Chapter 1

Concept of
Managerial
Finance

Learning Goals
1. Define finance, its major areas and
opportunities available in this field.
2. Identify the primary activities of the
financial manager.

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What is Finance?
Finance can be defined as the art and
science of managing money.
Finance is concerned with the process,
institutions, markets, and instruments
involved in the transfer of money among
individuals, businesses, and
governments.
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Major Areas & Opportunities in

Finance: Financial Services
Financial Services is the area of finance
concerned with the design and delivery of
advice and financial products to
individuals, businesses, and government.
Career opportunities include banking,
personal financial planning, investments,
real estate, and insurance.

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Major Areas & Opportunities in

Finance: Managerial Finance
Managerial finance is concerned with
the duties of the financial manager in the
business firm.
The financial manager actively manages the
financial affairs of any type of business, whether
private or public, large or small, profit-seeking or
not-for-profit.
They are also more involved in developing
corporate strategy and improving the firms
competitive position.
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Goal of the Firm: Maximize Profit???

Profit maximization fails to account for differences in the

level of cash flows (as opposed to profits), the timing of
these cash flows, and the risk of these cash flows.

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Goal of the Firm:

Maximize Shareholder Wealth!!!
Why?
Because maximizing shareholder wealth properly
considers cash flows, the timing of these cash flows, and
the risk of these cash flows.
This can be illustrated using the following simple stock
valuation equation:

level & timing

of cash flows

Share Price = Future Dividends

Required Return
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risk of cash
flows
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Goal of the Firm:

Maximize Shareholder Wealth!!! (cont.)
The process of shareholder wealth
maximization can be described using the
following flow chart:

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Financial Institutions & Markets:

Financial Institutions
Financial institutions are intermediaries that
channel the savings of individuals, businesses,
and governments into loans or investments.
The key suppliers and demanders of funds are
individuals, businesses, and governments.
In general, individuals are net suppliers of
funds, while businesses and governments are
net demanders of funds.
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Financial Institutions & Markets:

Financial Markets
Financial markets provide a forum in which
suppliers of funds and demanders of funds can
transact business directly.
The two key financial markets are the money
market and the capital market.
Transactions in short term marketable securities
take place in the money market while
transactions in long-term securities take place in
the capital market.
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Financial Institutions & Markets:

Financial Markets (cont.)
Whether subsequently traded in the money or
capital market, securities are first issued through
the primary market.
The primary market is the only one in which a
corporation or government is directly involved in
and receives the proceeds from the transaction.
Once issued, securities then trade on the
secondary markets such as the New York
Stock Exchange or NASDAQ.
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The Relationship between Financial

Institutions and Financial Markets

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The Money Market

The money market exists as a result of the
interaction between the suppliers and
demanders of short-term funds (those having
a maturity of a year or less).
Most money market transactions are made in
marketable securities which are short-term
debt instruments such as T-bills and
commercial paper.
Money market transactions can be executed
directly or through an intermediary.
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The Money Market (cont.)

The international equivalent of the
domestic (U.S.) money market is the
Eurocurrency market.
The Eurocurrency market is a market for
short-term bank deposits denominated in U.S.
dollars or other marketable currencies.
The Eurocurrency market has grown rapidly
mainly because it is unregulated and because it
meets the needs of international borrowers
and lenders.
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The Capital Market

The capital market is a market that enables suppliers
and demanders of long-term funds to make transactions.
The key capital market securities are bonds (long-term
debt) and both common and preferred stock (equity).
Bonds are long-term debt instruments used by
businesses and government to raise large sums of
money or capital.
Common stock are units of ownership interest or equity
in a corporation.
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The Role of Time Value in Finance

Most financial decisions involve costs & benefits
that are spread out over time.
Time value of money allows comparison of cash
flows from different periods.
Question
Would it be better for a company to invest
$100,000 in a product that would return a total
of $200,000 after one year, or one that would
return $220,000 after two years?
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The Role of Time Value

in Finance (cont.)
Most financial decisions involve costs &
benefits that are spread out over time.
Time value of money allows comparison of
cash flows from different periods.
Answer
It depends on the interest
rate!
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