TCH302

Bodie & Merton (2000), Finance, Chapter 1

Ceccetti and Schoenholtz (2015). Money, Banking and Financial Markets, Chapter 1,2,3
Mishkin (2019). The Economics of Money, Banking and Financial Markets, Chapter 1

4/28/2023 Overview of Finance 1

Learning objectives
Understand…
Finance

Financial decisions

Financial system
Introduction to finance

Finance is the study of how to allocate scarce resources over time

Finance is the study of applying specific value to things we own, services we use, and
decision we make

Finance examines the effective and efficient acquisition and utilisation of capital

Value
Decisions making
Uncertainty
 Introduction to finance: Example #1

You have just won a 10 billion VND jackpot. After paying taxes,
your debts and satisfying your wants (such as laptops, cars,
luxury items, charity) there are 5 billion VND left, but you do not
have any business idea. What will you do with your money?

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 Introduction to finance: Example #2

You are the owner of the company ABC which is the poultry producer in
Vietnam. Your products are sold to foodservice, retail, and frozen entrée
customers. The Company’s primary distribution is through retailers and
restaurants throughout the Vietnam. Recently, your consultant advised you
to export your products to Thailand. If you decided to undertake the
proposal, how can you get the capital you need to undertake it?

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Finance as an area of study
Investment
•Methods and techniques for making decisions about:
•What kinds of securities/ financial assets to own, which
firms’securities to buy,

Corporate finance
•Deals with a firm’s decisions in acquiring and using the cash that is
received from investors or from retained earnings
•Organise the firm in a manner that will attract capital
•Raise capital (such as bonds, stocks)
•Which projects to fund
•How much capital retain for ongoing operations and new projects
•How to minimise taxation
•Pay back capital provider
Finance as an area of study
Investment
•Portfolio theory: How can an investor achieve a better trade-off
between risk and return?
• Asset pricing: How much is a particular security worth? What is the
relationship between long-term interest rates and short-term interest
rates?

Corporate finance
•Asset management: What new assets should the company acquire? How
much should it pay for these assets?
•Capital structure: How much should the company borrow?
•Working capital management: How much cash should the company
hold? How much inventory?
•Payout policy: How much should the company pay out to its
shareholders?
•Mergers and acquisitions: Should the company take over another
company?
Why study finance?
To make decisions

To manage your personal resources (e.g. to borrow money to buy a new car, to
refinance your shop house at a lower rate…)

To deal with the world of business

To pursue interesting and rewarding career opportunities

To make informed public choices as a citizen

To expand your mind

Financial decisions
Financial decisions of households

Financial decisions of firms

Financial decisions of governments

Financial decisions of households
Consumption and saving decisions:
How much of their current income should they save for the future?
Investment decisions:
How should they invest the money they have saved?
Financing decisions:

When and how should they use other people’s money to satisfy their wants and needs?
Risk – management decisions:

How and on what terms should they seek to reduce the economic uncertainties they face or
to take calculated risks?
 Financial decisions of households

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Financial decisions of firms
The branch of finance dealing with financial decisions of firms is called corporate finance.

Strategic planning: deciding what businesses it wants to be in. That involves the evaluation of
costs the benefits spread out over time.

Capital budgeting: identifying ideas for new investment projects, evaluating them, deciding which
ones to undertake and then implement them.

Capital structure: figuring out how to finance projects

Working capital management: controlling the day – to – day prosaic financial affairs of the
business.
 Financial decisions of firms

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Financial decisions of firms
Cash Inflows = Cash Outflows
Inflows are new funds raised and Outflows are the investment outlay and
cash from operations distributions to owners

F + X = I + D

Financing Decision: Investment Decision: Dividend Decision:

Capital Structure Project Evaluation Payout Policy
Asset Pricing
Asset Acquisition
Working Capital Management
Portfolio Construction
Financial decisions of governments
Identify expenditure required for running its bodies

Sources of revenue

The budgeting process Budget Deficit

Debt issuances for public projects

Balance sheet
Balance sheet of a firm/person shows their assets (what they own) and their liabilities
(what they owe) at a point of time. The differences between assets and liabilities is the
net worth, also called owners’ equity.
Financial system

Transfer of: Capital/Consumption and Risk

Financial
Markets
Surplus Deficit
Units Units

Financial
Intermediaries
Six parts of the Financial system

1. Money

2. Financial instrument

3. Financial markets

4. Financial institutions

5. Regulatory agencies

6. Central bank
 Six parts of the Financial system
1. Money
•Anything is generally accepted in payment for goods or services or
in repayment of debts

•Acting as a medium of exchange

Goods/services Suppliers

•Used to store value Chocolate Nhung

Financial consulting Hoa

How differ from wealth, currency, income? Rice Minh

How about cyptocurrency? Barter economy Money

What is liquidity? Double coincidence

the relative ease and speed with which an asset can be converted
into a medium of exchange TRADE
 Currency – wealth – income - Liquidity
Currency: paper money and coins

Fiat money: paper currency decreed by governments as legal tender (meaning that legally it
must be accepted as payment for debts) but not convertible into coins or precious metal.

Wealth: net worth or the excess of assets over liabilities. (money, bonds, common stock, art, land,
furniture, cars, and houses...)

Income: a flow of earnings per unit of time

Liquidity of an asset reflects the relative ease and speed with which an asset can be converted into a
medium of exchange

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 Currency – wealth – income – Liquidity: Examples
Nam has VND100 million of stocks and bonds.

Rio wins A$20 million in blackjack, he puts it under his bed, quits his job.

Mary is a financial manager with earnings of A$100,000 per annum. She blows it all,
every paycheck.

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Six parts of the Financial system
2. Financial instruments
Financial instrument is the written legal obligation of one party to transfer something of value,
usually money, to another party at some future date, under specified conditions

o Uses of financial instruments

Means of payment
Employees take stock options as payment for working
Stores of value

Financial instruments generate increases in wealth that are larger than from holding money.

Financial instruments can be used to transfer purchasing power into the future
Transfer of risk

Insurance contracts, future contracts.

Six parts of the Financial system
2. Financial instruments
o Basic types of instruments

 Underlying instruments/ primitive securities are used by saver/lenders to transfer resources

directly to investors/borrowers
 Debt instruments: Contractual agreements by the borrowers to pay the holders of instruments
fixed amounts at regular intervals (interest and principal payments) until a special date (the
maturity date), when a final payment is made.
 E.g.: bond, certificate of deposit
 Equity instruments: claims to share in the net income (income after expenses and taxes) and the
assets of a business
 E.g.: stock
 Derivative instruments are those where their value and payoffs are “derived” from the behaviours
of the underlying
 E.g.: forward, future, option, swap
Six parts of the Financial system
3. Financial markets
•Financial markets are places where financial instruments are bought and sold.
There are many ways to classify financial markets
Equity, Debt, Currency, Commodity or Derivative
Primary or Secondary
Exchange-traded or Over-the-counter
Money Market (maturity < 12 months) or capital market (maturity > 12 months)

• These markets are the economy’s central nervous system.

• These markets enable both firms an individuals to find financing for their activities.
• These markets promote economic efficiency. They ensure resources are available to those
who put them to their best use. They keep transactions costs low
Six parts of the Financial system
4. Financial institutions
Financial institutions are the firms that provide access to the financial markets, both to savers
who wish to purchase financial instruments directly and to borrowers who want to issue them.

There are many types of financial institutions/ financial intermediaries:

Depository institutions: commercial banks, saving banks, credit union (PCFunds Association)
Insurance companies
Pension funds
Securities firms
Finance companies
Government-sponsored enterprises (GSEs) Vietnam Bank for Social Policies
Six parts of the Financial system
5. Regulatory agencies

They are responsible for making sure that the elements of the financial system—including its
instruments, markets, and institutions—operate in a safe and reliable manner.

6. Central bank
Central banks control the availability of money and credit to ensure low inflation, high growth
and stability of financial system