PART ONE
Fundamental Concepts
and Basic Tools
of Finance
,
,Chapter 1
Financial Management
Learning Objectives (Slides 1-2–1-3)
1. Describe the cycle of money, the participants in the cycle, and the common objective
of borrowing and lending.
2. Distinguish the four main areas of finance and briefly explain the financial activities that
each encompasses.
3. Explain the different ways of classifying financial markets.
4. Discuss the three main categories of financial management.
5. Identify the main objective of the finance manager and how that objective might be
achieved.
6. Explain how the finance manager interacts with both internal and external players.
7. Delineate the three main types of business organizations and their respective advantages
and disadvantages.
8. Illustrate agency theory and the principal-agent problem.
9. Review issues in corporate governance and business ethics.
In a Nutshell
Given that a large number of business students tend to be “terrified” of taking their first (and possibly,
their only) course in finance, the topics, concepts, and issues presented in this chapter provide an excellent
opportunity for the instructor to break the ice and dispel the premonitions and prejudices that cloud
students’ interest in the subject.
The chapter is organized into ten sections, beginning with the definitions of finance and financial
management. Next, the process known as the “cycle of money” is defined, and the role of financial
intermediaries such as commercial and investment banks in the smooth operation of this cycle is
discussed. The author then provides an overview of the four interrelated areas of finance, i.e., corporate
finance, investments, financial institutions and markets, and international finance. It is important to stress
that finance majors should have a strong grasp of all four of these areas.
©2010 Pearson Education, Inc. Publishing as Prentice Hall
, 4 Brooks • Financial Management: Core Concepts
The various classifications of financial markets follow; they are presented from four viewpoints—by type
of asset traded, by maturity of asset, by owner of asset, and by method of sale. A brief discussion of
financial management follows, and the three main categories of capital budgeting, capital structure, and
working capital management are introduced. The author then turns to the main responsibilities of a
financial manager and the main goal of financial management, which is to maximize the value of the
equity of the company. The relationship of the financial manager to a diverse set of players—both internal
and external—is subsequently explored. The similarities, differences, advantages, and disadvantages
of the various forms of business organizations—i.e., sole proprietorship, partnerships, and corporations—
then follow.
The complexity of the responsibility of financial management is introduced by presenting the various
stakeholders whose interests must be balanced by the financial manager. The author then explains the
relationship of the officers of a company to the owners of the company through a model called agency
theory and discusses the areas of conflict that often arise from this relationship, as well as the mechanisms
by which these conflicts can be minimized. Finally, he touches on some of the issues concerning how
corporations govern their activities and how the government attempts to regulate and monitor these
activities.
Lecture Outline
Definition of Finance (Slide 1-4)
Finance is the art and science of managing wealth. It is about making decisions regarding what assets to
buy/sell and when to buy/sell these assets. Its main objective is to make individuals and their businesses
better off.
Definition of Financial Management (Slide 1-5)
Financial management is generally defined as those activities that create or preserve the economic value
of the assets of an individual, small business, or corporation. Financial management comes down to
making sound financial decisions.
1.1 The Cycle of Money (Slide 1-6)
Financial intermediaries such as investment and commercial banks assist in the movement of money from
lenders to borrowers and back again. This process is termed the cycle of money, and its main objective is to
make all the participants better off (See Figure 1.1.) (Slide 1-7)
Example 1: A mutual fund issues shares, which are bought by individuals who save and invest part of
their paychecks. The pooled funds are invested by the mutual fund company in shares that
are issued by firms that are trying to raise capital for growth. The firms pay dividends
periodically, which are received by the mutual fund and passed through to their shareholders,
or reinvested in additional shares, and the cycle of money starts again. The mutual fund
managers earn fees; the firms whose securities are bought are able to raise capital for growth
and future returns; and the mutual fund shareholders earn dividends and capital gains. Thus,
all participants are generally better off. (Slide 1-8)
©2010 Pearson Education, Inc. Publishing as Prentice Hall
Fundamental Concepts
and Basic Tools
of Finance
,
,Chapter 1
Financial Management
Learning Objectives (Slides 1-2–1-3)
1. Describe the cycle of money, the participants in the cycle, and the common objective
of borrowing and lending.
2. Distinguish the four main areas of finance and briefly explain the financial activities that
each encompasses.
3. Explain the different ways of classifying financial markets.
4. Discuss the three main categories of financial management.
5. Identify the main objective of the finance manager and how that objective might be
achieved.
6. Explain how the finance manager interacts with both internal and external players.
7. Delineate the three main types of business organizations and their respective advantages
and disadvantages.
8. Illustrate agency theory and the principal-agent problem.
9. Review issues in corporate governance and business ethics.
In a Nutshell
Given that a large number of business students tend to be “terrified” of taking their first (and possibly,
their only) course in finance, the topics, concepts, and issues presented in this chapter provide an excellent
opportunity for the instructor to break the ice and dispel the premonitions and prejudices that cloud
students’ interest in the subject.
The chapter is organized into ten sections, beginning with the definitions of finance and financial
management. Next, the process known as the “cycle of money” is defined, and the role of financial
intermediaries such as commercial and investment banks in the smooth operation of this cycle is
discussed. The author then provides an overview of the four interrelated areas of finance, i.e., corporate
finance, investments, financial institutions and markets, and international finance. It is important to stress
that finance majors should have a strong grasp of all four of these areas.
©2010 Pearson Education, Inc. Publishing as Prentice Hall
, 4 Brooks • Financial Management: Core Concepts
The various classifications of financial markets follow; they are presented from four viewpoints—by type
of asset traded, by maturity of asset, by owner of asset, and by method of sale. A brief discussion of
financial management follows, and the three main categories of capital budgeting, capital structure, and
working capital management are introduced. The author then turns to the main responsibilities of a
financial manager and the main goal of financial management, which is to maximize the value of the
equity of the company. The relationship of the financial manager to a diverse set of players—both internal
and external—is subsequently explored. The similarities, differences, advantages, and disadvantages
of the various forms of business organizations—i.e., sole proprietorship, partnerships, and corporations—
then follow.
The complexity of the responsibility of financial management is introduced by presenting the various
stakeholders whose interests must be balanced by the financial manager. The author then explains the
relationship of the officers of a company to the owners of the company through a model called agency
theory and discusses the areas of conflict that often arise from this relationship, as well as the mechanisms
by which these conflicts can be minimized. Finally, he touches on some of the issues concerning how
corporations govern their activities and how the government attempts to regulate and monitor these
activities.
Lecture Outline
Definition of Finance (Slide 1-4)
Finance is the art and science of managing wealth. It is about making decisions regarding what assets to
buy/sell and when to buy/sell these assets. Its main objective is to make individuals and their businesses
better off.
Definition of Financial Management (Slide 1-5)
Financial management is generally defined as those activities that create or preserve the economic value
of the assets of an individual, small business, or corporation. Financial management comes down to
making sound financial decisions.
1.1 The Cycle of Money (Slide 1-6)
Financial intermediaries such as investment and commercial banks assist in the movement of money from
lenders to borrowers and back again. This process is termed the cycle of money, and its main objective is to
make all the participants better off (See Figure 1.1.) (Slide 1-7)
Example 1: A mutual fund issues shares, which are bought by individuals who save and invest part of
their paychecks. The pooled funds are invested by the mutual fund company in shares that
are issued by firms that are trying to raise capital for growth. The firms pay dividends
periodically, which are received by the mutual fund and passed through to their shareholders,
or reinvested in additional shares, and the cycle of money starts again. The mutual fund
managers earn fees; the firms whose securities are bought are able to raise capital for growth
and future returns; and the mutual fund shareholders earn dividends and capital gains. Thus,
all participants are generally better off. (Slide 1-8)
©2010 Pearson Education, Inc. Publishing as Prentice Hall
