UnderstandingFinancial

Managementand Securities

Markets CH

AP

TE

R 1

6

The Future of BusinessThe Essentials 4th EditionGitman & McDaniel

Prepared byDeborah Baker

Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved

© R

yan

McV

ay /

Dig

ital V

isio

n / G

etty

Imag

es

2

Learning Goals

CH

AP

TE

R 1

6

1 How do finance and the financial manager affect the firm’s overall strategy?

2 What types of short-term and long-term expenditures does a firm make?

3 What are the main sources and costs of unsecured and secured short-term financing?

4 What are the key differences between debt and equity, and the major types and features of long-term debt?

3

Learning Goals (continued)

CH

AP

TE

R 1

6

5 When and how do firms issue equity, and what are the costs?

6 How do securities markets help firms raise funding, and what securities trade in the capital markets?

7 Where can investors buy and sell securities, and how are securities markets regulated?

8 What are the current developments in financial management and the securities markets?

41

How do finance and the financial manager affect the firm’s overall strategy?

1

The Role of Finance and the Financial Manager

5

financial management

The art and science of managing a firm’s money so that it can meet its goals.

1

The Role of Finance and the Financial Manager

6

cash flows

The inflows and outflows of cash for a firm.

1

The Role of Finance and the Financial Manager

71

Key Activities of the Financial Manager

Financial planning

Investing (spending money)

Financing (raising money)

8

The Goal of the Financial Manager

1

Maximize the Value of the FirmMaximize the Value of the Firm

ReturnReturn RiskRiskVersus

9

risk-return trade-off

A basic principle in finance that holds that the higher the risk, the greater the return that is required.

1

The Goal of the Financial Manager

10

CONCEPT check

1

What is the role of financial management in a firm?

How do the three key activities of the financial manager relate?

What is the main goal of the financial manager? How does the risk-return trade-off relate to the financial manager’s main goal?

112

What types of short-term and long-term expenditures does a firm make?

2

How Organizations Use Funds

12

Short-Term Expenses

Manage Current Assets

Cash

Accounts Receivable

Inventory

2

13

1. Collect money owed to the firm quickly (accounts receivable)

2. Pay money owed to others as late as possible without damaging credit reputation (accounts payable)

3. Minimize funds tied up in inventory

Balancing Cash Outflow and Inflow

2

14

Credit policies

Guidelines on offering credit

Credit terms

Specific repayment conditions

Collection policies

Accounts Receivable Management

2

15

Inventory Management

2

Cost of inventory includes its purchase price, ordering, handling, storage, interest, and insurance costs.

Marketing managers want finished goods on hand to fill customer orders.

Financial managers prefer the least inventory possible without harming production efficiency or sales.

16

MachineryMachinery

BuildingsBuildings

LandLand

EquipmentEquipment

Information SystemsInformation Systems

Capital Expenditures

2

17

Reasons for Capital Expenditures

Capital Expenditures

2

Expand

Replace or renew fixed assets

Develop new products

18

CONCEPT check

Distinguish between short- and long-term expenses.

What is the financial manager’s goal in cash management? List the three key cash management strategies.

Describe a firm’s main motives in making capital expenditures.

2

193

What are the main sources and costs of unsecured and secured short-term financing?

3

Obtaining Short-Term Financing

20

Funding

3

213

Bank LoansBank Loans

TradeCreditTradeCredit

CommercialPaper

CommercialPaper

Lines of creditLines of credit

Revolving credit agreementRevolving credit agreement

Unsecured Short-Term Loans

223

Secured Short-Term Loans

23

CONCEPT check

Distinguish between unsecured and secured short-term loans.

Briefly describe the three main types of unsecured short-term loans.

Discuss the two ways that accounts receivable can be used to obtain short-term financing.

3

244

What are the key differences between debt and equity, and the major types and features of long-term debt?

4

Raising Long-Term Financing

25

financial risk

The chance that a firm will be unable to make scheduled interest and principal payments on its debt.

Debt versus Equity Financing

4

26

Debt Financing

4

275

When and how do firms issue equity, and what are the costs?

5

Equity Financing

285

Venture CapitalVenture Capital

Preferred Stock Preferred Stock

Dividends & Retained EarningsDividends & Retained Earnings

Selling New Issues of Common StockSelling New Issues of Common Stock

Equity Financing

295

Equity Financing

PreferredStock

PreferredStock

An equity security for which the dividend amount is set at the time the stock is issued.

An equity security for which the dividend amount is set at the time the stock is issued.

CommonStock

CommonStock

A security that represents an ownership interest in a corporation.A security that represents an ownership interest in a corporation.

30

CONCEPT check

Compare the advantages and disadvantages of debt and equity financing.

Discuss the costs involved in issuing common stock.

Briefly describe these sources of equity: retained earnings, preferred stock, and venture capital.

5

316

How do securities markets help firms raise funding, and what securities trade in the capital markets?

6

Securities Markets

32

Types of Securities Markets

6

SecondaryMarket

SecondaryMarket

The securities market where old (already issued) securitiesare bought and sold, or traded,among investors.

The securities market where old (already issued) securitiesare bought and sold, or traded,among investors.

PrimaryMarket

PrimaryMarket

The securities market where new securities are sold to the public, usually with the help of investment bankers.

The securities market where new securities are sold to the public, usually with the help of investment bankers.

33

Securities Markets

6

StockbrokerStockbroker

InvestmentBankers

InvestmentBankers

InstitutionalInvestors

InstitutionalInvestors

A person who is licensed to buy andsell securities on behalf of clients. A person who is licensed to buy andsell securities on behalf of clients.

Firms that act as intermediaries, buying securities and reselling themto the public (underwriting).

Firms that act as intermediaries, buying securities and reselling themto the public (underwriting).

Investment professionals who arepaid to manage other people’s money.Investment professionals who arepaid to manage other people’s money.

34

Government Securities and Municipal Bonds

Municipal BondsMunicipal Bonds

Treasury BondsTreasury Bonds

U.S. TreasuryU.S. Treasury Treasury NotesTreasury Notes

Treasury BillsTreasury Bills

Revenue BondsRevenue Bonds

General Obligation Bonds

General Obligation Bonds

6

35

Bond Ratings

6Exhibit 16.3

36

Other Popular Securities

Mutual Funds

Exchange-Traded Funds

Futures Contracts

Options

6

37

CONCEPT check

Distinguish between primary and secondary securities markets. How does an investment banker work with companies to issue securities?

Describe the types of bonds available to investors and the advantages and disadvantages they offer.

Why do mutual funds and exchange-traded funds appeal to investors? Discuss why futures contracts and options are risky investments.

6

387

Where can investors buy and sell securities, and how are securities markets regulated?

7

Buying and Selling at Securities Exchanges

39

Secondary Markets

Secondary Markets

Broker Markets

NationalExchanges

RegionalExchanges

Dealer Markets

NASDAQ

OTC

7

40

Broker Markets

7

New York Stock Exchange(NYSE)

New York Stock Exchange(NYSE)

Regional ExchangesRegional Exchanges

41

Dealer Markets

7

2. The buyer purchases the securities from another dealer.2. The buyer purchases the securities from another dealer.

1. The selling investor sells his/her securities to one dealer.1. The selling investor sells his/her securities to one dealer.

42

Dealer Markets

7

OTC MarketsOTC Markets

NASDAQNASDAQ

43

electronic communications networks (ECNs)

Electronic trading networks that allow institutional traders and some individuals to make securities transactions directly.

Alternative Trading Systems

7

447

Regulation of Securities Markets

Securities andExchange

Commission

Securities andExchange

Commission

The main federal government agency responsible for regulating the U.S. securities industry.

The main federal government agency responsible for regulating the U.S. securities industry.

Insider TradingInsider TradingThe use of information that is not available to the general public to make profits on securities transactions.

The use of information that is not available to the general public to make profits on securities transactions.

45

circuit breakers

Measures that, under certain conditions, stop trading in the securities markets for a short cooling-off period to limit the amount the market can drop in one day.

Self-Regulation

7

46

CONCEPT check

How do the broker markets differ from dealer markets, and what organizations compose each of these two markets?

Why is globalization of the securities markets important to U.S. investors? What are some of the other exchanges where U.S. companies can list their securities?

Briefly describe the key provisions of the main federal laws designed to protect securities investors. What is insider trading, and how can it be harmful? How does the securities industry regulate itself?

7

478

What are the current developments in financial management and the securities markets?

8

Trends in Financial Management and Securities Markets

48

Trends in Financial Management and Securities Markets

Technology

Stronger role of SEC

Mergers in global securities markets

Electronic trading

8

49

CONCEPT check

How has the role of CFO changed since the passage of the Sarbanes-Oxley Act?

Describe the major changes taking place in the U.S. securities markets. What trends are driving these changes?

8