FMT - Financial Management, Spring 2020

Topic 1 (P1)– introduction to financial

management

1-1

 1

Learning objectives
 Explain the role of finance and the different types of
jobs in finance
 Identify the advantages and disadvantages of different
forms of business organization
 Explain the link between stock price, intrinsic value, and
executive compensation
 Discuss the importance of business ethics and the
consequences of unethical behaviour
 Identify the potential conflicts that arise within the firm
between stockholders and managers and between
stockholders and bondholders, and discuss the
techniques that firms can use to mitigate these potential
conflicts

1-2

 2

Topic content

1.1 What is finance?

1.2 Why study finance?
1.3 Forms of Businesses
1.4 Goals of the Corporation
1.5 Agency Relationships
1.6 Three Critical Factors in Finance

1-3

 3

Topic 1: Introduction to Financial Management

 FMT - Financial Management, Spring 2020

1.1 What is finance?

 Finance grew out of economics and accounting.
 Economists developed the notion that an asset’s value
is based on the future cash flows the asset will provide,
 Accountants provided information regarding the likely
size of those cash flows.
 Finance people need knowledge of those two fields.
 There are three areas in finance:
 Financial management (also called corporate finance)
 Investment
 Capital markets

1-4

 4

Three areas in Finance

 Financial management
 How much and what types of asset to acquire?
 How to raise capital needed to purchase assets?
 How to run the firm as so to maximize its value
 Investments
 Security analysis deals with finding proper values of individual asset.
 Portfolio theory deals with the best way to structure portfolio.
 Market analysis deals with the issue of whether stock and bond
markets at any given time are “too high,” “too low,” or “about
right.”
 Capital markets – study of
 Financial instruments such as stocks and bonds
 Financial institutions that supply capital to business.
 Government organizations who are the main players in the market.
1-5

 5

Cash flows of a firm.

1-6

 6

Topic 1: Introduction to Financial Management

 FMT - Financial Management, Spring 2020

Real assets vs. Financial

assets
 Real assets are goods (generally tangible) that are used
to produce other goods or services: buildings, machines,
land, knowledge.
 Productivity of economy determined by real assets.
 Financial assets are claims to income generated by real
assets. Firms use the money raised through financial assets
to invest in plants, equipment, labour, etc. Holder of
financial asset receives a portion of the resulting returns
from real assets.
 While real assets determine wealth, financial assets
determine distribution of wealth.

1-7

 7

Role of Finance in a Typical

Business Organization

1-8

 8

Responsibility of the
Financial Staff
 Maximize stock value by:
 Forecasting and planning
 Investment and financing decisions
 Coordination and control
 Transactions in the financial markets
 Managing risk

Important details presented in page 11, page 12

1-9

 9

Topic 1: Introduction to Financial Management

 FMT - Financial Management, Spring 2020

Financial Management Decisions

 Investing decisions: How much should we
invest and what assets should we invest
in?
 Financing decisions: How much the cash
required for the operation of the firm be
raised? – debt financing vs. equity
financing
 Dividend policy: How to pay to
shareholders

1-10

 10

Examples of corporate
financial decisions
 Investing decision: company replaces old
machines with new ones.
 Financing decision: company decided to
borrow $3million from a bank to finance
its expansion project.
 Dividend policies: company decided to
pay 40% of its earnings as cash dividend
to its shareholders.

1-11

 11

Recap of financial
decisions
Financial
decisions

Investing Financing Dividend

Working
Capital Cost of Capital
capital
budgeting capital structure
management

1-12

 12

Topic 1: Introduction to Financial Management

 FMT - Financial Management, Spring 2020

1.2 Jobs in Finance

 Commercial banking and investment banking

 Corporate finance
 Trading and dealing
 Consulting
 Financial risk management
 Financial analysis
 Fund management
 ...

1-13

 13

Financial Management Issues of

the New Millennium
 The effect of
changing
technology
 The globalization of
business
 Corporate
governance
 Business Ethics

1-14

 14

Percentage of Revenue and Net Income

from Overseas Operations for 10 Well-
Known Corporations, 2001

Company % of Revenue % of Net Income

from overseas from overseas

Coca-Cola 60.8 35.9

Exxon Mobil 69.4 60.2
General Electric 32.6 25.2
General Motors 26.1 60.6
IBM 57.9 48.4
JP Morgan Chase & Co. 35.5 51.7
McDonald’s 63.1 61.7
Merck 18.3 58.1
3M 52.9 47.0
Sears, Roebuck 10.5 7.8
1-15

 15

Topic 1: Introduction to Financial Management

 FMT - Financial Management, Spring 2020

1.3 Forms of Business

Organization
 Sole proprietorship
 Partnership
 Corporation
 Limited liability company (LLC)

1-16

 16

Common Characteristics

Sole proprietorship  Unlimited Liability

 Personal tax on
profits
Partnership

 Limited Liability
 Corporate tax on
profits + Personal
Corporation tax on dividends
 Principal – Agent
Problems
1-17

 17

Sole proprietorships &

Partnerships
 Advantages
 Ease of formation
 Subject to few regulations
 No corporate income taxes
 Disadvantages
 Difficult to raise capital
 Unlimited liability
 Limited life

1-18

 18

Topic 1: Introduction to Financial Management

 FMT - Financial Management, Spring 2020

Corporation

1-19

 19

Corporation (cont’d)

 Advantages
 Unlimited life
 Easy transfer of ownership
 Limited liability
 Ease of raising capital
 Disadvantages
 Double taxation
 Cost of set-up and report filing

1-20

 20

Example of double
taxation
 Assume earnings before tax (EBT) = VND 100b
 Corporate income tax rate (CIT) = 20%, amount of tax
= 20%* 100b = VND 20b
 After tax income (NI) = 100b- 20b = VND 80b.
 Assume the company distributes all VND 80b as cash
dividend to shareholders.
 Assume marginal personal tax rate of all
shareholders is 25%. Thus, shareholders will be taxed
again. Note that shareholders have already paid
CIT.
 Tax on dividend income = 25% * 80b = VND 20b
 Total tax = 20b + 20b = VND 40b (or 40%)

1-21

 21

Topic 1: Introduction to Financial Management

 FMT - Financial Management, Spring 2020

Limited liability company

- Hybrid between a partnership and a corporation

- Limited liability
- Taxed at personal income tax rates
- Investors in LLC have voting right

1-22

 22

1.4 Financial Goals of the Corporation

 All business financial decisions should be made in the text
of the overriding goal of financial management: to
maximise the wealth of the owners, the shareholders
 The shareholders have invested in the corporation,
putting their money at risk, and the financial manager
acts as their agent, or as caretaker of their money,
making decisions in their interests and on their behalf
 Since the wealth of shareholders is related to the value of
their shares, and since the value of each share is, by
definition, a specified proportion of the total value of the
corporation
Maximisation of

Maximisation of
=
 the value of the
shareholder corporation

1-23

 23

Is stock price maximization the

same as profit maximization?
 No, despite a generally high correlation amongst stock
price, EPS, and cash flow.
 Current stock price relies upon current earnings, as well as
future earnings and cash flow.
 Some actions may cause an increase in earnings, yet cause
the stock price to decrease (and vice versa).

1-24

 24

Topic 1: Introduction to Financial Management

 FMT - Financial Management, Spring 2020

1.5 Agency relationships

 An agency relationship exists whenever a

principal hires an agent to act on their behalf.
 Within a corporation, agency relationships exist
between:
 Shareholders and managers
 Shareholders and creditors

1-25

 25

Shareholders versus
Managers
 Managers are naturally inclined to act in their
own best interests.
 But the following factors affect managerial
behavior:
 Managerial compensation plans
 Direct intervention by shareholders
 The threat of firing
 The threat of takeover

1-26

 26

Shareholders versus
Creditors
 Shareholders (through managers) could take
actions to maximize stock price that are
detrimental to creditors.
 In the long run, such actions will raise the cost of
debt and ultimately lower stock price.

1-27

 27

Topic 1: Introduction to Financial Management

 FMT - Financial Management, Spring 2020

1.6 Factors that affect stock

price
 Projected cash
flows to
shareholders
 Timing of the cash
flow stream
 Riskiness of the
cash flows

1-28

 28

Factors that Affect the Level

and Riskiness of Cash Flows

 Decisions made by financial managers:

 Investment decisions
 Financing decisions (the relative use of debt
financing)
 Dividend policy decisions
 The external environment
 Economic conditions
 Political climate
 Taxes
 ...

1-29

 29

Basic Valuation Model

 To estimate an asset’s value, one estimates the

cash flow for each period t (CFt), the life of the
asset (n), and the appropriate discount rate (k)
 Throughout the course, we discuss how to
estimate the inputs and how financial
management is used to improve them and thus
maximize a firm’s value.
1-30

 30

Topic 1: Introduction to Financial Management

 FMT - Financial Management, Spring 2020

Important principle
summary
 Principle 1: cash flow is what matters
 Principle 2: conflicts of interest cause agency
problems

1-31

 31

Key Terms

 Proprietorship, partnership, corporation, limited

company
 Limited liability
 Stockholder wealth maximisation
 Stock prices: intrinsic value, market price
 Business ethics
 Agency problems
 Financing decisions, investment decisions, cash
management decisions
 Cash flows, timing, riskiness

1-32

 32

Topic 1: Introduction to Financial Management

FMT – Financial Management, Spring 2020

PART 2

2020

Learning objectives
 Identify the different types of financial markets and
financial institutions, and explain how these markets and
institutions enhance capital allocation.
 Explain how the stock market operates, and list the
distinctions between the different types of stock markets.
 Explain how the stock market has performed in recent
years.
 Discuss the importance of market efficiency, and explain
why some markets are more efficient than others.

2-2

Agenda

Financial Markets
Flow of Funds
Types of Financial Institutions
Stock Market
Market Efficiency
Taxes

2-3

Topic 1, Part 2: Financial Market and Institution

FMT – Financial Management, Spring 2020

2.1 What is a market?

 A market is a venue where goods and services are
exchanged.
 A financial market is a place where individuals and
organizations wanting to borrow funds are brought
together with those having a surplus of funds.
 Businesses interact continually with the financial markets.
 The purpose of financial markets is to efficiently allocate
savings to ultimate users.

2-4

Types of financial markets

 Physical asset vs. Financial asset
 Money vs. Capital
 Primary vs. Secondary
 IPO market: The market for stocks of companies that are in
the process of going public
 Going public:The act of selling stock to the public at large by a
closely held corporation or its principal stockholders
 Spot vs. Futures
 Public vs. Private

2-5

2.2 Flow of Funds in the Economy

INVESTMENT SECTOR  Direct transfers

Investment banking
INTERMEDIARIES


house
FINANCIAL

FINANCIAL BROKERS
 Financial
intermediaries
SECONDARY MARKET

SAVINGS SECTOR

2-6

Topic 1, Part 2: Financial Market and Institution

FMT – Financial Management, Spring 2020

Investment Sector

INVESTMENT SECTOR
INVESTMENT
SECTOR

INTERMEDIARIES
FINANCIAL
FINANCIAL BROKERS
Businesses

SECONDARY MARKET Government

Households
SAVINGS SECTOR

2-7

Saving Sector

INVESTMENT SECTOR
SAVINGS
SECTOR
INTERMEDIARIES
FINANCIAL

FINANCIAL BROKERS
Households

SECONDARY MARKET Businesses

Government
SAVINGS SECTOR

2-8

Financial Brokers

INVESTMENT SECTOR
FINANCIAL
BROKERS
INTERMEDIARIES
FINANCIAL

FINANCIAL BROKERS
Investment
Bankers
SECONDARY MARKET
Mortgage Bankers

SAVINGS SECTOR

2-9

Topic 1, Part 2: Financial Market and Institution

FMT – Financial Management, Spring 2020

2.3 Types of Financial Intermediaries

INVESTMENT SECTOR
FINANCIAL
INTERMEDIARIES

INTERMEDIARIES
FINANCIAL
FINANCIAL BROKERS
Commercial Banks
Savings Institutions
SECONDARY MARKET Insurance Cos.
Pension Funds
Finance Companies
SAVINGS SECTOR Mutual Funds

2-10

10

Secondary Market

INVESTMENT SECTOR
SECONDARY
MARKET
INTERMEDIARIES
FINANCIAL

FINANCIAL BROKERS
Security
Exchanges
SECONDARY MARKET
OTC
Market
SAVINGS SECTOR

2-11

11

2.4 The Stock Exchange

 The financial manager’s goal is to maximise shareholder
wealth, and this is determined by share price, so an
alternative way to state this goal is the maximisation of
share price

2-12

12

Topic 1, Part 2: Financial Market and Institution

FMT – Financial Management, Spring 2020

Stock Market
 Where the prices of
firms’ stocks are
established.
 Where businesses can
raise new capital.
 Auction market vs.
Dealer market
(Exchanges vs. OTC)
 NYSE vs. NASDAQ
 Differences are
narrowing

2-13

13

Vietnamese Stock Exchanges

 State Securities Commission of VN was established in
Nov 1996.
 Two exchanges: Hanoi Stock Exchange (HNX) - 2005
and Ho Chi Minh Stock Exchange (HOSE) – 07/2000
 Regulation on trading, listing and providing information on
the two exchanges will be provided on the subject forum.

HOSE 31st Dec. 2013 HNX 31st Dec. 2013

 303 listed stocks  365 listed stocks
 Market cap: VND  Market cap: VND
804,000 Billion 107,000 Billion
 23.5% GDP  3.1% GDP

2-14

14

2.5 Stock Market Efficiency

 Definition: A market in which prices are close to intrinsic
values and stocks seem to be in equilibrium
 Why: When markets are efficient, investors can buy and
sell stocks and be confident that they are getting good
prices. When markets are inefficient, investors may be
afraid to invest and may put their money “under the
pillow,” which will lead to a poor allocation of capital and
economic stagnation.
 Implication: stock market is efficient, it is a waste of time
for most people to seek bargains by analyzing published
data on stocks

2-15

15

Topic 1, Part 2: Financial Market and Institution

FMT – Financial Management, Spring 2020

Level of market efficiency

2-16

16

Taxes in Vietnam

 Corporate Income Tax  Personal Income Tax

 Standard CIT is 22% (2014)  Employment and business
and 20% (2016) income is taxed in a
 CIT for oil and gas companies progressive tax rates basis
range from 32% to 50% (5%-35%)
 Taxes incentives  Other income is taxed at
different rates
 Other types of Taxes  Dividend income: 5%
 Special Sales Taxes  Capital gain: 20% on net gain
or 0.1% on sales proceed.
 Valued added taxes (VAT)

2-17

17

Key Term
 Money market, capital market
 Primary market, secondary market
 Spot market, futures market (and derivatives)
 Financial intermediaries, investment bank, commercial
banks, mutual fund
 Stock exchange, OTC
 Corporate income tax, personal income tax, capital gain
tax.
 Market efficiency
 Going public – IPO

2-18

18

Topic 1, Part 2: Financial Market and Institution