regarding the value of that asset?
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