Finance Week 1 - Chapter 1 Notes  Diversification helps manage risk by offsetting losses

Chapter Introduction in one asset with gains in another.

 Finance is compared to fire: powerful and beneficial  Sources of return: income and price appreciation.
when controlled; destructive when misused. 1.2c Financial Leverage
 Historical examples of finance used for harm: the  Leverage involves borrowing funds with the
transatlantic slave trade, the South Sea Bubble, the expectation of higher returns.
2008 real estate crash, LIBOR manipulation.  Increases both potential return and potential loss.
 Examples of finance used for good: creation of  Common in both corporate and government finance.
derivatives (Dojima Rice Exchange), Social Security, 1.2d Valuation
Ford's workplace reforms, and the rise of Uber.  Valuation = present value of future cash flows.
 Finance impacts daily life and is essential for  Used for stocks, bonds, equipment, and entire firms.
personal and societal financial decisions.  A firm’s value is the sum of its assets’ values, often
 Discussion prompt: Why should you understand reflected in stock price.
finance even if you don’t plan a career in it? Finance 1.3 Assumptions
is pervasive, impacts life decisions, and enables  Financial models rely on assumptions (e.g., timing,
informed advocacy for its responsible use. interest rate, consistency).
1.1 The Divisions of Finance  Assumptions impact the accuracy and reliability of
1. Financial Institutions: financial projections.
o Focus on creation and trading of financial assets  Common assumptions include timing of cash flows,
(e.g., banks, stock exchanges). return rates, and frequency of contributions.
o Intermediaries (banks, insurance) link savers to 1.4 Finance and Other Business Disciplines
borrowers.  Finance evolved from accounting and economics.
2. Investments:  Emphasizes both business and individual
o Analysis of individual securities and portfolio perspectives.
construction.  Corporate finance and investments use similar tools
o Influenced by taxes, monetary policy, and firm but focus on different goals.
disclosures.  Distinct from other business fields by its dual
3. Business (Corporate) Finance: perspective approach.
o Managed by financial managers to ensure  Valuation of securities and portfolio construction are
liquidity, financing, and investment allocation. central to finance.
o Even small businesses engage in financial 1.5 Plan of the Text
management.  Part 1: Financial institutions and markets (Ch. 1–6)
o Financial decisions of individuals and firms  Part 2: Financial tools—Time value of money, risk,
parallel but differ in scale. and financial statements (Ch. 7–9)
 Part 3: Financial assets—stocks, bonds, and
1.2 Key Financial Concepts
 Sources of Funds: Assets must be financed through
investment companies (Ch. 10–17)
 Part 4: Business finance—taxes, leverage, capital
debt (creditors) or equity (owners).
 Risk and Return: All investments aim for a return,
structure, budgeting, forecasting (Ch. 18–27)
 Part 5: Derivatives—options, futures, and swaps
but uncertainty (risk) is inherent.
 Financial Leverage: Using debt to magnify potential
(Ch. 28–29)
 Emphasis is placed on corporate finance in early
gains/losses.
 Valuation: Present value of future returns determines
courses, but personal investment perspective is
an asset's worth. equally important.
 Goal of management: maximize shareholder value.
Active Learning Prompts (from slides)
 Question: How is finance studied from a business
1.2a Sources of Finance
 Balance sheet: snapshot of assets, liabilities, and
perspective in corporate finance courses?
o Answer: Corporate finance focuses on
equity.
 Creditors and equity investors both fund assets; the raising funds and allocating them efficiently,
nature of their claims differs. while investments focus on constructing
 Bonds: source of funds for firms; investment for portfolios and allocating wealth.
buyers.  Discussion Prompt: Why is it important to
1.2b Risk and Return understand finance regardless of your career path?
 Expected returns vary by investment type (stocks, o Answer: Finance affects all major life
real estate, savings). decisions, from saving for retirement to
 Risk: potential that actual returns deviate from purchasing a home. Understanding finance
expected. empowers individuals to make informed,
beneficial decisions.