Business 2019 – Finance I

1
Business 2019 Finance I

• COURSE INTRODUCTION

Prepared by Ken Hartviksen
2
Lecture Agenda Course Introduction
1. Course Outline - Expectations
2. Website WebCT Online Quizzes
3. Assignment Expectations
4. What Does a Financial Manager Do?
5. Chapter 1 - Finance
3
Finance I Course Outline
4
Course Outline - Regulations

• Download from
• http//foba.lakeheadu.ca/hartviksen/2039
• Note Page
• Learning outcomes 1
• Detailed topic outline 3 7
• Evaluation (due dates times) 10
• Policies
• Pass/Fail Quizzes 11
• Attendance 11
• Participation 11
• Quiz not challenged 0 13
• Late assignment shall not be graded 0 13
• Assignments are your own individual work 15
• Quizzes are written by you in accordance with
  University academic regulations and without
  outside assistance.

Assignments
Outline
Online
Financial Mgrs.
Ch. 1 - Finance
5
Course Expectations

• Positive and rich learning experience.
• Operative word respect
• Respect for ones self
• Respect for ones classmates
• Respect for the Faculty
• Respect for the University
• Respect for academic integrity of this experience
• See course outline
• page 15 legal declaration
• pages 17 - with respect to academic dishonesty.

Assignments
Outline
Online
Financial Mgrs.
Ch. 1 - Finance
6
Finance I 2010 Evaluation System
Assignments
Outline
Online
Financial Mgrs.
Ch. 1 - Finance
7
Finance I Participation

• Objective everyone in the class has a
  responsibility to make a positive contribution to
  the learning experience of the class.
• Options to participate found in course outline,
  page 12
• In class
• WebCT Discussion groups
• Email to instructor resulting in a blanket answer
  to all class members
• Participation marks can be lost.
• Evaluated every three weeks (four times during
  the course)
• Ranked on a Likert scale (0 5)
• Full range utilized if no participation grade
  out of 5 is 0.
• Example (0 / 2.5 / 2.5 / (4 1) / 1) (9 / 20)
  45

Assignments
Outline
Online
Financial Mgrs.
Ch. 1 - Finance
8
Finance I WebCT Delivered Quizzes

• Purpose
• To confirm your knowledge of the course material
  that has been delivered.
• Provide feedback to you, the student on what you
  need to work on.
• Be sure to challenge the sample quiz available to
  you now!

Assignments
Outline
Online
Financial Mgrs.
Ch. 1 - Finance
9
Finance I Individual Assignments

• Purpose
• To develop your skills at professional report
  writing and use of the basic tools available in
  modern written communication software packages
  including
• Electronic page numbering
• Electronic tables of contents/referencing
• Headers and Footers
• Embedded spreadsheets, charts and graphs
• See a sample of a completed assignment
• Provide an opportunity to challenge applied
  problems and questions that encourage integration
  and synthesis of knowledge and skills.

Assignments
Outline
Online
Financial Mgrs.
Ch. 1 - Finance
10
On line Resources
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Distance Learning - CEDL

• Combined use of electronic resources
• Course Website
• Access to powerpoint slides via course website
• Access to print resources via course website
• Access to internet links / sample exams / other
  resources
• WebCT
• Access to on line concept review quizzes via
  WebCT
• Access the discussion groups via WebCT
• Ability to submit assignments via WebCT
• MyInfo
• Access grades

Assignments
Outline
Online
Financial Mgrs.
Ch. 1 - Finance
12
Individual Hand-in Assignments
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Individual Hand-in Assignments

• Must be done individually
• Legal intellectual property/academic integrity
  declaration

Assignments
Outline
Online
Financial Mgrs.
Ch. 1 - Finance
14
Chapter 1 An Introduction to Finance

• INTRODUCTION TO CORPORATE FINANCE
• First Edition
• Laurence Booth W. Sean Cleary

Prepared by Ken Hartviksen
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Lecture Agenda
1. Finance Defined
2. Real and Financial Assets
3. The Financial System
4. Financial Instruments
5. Financial Markets
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Learning Objectives

• What is finance?
• How financial securities meet needs of both
  borrowers and lenders simultaneously.
• How financial systems work.
• Channels of intermediation and the role of
  markets and financial intermediaries.
• Basic types of financial instruments and how they
  are traded.
• The importance of the global financial system.

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Finance Defined
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What is Finance?

• Finance is the study of how and under what terms
  savings (money) are allocated between lenders and
  borrowers.
• Finance is distinct from economics in that it
  addresses not only how resources are allocated
  but also under what terms and through what
  channels
• Financial contracts or securities occur whenever
  funds are transferred from issuer to buyer.

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The Study of Finance

• The study of finance requires a basic
  understanding of
• Securities
• Corporate law
• Financial institutions and markets

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Real and Financial Assets
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Real versus Financial Assets

• Real assets are tangible things owned by persons
  and businesses
• Residential structures and property
• Major appliances and automobiles
• Office towers, factories, mines
• Machinery and equipment
• Financial assets are what one individual has lent
  to another
• Consumer credit
• Loans
• Mortgages

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Real Versus Financial AssetsThe Household
Balance Sheet

• Households hold both real and financial assets
• Households also acquire some of those assets
  through debt
• A Household with no financial assets often faces
  financial problems because real assets cant be
  used to pay off debt or to service debt (make
  loan and interest payments)
• Real assets are not liquid
• (See Table 1-2 on the next slide)

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Assets and Liabilities of Households
24
The Financial System
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The Financial System Overview

• The household is the primary provider of funds to
  businesses and government.
• Households must accumulate financial resources
  throughout their working life times to have
  enough savings (pension) to live on in their
  retirement years
• Financial intermediaries transform the nature of
  the securities they issue and invest in
• Banks, trust companies, credit unions, insurance
  firms, mutual funds
• Market intermediaries simply help make markets
  work
• Investment dealers
• Brokers
• (See Figure 1-2 on the next slide)

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The Financial System
FIGURE 1-2
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The Financial SystemChannels of Intermediation

• Funds can be channeled from saver to borrower in
  three ways
• Direct intermediation (direct transfer from saver
  to borrower a non-market transaction)
• Direct intermediation (a market-based transaction
  usually through a market intermediary such as a
  broker)
• Indirect claims through a financial intermediary
  (where the financial intermediary such as a bank
  offers deposit-taking services and ultimately
  lends those deposits out as mortgages or loans)
• (See Figure 1-3 on the next slide)

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Channels of Intermediation
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The Financial SystemFinancial Intermediaries

• Banks and other deposit-taking institutions
• Insurance companies
• Pension Funds
• Mutual Funds

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Financial IntermediariesCanadian Chartered Banks

• Banks take deposits from numerous depositors from
  across Canada
• The deposits are pooled in the Bank
• The bank takes these pooled funds and lends them
  out to households and businesses in the form of
  mortgages and loans
• The bank transforms the original nature of the
  savers (depositors) money
• Deposits are usually small in amountface little
  or no risk, and depositors expect to withdraw the
  amount at any time
• Loans and mortgages on the other hand usually
  have the following characteristics
• Large sums
• Borrowed for long periods of time
• Borrowed for risky purposes.
• Banks can perform this transformation function
  because they become experts at risk assessment,
  financial contracting (pricing the risk) and
  monitoring the activities of borrowers.
• (See Table 1-3 on the next slide)

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Financial IntermediariesCanadian Chartered Banks
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Financial IntermediariesInsurance Companies

• Insurers sell policies and collect premiums from
  customers based on the pricing of those policies
  given the probability of a claim and the size the
  policy and administrative fees.
• They invest the premiums so that the accumulated
  value in the future will grow to meet the
  anticipated claims of the policyholders.
• In this way, unsupportable risks (such as the
  death of wage earner or the burning down of a
  business) are shared among a large number of
  policyholders through the insurance company.
• Insurance allows households, business and
  government to engage in risky activities without
  having to bear the entire risk of loss
  themselves.
• (See Table 1-4 on the next slide)

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Financial IntermediariesInsurance Companies
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Financial IntermediariesPension Plan Assets

• Individuals and employers make payments over the
  entire working life of a person with those funds
  invested to grow over time.
• Ultimately, the accumulated value in the pension
  can be used by the person in retirement.
• Pension plans accumulate considerable sums of
  money, and their managers invest those funds with
  long-term investment time horizons in diversified
  portfolios of investments. These investments
  are a major source of capital, fuelling
  investment in research and development, capital
  equipment, resource exploration and ultimately
  contributing in a substantial way to growth in
  the economy.
• (See Table 1-5 on the next slide)

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Financial IntermediariesPension Plan Assets
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Financial IntermediariesCanadian Mutual Fund
Assets

• Mutual funds give small investors access to
  diversified, professionally-managed portfolios of
  securities.
• Small investors often do not have the funds
  necessary to invest directly into market-traded
  stocks and bonds.
• This is called denomination intermediation
  because the mutual fund makes investments
  available in smaller, more affordable amounts of
  money.
• Canadian indirect investment in the markets
  through managed products such as mutual funds and
  segregated funds has grown exponentially.
• (see 1-4 Figure on the next slide)

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Financial IntermediariesCanadian Mutual Fund
Assets
FIGURE 1-4
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The Financial SystemThe Major Borrowers

• Public Debt
• Governments
• Federal
• Provincial
• Municipal
• Crown Corporations
• Private Debt
• Households
• Non-financial Corporations
• (See Table 1-6 on the next slide)

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The Financial SystemLargest Non-financial
Companies
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Financial Instruments
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Financial Instruments

• There are two major categories of financial
  securities
• Debt Instruments
• Commercial paper
• Bankers acceptances
• Treasury bills
• Mortgage loans
• Bonds
• Debentures
• Equity Instruments
• Common stock
• Preferred stock

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Financial Instruments Non-marketable

• Characteristics of Non-marketable securities
• Cannot be traded between or among investors
• May be redeemable (a reverse transaction between
  the borrower and the lender)
• Examples
• Savings accounts
• Term Deposits
• Guaranteed Investment Certificates
• Canada Savings Bonds

43
Financial Instruments Marketable

• Characteristics of Marketable securities
• Can be traded between or among investors after
  their original issue in public markets and before
  they mature or expire
• The market value will change over time due to
  changes in the general economic environment (for
  example, interest rate increases or decreases)
  and/or changes in the issuer of the security.
• Market Capitalization
• Is an important term in finance
• It is the total market value of a company
• It is found by multiplying the number of shares
  outstanding by the market price per share.

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Market Capitalization

• Market Capitalization
• Is an important term in finance
• It is the total market value of a company
• It is found by multiplying the number of shares
  outstanding by the market price per share.

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Financial Instruments Marketable

• Markets can be categorized by the time to
  maturity
• Money Market Securities (for short-term debt
  securities that are pure discount notes)
• Bankers acceptances
• Commercial Paper
• Treasury Bills
• Capital Market Securities (for long-term debt or
  equity securities with maturities greater than 1
  year)
• Bonds
• Debentures
• Common Stock
• Preferred Stock

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Financial Markets

• An Introduction to Finance

47
Financial Markets

• Primary Market
• Markets that involve the issue of new securities
  by the borrower in return for cash from investors
  (Capital formation occurs)
• Secondary Market
• Markets that involve buyers and sellers of
  existing securities. Funds flow from buyer to
  seller. Seller becomes the new owner of the
  security. (No capital formation occurs)

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Financial Markets Types of Secondary Markets

• Exchanges or Auction Markets
• Secondary markets that involve a bidding process
  that takes place in specific location
• For example TSX, NYSE
• Dealer or Over-the-counter (OTC) Markets
• Secondary markets that do not have a physical
  location and consist of a network of dealers who
  trade directly with one another.
• For example the bond market

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Financial Markets Other Markets

• Third Market
• Trading of securities that are listed on
  organized exchanges in the Over-the-counter
  market
• Fourth Market
• Trading of securities directly between investors
  (usually between two large institutions) without
  the involvement of brokers or dealers.
• Operates through the use of privately owned
  automated systems such as Instinet

50
The Global Financial Community

• Represents an important source of funds for
  borrowers
• Provides investors with important alternatives as
  they seek to build wealth through diversified
  portfolios
• (See Table 1-7 on the next slide)

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The Global Financial Community
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Summary and Conclusions

• In this chapter you have learned about
• Financial systems in general, and the Canadian
  financial system in particular
• Major participants in the Canadian financial
  system, including the different types of
  financial securities and financial markets

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Concept Review Questions

• Chapter 1 - An Introduction to Finance

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Concept Review Question 1Finance

• What is finance?
• Finance is the study of how and under what terms
  savings are allocated between borrowers and
  lenders.
• It also examines under what terms and through
  what channels resources are allocated.

End-of-Chapter Problems
55
Concept Review Question 2Real and Financial
Assets

• Distinguish between real and financial assets.
• Real assets are tangible property owned by people
  and businesses such as buildings, land, machinery
  and equipment
• Financial assets are paper claims that are
  evidence of contracts between people, or between
  people and businesses (government)

End-of-Chapter Problems
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Concept Review Question 3Net Providers and Users
of Funds

• Which sectors of the economy are net providers of
  financing and which are the net users of
  financing?
• Households and the non-resident sector
  traditionally are the net provider of financing
  for businesses and government.

End-of-Chapter Problems
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Concept Review Question 4Channels of Savings

• Identify and briefly describe the three main
  channels of savings.
• Direct claims through Non-market transactions
• A daughter arranging a loan through her mother
• Direct claims through market intermediaries
• Purchase of a stock through a broker
• Indirect claims through financial intermediaries
• Deposit in a savings accountthe funds eventually
  find themselves lent by the bank to a business to
  finance purchase of equipment.

End-of-Chapter Problems
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Concept Review Question 5Market and Financial
Intermediaries

• Distinguish between market and financial
  intermediaries.
• Market intermediaries help with the proper
  functioning of financial markets
• Investment dealers
• Financial intermediaries transform financial
  assets and meet the needs of both savers and
  borrowers simultaneously through the asset
  transformation function
• Banks
• Insurance firms
• Mutual funds

End-of-Chapter Problems
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Concept Review Question 6How financial
intermediaries operate

• Discuss how the three most important types of
  financial intermediaries operate.
• Banks
• Deposit-taking and lending
• Insurance Firms
• Sale of policies, collecting of premiums,
  investing premiums and underwriting losses
• Pension Plans
• Long-term accumulation of savings and channeling
  them to productive long-term investments that
  will yield long-term positive returns and provide
  financial security in old age for beneficiaries.

End-of-Chapter Problems
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Concept Review Question 7Types of financial
assets

• Distinguish among the various types of financial
  assets.
• Debt (represents a lending arrangement)
• Short-term debt is traded in the money market
• Commercial paper
• Bankers acceptances
• Treasury Bills
• Long-term debt is traded in the OTC capital
  market
• Bonds and debentures
• Equity (represents an ownership claim)
• Common Stock
• Preferred Stock

End-of-Chapter Problems
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Concept Review Question 8Sources of financing
used by governments and business

• Identify the major sources of financing used by
  governments and businesses.
• Governments
• Tax revenue (income taxes, excise taxes,
  consumption taxes (PST and GST), property taxes
• Borrowing (short-term through Treasury bills, and
  long-term through Government bonds)
• Businesses
• Reinvested Profits
• Common Stock
• Bonds
• Short-term loans from banks

End-of-Chapter Problems
62
Concept Review Question 9Primary and Secondary
Markets

• Distinguish between primary and secondary
  markets.
• Primary market is where new securities are sold
  for the first time. This is where the corporate
  issuer raises capital.
• Secondary markets occur when existing securities
  are traded among and between investors without
  capital formation occurring.

End-of-Chapter Problems
63
Concept Review Question 10Importance of global
financial markets to Canadians

• Explain why global financial markets are so
  important to Canadians.
• Canadians as savers need to diversify their
  investment portfolios, and access to global
  financial markets allows that diversification to
  be more complete.
• Having access to funds in global markets,
  Canadian companies can raise more capital more
  cheaply making them more competitive in their
  chosen industry.

End-of-Chapter Problems
64
Concept Review Question 11Major U.S. Stock
Markets

• Identify and briefly describe the two major stock
  markets in the United States.
• New York Stock Exchange (NYSE)
• Worlds largest
• Most famous
• Market capitalization US 21.2 trillion (2005)
• Nasdaq
• Second largest and most important in U.S.
• Third largest in the world
• More listed companies than the NYSE

End-of-Chapter Problems
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Questions Practice Problems

• Chapter 1 - An Introduction to Finance

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Multiple Choice Question 1 - 1

• According to Canadas national balance sheet,
  which of the following items is not a real asset?
• A. Land
• B. Machinery and equipment
• C. Net worth
• D. Residential structures
• Answer

C
End-of-Chapter Problems
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Multiple Choice Question 1 - 2

• In business finance, managers make capital
  expenditure decisions, which may include all of
  the following except
• A. Land purchases
• B. Takeovers of another firm
• C. Inventory purchases
• D. Machine purchases
• Answer
• C

End-of-Chapter Problems
68
Multiple Choice Question 1 - 3

• Consider the following environments. Which one
  would cause a firm to make different decisions
  about capital expenditures and corporate
  financing than it would otherwise?
• A. High unemployment rate
• B. High real gross domestic produce (GDP) growth
  rate
• C. High corporate profits
• D. Low interest rates
• Answer
• A
• High real GDP growth rate and low unemployment
  rate are key macroeconomic indicators of a good
  economy environment, where corporate profits are
  high and interest rates are low. Therefore A
  (high unemployment) is an indication of a weak
  environment and might cause different decisions.
  Capital expenditure and corporate financing
  decisions are made based on these macroeconomic
  factors.

End-of-Chapter Problems
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Multiple Choice Question 1 - 4

• Which of the following is a correct combination
  of primary fund lenders and fund borrowers in the
  financial system?
• A. Households government
• B. Households non-residents
• C. Businesses households
• D. Government non-residents
• Answer
• A
• In the financial system, households are the
  primary fund providers to the government and
  businesses.

End-of-Chapter Problems
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Multiple Choice Question 1 - 5

• Which of the following financial intermediaries
  does not transform the nature of the underlying
  financial securities?
• A. Banks
• B. Insurance firms
• C. Mutual funds
• D. Pension funds
• Answer
• C
• Banks, pension funds, and insurance firms do
  transform the nature of their underlying
  financial securities. However, mutual funds do
  not transform the nature of the underlying
  financial securities.

End-of-Chapter Problems
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Practice Problem 6The Four Major Financial
Sectors

• State the four major financial sectors in the
  financial system and discuss how they relate to
  one another
• Borrowers
• Deficit spending economic units (households,
  businesses, government) require funds now for
  investment and are willing to pay investors a
  return for the use of these funds
• Lenders/investors
• Surplus saving economic units (households,
  businesses, government) have a surplus of funds
  available that they want to earn a return on so
  they lend or invest these funds to net borrowers
• Financial intermediaries
• Banks, trusts, credit unions, pension funds,
  mutual funds, channel surplus savings to deficit
  spending economic units
• Financial markets
• Money, bond and equity markets bring buyers
  (lenders/investors) and sellers (borrowers) of
  financial assets together to trade in those
  assets and establish market prices for them.

End-of-Chapter Problems
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Practice Problem 7The role of different
financial intermediaries

• Explain how banks, pension funds, insurance
  firms, and mutual funds work in the financial
  system.
• Banks
• Accept deposits, pool the funds and lend them out
  as mortgages and loans
• Pension Funds
• Professionally managed pools of funds that fuel
  current investment in Canadian business and
  government but at the same time provide for the
  long-term financial security of the plan
  beneficiaries
• Insurance Firms
• Facilitate the pooling or sharing of risks among
  the many policyholders thereby underwriting
  economic activity and minimizing the negative
  impacts of unsupportable losses.
• Mutual Funds
• Permits small investors with access to direct
  claims that are market traded such as stocks and
  bonds.

End-of-Chapter Problems
73
Practice Problem 8Why financial intermediaries
and markets exist

• Briefly describe why financial and market
  intermediaries exist in our financial system.
• Financial and market intermediaries serve to
  channel scarce financial resources from economic
  units that have a surplus of savings to economic
  units that have a deficit of savings.
• Ideally, financial and market intermediaries will
  ensure that these scarce financial resources will
  be put to the greatest and best use (ie. Perform
  their functions with effectiveness)
• Ideally, financial and market intermediaries will
  perform the channeling function at a low net cost
  to both borrower and saver (ie. Perform their
  functions with efficiency).

End-of-Chapter Problems
74
Practice Problem 9Primary Market Transactions

• List the two main types of primary market
  transactions and concisely explain them.
• Debt Offerings
• When governments or businesses sell bonds to
  investors in return for cash that the issuer
  needs
• Equity Offerings
• When businesses sell shares to the investing
  public in return for cash that the issuer needs.

End-of-Chapter Problems
75
Practice Problem 10Secondary Market Transactions

• What are secondary market transactions? How do
  secondary markets facilitate the primary markets?
• Secondary market transactions occur between two
  parties that wish to trade in a financial asset.
• Funds flow from the purchaser to the seller of
  the financial asset
• No funds flow to the issuer of the financial
  asset
• Secondary markets provide liquidity in the market
  place and continuous pricing function.
• The fact that securities with long terms to
  maturity (or non-maturing securities such as
  stock) can be sold, allows investors with shorter
  investment time horizons to consider their
  purchase.

End-of-Chapter Problems
76
How Do DTIs Meet the Needs of Both Savers and
Borrowers?

• Pooling of deposits maintaining adequate
  liquidity reserves
• Expertise in financial contracting
• Expertise in risk assessment and contract pricing
• Expertise in contract monitoring
• Expertise in portfolio management

Assignments
Outline
Online
Financial Mgrs.
Ch. 1 - Finance
77
Financial InstitutionsTypes Functions

• Deposit-Taking Institutions (Banks, Trusts,
  Credit Unions)
• Lending (consumer and commercial loans
  mortgages)
• Transaction services (deposits, GICs/Term
  Deposits, savings, chequing accounts,
  money-orders, currency exchange)
• Insurance Companies (risk offlay and
  intergenerational transfers)
• Property Casualty Insurers home auto
• Life Insurance mortalility and morbidity
  (health) products (life insurance, disability
  insurance, accidental death dismemberment,
  critical illness, etc.)
• Pooled Investment Funds (denomination
  intermediation)
• Mutual funds ETFs
• Pension/endowment fund management (Investment
  counsel)
• Investment Dealers
• Underwriting
• Brokerage and wealth management
• Finance Companies
• Leasing/lending services

Assignments
Outline
Online
Financial Mgrs.
Ch. 1 - Finance
78
Today You Have Learned

• Expectations for Business 2039.
• Where to access the resources for Business 2039.
• How to prepare professional business reports.
• What financial managers do.
• How money flows from lenders/investors to
  borrowers.
• Role of markets and financial intermediaries.
• Basic types of financial instruments.

79
Assignment for Class 2

• Read course outline
• Follow detailed topic outline starting on page 3
  of the outline.
• Access WebCT site for this course
• Challenge the sample on line quiz
• Participate in discussion groups
• Start to attempt Pass/Fail Quizzes on Monday,
  January 10, 2011
• Fully review the course website
• Scan the financial environment for current
  developments/issues