FIn 351: Lecture 1

Introduction to Financial Management

Administrative Issues and Course Overview

FIn 351: Lecture 1

Today’s plan

administrative issues• syllabus

• prerequisite

• add, drop and withdraw

• Middle-term and final exams

• final grade

course overview The functions of the financial market The cost of capital

FIn 351: Lecture 1

The instructor My name is George Li

• Call me George, not professor Office: BUS 315 Office hours:

• 17:15 to 18:15 MW Website: http://online.sfsu.edu/~li123456 Research interest:

• Corporate finance: real options, technological innovations, and valuations

• Asset pricing: information and stock prices

FIn 351: Lecture 1

Why do you want to take this course

First, what ‘s your objective or why are you taking Fin 351?• nothing better to do today ?

• become a millionaire overnight?

• the instructor is a nice guy for a good grade?

• get a “stamp of approval” to get a job ?

• learn finance for fun ?

• simply a required course ?

• learn finance to be more successful?

FIn 351: Lecture 1

My objectives in this course

My objectives• i want you to understand the concepts / issues better

• i want you to feel comfortable talking about finance and answering finance questions.

• i want you to gain a set of tools and concepts that will help you look at the world in a slightly different way.

What is standing in the way of those objectives?• Over-confidence

• Under-confidence

FIn 351: Lecture 1

Two ways of learning

Positive • Can be a fun, since it is an opportunity to improve your

future career, open your mind and broaden your vision

• Look at each difficulty as an opportunity to learn new things

• Good performance Negative

• Can be boring, since it is regarded as a burden, a task

• Look at each difficulty as a “torture” or pain

• Bad performance

FIn 351: Lecture 1

Textbook

fundamentals of corporate finance, by Brealey, Myers and Marcas (6th edition) sorry about the cost this is a standard textbook used in many

major schools for the first course in corporate finance

FIn 351: Lecture 1

Prerequisite

You are required to take Fin 350 with a grade of at least C-.

It is the school’s policy that all the students in this course must satisfy this requirement and there is no exception

FIn 351: Lecture 1

Add, drop and withdrawal policy

The business school has the policy for add, drop and withdrawal• Students can withdraw once

• Please read the bulletin for detail information about the withdrawal and adding to this course.

FIn 351: Lecture 1

Homework and cases To help you understand the concepts taught in class,

and prepare the mid-term and the final exams, there is a homework set assigned for each covered chapter, which is not graded, but its solution will be posted in my website. The best way to learn is to do a lot of problems, think a lot and try to apply what you have learned to real world problems.

In addition, I will discuss two or three cases in lectures to apply the concepts you have learned in this course to solve problems in the real financial world. These cases will also help you to get better prepared for the final.

FIn 351: Lecture 1

The mid-term and the final exam

The mid-term and final exams will be in class (closed book), with a form of multiple choice questions.

There are no makeup or in-advance exams.

The final exam is cumulative, based on all the covered materials.

FIn 351: Lecture 1

Final grade

Your overall course grade will be based on your performance in the mid-term and the final exams as follows:

Class attendance 5 pts Mid-term exam: 35 pts final exam: 60 pts total 100 pts

FIn 351: Lecture 1

Grading policy

Your grades are based on the distribution of the scores of the class. If you are at the top 10% of the class, you will get a grade of at least A-.

The average grade for this class is about B-, which is the average grade for this course in the last two years.

FIn 351: Lecture 1

The curve of grades

Ranking (from top to bottom) Grade 0%-10% A Range ( A, A-) 10%-50% B Range (B+, B, B-) 50%-85% C Range (C+, C, C-) 85% - 95% D Range (D+,D,D-) 95%-100% F

FIn 351: Lecture 1

Corporate finance: what is it?

Corporate Finance• A set of concepts, theories and approaches

that help the firm to make financial decisions

FIn 351: Lecture 1

Financial decisions

Capital budgeting (use of the capital)• Real investments

• Mergers; acquisitions

Financing (capital structure decision)• Equity

• Debt

FIn 351: Lecture 1

FIN 351: course organization

FIN 351

Module 1Fundamentals of valuation

Module 2Valuing risky investments

Risk and return

Module 3 Corporate financial decisions

Module 4 Market efficiency and options

Fundamentals of PVFinancial decision

Interest rates

Perpetuities and annuities calculation

Valuing stocks and bonds

NPV and other criteria

Portfolio theoryDiversification and covariance

Modigliani-Miller theorem 1Pizza size is independent of

how sliced

Tangency portfolio, CAPMrisk and return

Effect of leverageWACC and discount rate

Binomial model, replicationRisk-neutral probabilities

Options and Black-Scholes

Weak, semi-strong and strong form efficiency

Information and stock prices

Types of securitiesStocks, bonds and other

Modigliani-Miller theorem 2WACC

FIn 351: Lecture 1

Course organization

This course is broken-down into four modules

Module 1: time value of money Module 2: risk and return Module 3: capital structure Module 4: financial markets

FIn 351: Lecture 1

Time value of money

This module is a “skill building” block in this course

We will soon have the necessary skills needed to value stocks and bonds

In this module, we don’t consider risk explicitly:• future cash flows forecasts are given

• discount rates are given

FIn 351: Lecture 1

Risk and return

This part teaches us about uncertainty How do we measure risk? How much is one piece of risky cash

flow in the future worth (today)? They are both:

• skill building sections

• conceptually more difficult sections

FIn 351: Lecture 1

Financing decisions

If you are the CEO of an industrial company• you can make your company more valuable

by choosing “better” projects

• we want to know if you (and the CFO) can make your company more valuable by changing the mixture of your financing (i.e. the ratio of debt to equity)

FIn 351: Lecture 1

The efficiency of financial markets and options

We will look at how information gets into security prices

We will learn three forms market efficiency

We will examine the implication of market efficiency on financing

We don’t have time to examine options

FIn 351: Lecture 1

Financial

Manager

Firm's

operations

Investors

(1) Investors buy shares with cash

(1)

(2)Cash is invested

(2)

(3) Operations generates cash

(3)

(4a) Cash reinvested

(4a)

(4b) Cash returned to investors

(4b)

Financial markets and investors

Real assets

(timberland)

(stockholders save and invest in closely held firm.)

FIn 351: Lecture 1

Financial markets

A financial market • Securities are issued and traded

The classification of the financial market• By seasoning of claim

• Primary market

• Secondary market

• By nature of market• Debt market

• Equity market

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Financial markets (continue)

• By maturity of claim• Money market

• Capital market

FIn 351: Lecture 1

The functions of financial markets

1. Conducting exchange

2. Providing liquidity

3. Pooling money to fund large corporations

4. Transferring money across time and distance

5. Risk management (hedge, diversify)

6. Providing information

7. Providing efficient allocation of money

FIn 351: Lecture 1

Conducting exchange

What does it mean ? Examples

FIn 351: Lecture 1

Providing liquidity

What does this mean? Examples

FIn 351: Lecture 1

Pooling money to fund large corporation investments

What does this mean? Examples

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Transferring money across time and distance

What does this mean? Examples

FIn 351: Lecture 1

Risk management

What does this mean? Examples

FIn 351: Lecture 1

Providing information

What does this mean? Examples

FIn 351: Lecture 1

Providing efficient allocation of money

What does this mean? Examples

FIn 351: Lecture 1

The cost of capital

The cost of capital is a very important concept in capital budgeting.

It links investment opportunities in financial markets and investment opportunities in real assets markets.

FIn 351: Lecture 1

What is the cost of capital?

Cash

Investment opportunity (real

asset)Firm Shareholder

Investment opportunities

(financial assets)

Invest Alternative: pay dividend to shareholders

Shareholders invest for themselves