FINA274 lecture 1

FINA274 lecture 1 - Role of the Corporation in Financial...

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Role of the Corporation in Financial Markets Topic 1.a. 1 FINA 274 Lecture 1
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The Role of Financial Markets Price discovery : Trading on secondary markets provides public information on asset prices (market price = last traded price of an asset) Lower search costs : Since all trading parties converge to the same location, matching is made easier Provides liquidity : investors can sell assets prior to maturity on secondary markets to satisfy their time preference for consumption and diversification needs. Purpose : 1. To facilitate the transfer of funds between borrowers and lenders 2. Trade TIME & RISK 2 FINA 274 Lecture 1
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Financial Market Participants Market Participants: 1. Firms (e.g. corporations)  Net Borrowers 2. Households (Individuals/Consumers)  Net Savers 3. Financial Institutions  Borrowers and Savers 4. Government (Federal/State/Local)  Neutral (zero in long-run) 5. Regulators  FRB, SEC, FDIC, OCC, FTC, etc Government Borrowing (annual) + 0 time - 3 FINA 274 Lecture 1
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Purpose of the firm (e.g. corporation) Efficient Production : Organizing human capital (workers) and financial capital to accomplish what individuals cannot do as efficiently on their own (ie. build a car) Investment & consumption path smoothing : The firm can be viewed as a storage device, where investors place their capital for safe keeping, earning interest, until such time that the investors needs to trade the investment for consumption Wealth maximization : But for whom? Workers (agents) or owners (principals of the firm). Diminishing returns : Is all capital investment in the firm worth the same? This is captured by the Marginal Rate of Transformation (ie. the slope of the curve. Consumption today Consumption tomorrow Increasing investment in the firm A A’ B B’ Investment: A=A’ Return: B>B’ Firm Production Function MRT 4 FINA 274 Lecture 1
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Consumption today Consumption tomorrow MRT = The marginal benefit of capital to the firm - (1 + r) high return (steep slope) Initial firm capitalization  Microsoft IPO  Intel IPO IPO SEO Increasing investment in the firm MRT = - (1 + r) lower return (shallow slope) Firm production function is the rate of return on capital investment A mature Intel and Microsoft: begin returning capital, paying dividends, since they can no longer invest capital at high rates of return 5 FINA 274 Lecture 1
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Firm capital structure Firm Balance Sheet A L E Debt Equity (ownership) Real Assets Claims to Assets Real Assets : Are tangible (have physical properties) 1. Property 2. Plant 3. Inventory Financial Assets : A legal claim to some future benefit 1. Debt (private & public) 2. Equity (firm owners – voting control) 6 FINA 274 Lecture 1
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Ownership of the firm through financial assets Equity Claims : Equity is infinitely lived and does not require cashflow payments (dividend size and frequency is set by management) 1.
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This note was uploaded on 02/29/2012 for the course FINA 274 taught by Professor Williamhandorf during the Fall '11 term at GWU.

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FINA274 lecture 1 - Role of the Corporation in Financial...

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