Principles of Finance

TCH 302

Lecturer: Chu Mai Linh, Ms.

Email: [email protected]

Introduction to Finance 1
 • ATTENDANCE

ASSIGNMENTS Attendance is compulsory in accordance with FTU regulations. Students

& are strongly advised not to miss lecture hours since success is closely

ASSESSMENTS related with attendance.

• ASSIGNMENTS & ASSESSMENTS

% Form of Size of the Feedback

Contribution Assessment assessment method
Duration
10% of the Attendance
final mark
30% of the Examination 45 minutes Correct
final mark (4 pages) answers
Multiple Choices and
Short answer
questions

60% of the Examination 75 Minutes Correct

final mark answers
Introduction to Finance 2
 TEXTBOOKS

A. Compulsory books:

1. The Economics of Money, Banking,

and Financial Markets, Frederic S.
Mishkin, 11th edition, 2016

2. Money, Banking and Financial Markets,

S.G. Cecchetti and K. L. Schoenholtz,
5th edition, 2017

3. Saunders (2022). Financial Markets

and Institutions

4. Bodie & Merton (2000). Finance,

Prentice Hall

B. Complementary book:

1. Finance: Applications and Theory,

Marcia M. Cornett, 2nd edition, 2012

Introduction to Finance 3
 SYLLABUS PLAN

Modules Compulsory readings

Mishkin, Chapter 1,2,3
Introduction to Finance
Cecchetti, Chapters 1 & 3
Bodie, Chapters 1& 2

Time Value of Money Mishkin, Chapter 4

Cecchetti, Chapters 4
Personal Finance
Bodie & Merton Chapter 4,5

Understanding Financial Saunders, Chapter 1

Markets and Institutions Mishkin, Chapter 8
Cecchetti, Chapters 6,8,11

Valuation of securities Bodie & Merton, Chapters 7,8,9

Understanding Risk Cecchetti, Chapter 5, 6,11
Saunders Chapters 3,5,6
Managing financial health Cornett, Chapters 2 & 3
Bodie & Merton Chapter 3

Introduction to Finance 4
1 INTRODUCTION TO FINANCE

Mishkin, Chapter 1,2,3

Cecchetti, Chapters 1 & 3
Bodie, Chapters 1& 2

Introduction to Finance 5
 Content
PART 1

1. Defining Finance

2. Why study Finance?

3. Financial Decisions

PART 2

1. Form of Business Organization

2. Separation of Ownership and Management

3. The Goal of Management

PART 3

1. The Financial System

2. Six Parts of the Financial System

3. Flows of Funds
Introduction to Finance 6
 Finance in Business and in Life
Example #1

• Lucas has a plan to provide an online learning platform for

students. He has finally designed the websites and feels that he is
offering a perfect educational service, combining tutorial and self-
learning. As the result, his business runs well and starts bringing
some profits. Lucas would like to invest more in this website and
expand the customer base. Lucas needs more money to upgrade
the technology and hire and train more people.

• Where can he get the capital he needs to expand?

Introduction to Finance 7
 Source of funds

EQUITY Borrowings

8
 Finance in Business and in Life
Example #2

• Suppose you have some savings money. What kinds of financial

assets should you choose these days?

• You have decided to get a car. Should you buy it or lease it?

• You are part of a team working at the WB analyzing an application

for a loan to a project of providing clean water to some rural areas
in Vietnam. How do you decide what to recommend?

• Additional information for who intend to work for WB:

• https://www.facebook.com/photo/?fbid=288453000781919&set=a.
118060867821134

Introduction to Finance 9
 Defining Finance

• Finance is the study of how people allocate scare resources over

time.

• Costs and benefits of financial decision are:

1. spread out over time

2. usually not known with certainty in advance by either the

decision maker or anybody else.

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 Defining Finance

• In finance, cash flow is the term that

describes the process of paying and
receiving money.

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 Financial system

• In implementing their decisions people make use of the financial

system, defined as the set of markets and other institutions used
for financial contracting and the exchange of assets and risks.

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 Finance theory

• Finance theory consists of a set of concepts that help to organize

one’s thinking about how to allocate resources over time and a set
of quantitative models to help one evaluate alternatives, make
decision and implement them.

Introduction to Finance 13
 Finance theory

• Finance theory treats people’s consumption preferences as given

(how and why the change their preferences is not addressed by
the theory).

• People’s behavior is explained as an attempt to satisfy those

preferences.

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 Why study Finance?

1. To manage your personal resources (for instance:

to borrow money to buy a new car, to refinance
your shop house at a lower rate…)

2. To deal with the world of business

3. To pursue interesting and rewarding career

opportunities

4. To make informed public choices as a citizen

5. To expand your mind

Introduction to Finance 15
 Financial Decisions

1. Financial decisions of households

2. Financial decision of firms
3. Financial decision of government

Introduction to Finance 16
 Financial decisions of households

When people choose how to hold their pool of accumulated

savings, that is called personal investing or asset allocation.

Households face 4 basic types of financial decision:

1. Consumption and saving decisions

2. Investment decisions

3. Financing decisions (if they borrow, they incur a liability = debt;

their wealth or net worth = assets – liabilities)

4. Risk-management decisions

Introduction to Finance 17
 Financial decision of firms

The branch of finance dealing with financial decisions of firms is

called business finance or corporate finance.
• Strategic planning → capital budgeting process consists of
identifying ideas for new investment projects, evaluating them
and make decisions and them implement them.
• Capital structure decision figures our how to finance the projects.
such as how much debt and how much equity it should have in
its capital structure.
• Working capital management: managers should also worry
about collecting from customers, paying bills as they come due,
and generally managing the firm’s cash flow to ensure that
operating cash flow deficits to be financed and cash flow
surpluses are efficiently invested to earn a good return.

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 Financial decision of government

• Public finance is the study of the role of the government in

the economy. This is a very broad definition. This study
involves answering the four questions of public finance:

1. When should the government intervene in the economy?

2. How might the government intervene?

3. What is the effect of those interventions on economic

outcomes?

4. Why do governments choose to intervene in the way that

they do?
Introduction to Finance 19
 Financial decision of government

• A government budget is a government document presenting the

government's proposed revenues and spending for a financial year
that is often passed by the legislature (parliament", "congress", and
"assembly“)- - Government budgets are of three types:
• Balanced Budget: when government revenue and expenditure are
equal.
• Surplus Budget: when anticipated revenues exceed expenditure.
• Deficit Budget: when anticipated expenditure is greater than
revenues.

* The International Monetary Fund defines the general government

expenditure as consisting of total expense and the net acquisition of
nonfinancial assets. The general government revenue consists of the
revenue from taxes, social contributions, grants receivable, and other
revenue.

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Vietnam: Budget balance between 2018 to 2028
in relation to GDP

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ASEAN countries: Budget balance between 2018 to 2028 in relation to GDP

Introduction to Finance 22
Why Do We Care About the Government’s
Fiscal Position?

for thị trường

chứng khoán

Introduction to Finance 23
 Finance theory

• Theory therefore tells us that higher deficits lead

to higher interest rates and less capital
investment, but it does not tell us how much
higher and how much less.

• Gale and Orszag (2003) conclude for every 1%

of GDP increase in the U.S. government’s
budget deficit, long -term interest rates rise by
between 0.5% and 1%.
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Spread between 10-year Treasury bond and 3-month
Treasury bill since 1960

Introduction to Finance 25
 Forms of Business Organization

• A sole proprietorship

• A partnership

• A corporation

Introduction to Finance 26
 A sole proprietorship

• A sole proprietorship is a firm owned by an

individual or a family, where the assets and
liabilities of the firms are the personal assets and
liabilities of the proprietor, who has unlimited
liability for the debts and other liabilities.

Introduction to Finance 27
 A partnership

• A partnership is a firm with two or more owners,

called the partners, who share the equity in the
business.

• All partners have unlimited liability, called the

“general partners”

• However, it is possible to limit the liability for

some partners called “limited partners”.
Introduction to Finance 28
 A corporation

• A corporation is a firm that is a legal entity distinct from its

owners.

• Corporations can own property, borrow and enter into

contracts. They can sue or be sued.

• Shareholders have limited liability for the debts and other

liabilities of the firm.

• Shareholders are entitled to a share of any distribution from

the corporation in proportion to the number of shares they
own.

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 Business Organization
Corporations
• A public corporation is legally independent entity that completely
separate from its owners.

✓ Limited liability

✓ Double taxation

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 Business Organization
Corporations

• Double taxation

You are a shareholder in a corporation. The corporation

earns $5 per share before taxes. After it has paid taxes, it
will distribute the rest of its earnings to you as a dividend.
The dividend is income to you, so you will then pay taxes
on these earnings. The corporate tax rate is 40% and
your tax rate on dividend income is 15%. How much of
the earnings remains after all taxes are paid?

Introduction to Finance 31
 If a firm is a corporation, …

Country Letters after a firm’s name

1 In the United States Inc. (incorporated)

2 In France SA (Sociedad Anonima)

3 In Germany AG (Aktiengesellschaften)

4 In the United Kingdom PLC (public limited company)

LTD (private corporation)
5 In the Netherland NV (Naamloze Venootschap)

6 In the Sweden AB (Aktienbolag)

7 In Vietnam ?

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Business Organization
Types of U.S firms

Source: www.irs.gov, 2017

Introduction to Finance 33
 Business Organization

• The number of owners is the key to how business structures are

classified.

• Who controls the firm.

• Who owns the firm.

• What the owners’ risks are

• What access to capital exists.

• What the tax ramifications are.

Introduction to Finance 34
Business Organization

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 Separation of ownership and management

Advantages:

1. Professional managers may have a superior ability to run

the business.

2. Not all owners can be actively involved in managing the

business.

3. Owners could diversify their risks across many firms. dont have to stick to
1 stock -> mitigate
stock

4. Owners could save money in gathering information.

5. Learning curve or going concern effect favors the

separate structure.
Introduction to Finance 36
 Separation of ownership and management

Disadvantage:

• A conflict of interest between the owner and the manager.

Introduction to Finance 37
 The goal of management

• The manager’s primary commitment to make decision which

are in the best interests of the shareholders.

• Any individual owner would want mangers to choose the

investment project which maximizes the market value of his
shares.

• The shareholder-wealth-maximization rule depends only upon

the firm’s production technology, market interest rates, market
risk premium and security prices.
MAXIMIZE THE STOCK PRICE

• How about the profit maximization rule? Which one is better?

• How about the goal of sustainability?

Introduction to Finance 38
 A statement of the firm’s goal

• Normally, the financial goals can be found in the opening

letter from the company’s chief executive officer in the
annual report to shareholders.

Vietcombank, 2021 Digiworld, 2022 Sabeco, 2022

Introduction to Finance 39
 Market discipline: TAKEOVER

• The threat of a takeover and the subsequent replacement

from the shareholders, one might expect manager to move
in the direction of value maximization as a matter of self-
preservation.

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 The financial system

• The financial system encompasses money, financial instruments,

financial markets, financial institutions, government regulatory
agencies and central banks to carry out the financial decisions of
households, business firms and governments.

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 Six Parts of the Financial System

1.Money
2.Financial Instruments
3.Financial Markets
4.Financial Institutions
5.Regulatory Agencies
6.Central Bank

Introduction to Finance 42
 Money

• Money is the medium of exchange and to

store value

• Money is at the heart of the payments

system.
……………………………………………………………….

• What is the difference between wealth and income?

• What about liquidity?

Introduction to Finance 43
 Financial Instruments

• The written legal obligation of one party to

transfer something of value, usually money, to
another party at some future date, under certain
conditions.

Introduction to Finance 44
 Financial Instruments

1. Financial instruments act as a means of payment (like money).

Employees take stock options as payment for working.
2. Financial instruments act as stores of value (like money).
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.
3. Financial instruments allow for the transfer of risk (unlike money).
Examples: Insurance contracts, future contracts.

Introduction to Finance 45
 Features of Financial Instruments

• These contracts are very complex.

This complexity is costly, and people do not want
to bear these costs.
• Standardization of financial instruments
overcomes potential costs of complexity.
Most mortgages feature a standard application
with standardized terms.

•
Introduction to Finance 46
 Features of Financial Instruments

• Financial instruments also communicate

information, summarizing certain details about the
issuer.

• Financial instruments are designed to handle the

problem of asymmetric information.

Introduction to Finance 47
 Financial Markets

Financial markets are places where financial instruments are bought and sold.
• 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.

Introduction to Finance 48
Stock Market Indexes

Introduction to Finance 49
 Financial Institutions

• 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.
• Also known as financial intermediaries.
▫ Examples: commercial banks, investment
banks, insurance companies,
securities firms, and pension funds.
Introduction to Finance 50
 Government regulatory agencies

• Government regulatory agencies provide

wide-ranging financial regulation – rules
and supervision.
→Increasing Information Available to Investors

→Ensuring the Soundness of Financial Intermediaries (Restrictions on

Entry, Disclosure, Restrictions on Assets and Activities, Deposit
Insurance, Limits on Competition, Restrictions on Interest Rates)

Introduction to Finance 51
Government regulatory agencies

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 Central banks

• Central banks began as large private banks to

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

Introduction to Finance 53
 Financial system
A healthy and constantly evolving financial system is the foundation for
economic efficiency and economic growth. It has six parts:
1. Money is used to pay for purchases and to store wealth.
2. Financial instruments are used to transfer resources and risk.
3. Financial markets allow people to buy and sell financial instruments.
4. Financial institutions provide access to the financial markets, collect
information and provide a variety of other services.
5. Government regulatory agencies aim to make the financial system
operate safely and reliably.
6. Central banks stabilize the economy.

Introduction to Finance 54
Flow of Funds Through the Financial System

Introduction to Finance 55
 Flow of Funds

• Return of
capital to investors

-----------------------------------------------------------------
• Not all of the cash
will return to the investors

Introduction to Finance 56
 Flow of Funds

• Investments
methods and techniques for making decisions
about:
what kinds of securities to own, which firms’
securities to buy,
and how to pay the investor back in the form
that the investors wishes (e.g., the timing and
certainty of the promised cashflows).

---------------------------------------------------------------
• Financial managements
deals with a firm’s decisions in acquiring and
using the cash that is received from
investors or from retained earnings

Introduction to Finance 57
 Flow of Funds
Financial Institutions and Markets

• The organization that

facilitate the flow of capital
between investors and
companies like banks,
insurance companies,
stock companies, mutual
funds

Introduction to Finance 58
 Flow of Funds
International Finance

The use of finance theory in a

global business environment.
e.g.: law, risks and business
relationships across different
countries

Introduction to Finance 59
 The functional perspective of a financial system

1. To provide ways to transfer economic resources through

time, across borders, and among industries.

2. To provide ways of managing risk.

3. To provide ways of clearing and settling payments ro

facilitate trade.

4. To provide a mechanism for the pooling of resources and

for subdividing of ownership of the economy.

5. To provide price information

6. To provide ways of dealing with the incentive problems.

Introduction to Finance 60
 Exercise: Net worth

• Joe and Mike purchase identical houses for $200,000. Joe makes a
down payment of $40,000, while Mike puts down only $10,000; for
each individual, the down payment is the total of his net worth.
Assuming everything else is equal, who is more highly leveraged? If
house prices in the neighborhood immediately fall by 10 percent
(before any mortgage payments are made), what would happen to
Joe’s and Mike’s net worth?
net worth = total asset - total liabilities (debt)
to be leveraged = to obtain debt
leverage rate = debt/total asset
highly leveraged = higher leveraged ratio= using more debt
to finance the activity or asset purchasement
Lecture 1 61