1. By Dr. B. Krishna Reddy
Professor and Head_SKIM

3. 1.1. Introduction
1.2. Defining finance
1.3. The Firm: a sistemic approach
1.4. Corporate Finance: the financial
function
1.5. The financial objective: value creation
1.6. Financial main principles
1.7. Finance: historic evolution
1.8. Main programmes in Finance

4. I am saving for retirement. Should I use a pension fund,
mutual fund, direct stock market investment ?
I want that new car. Should I use my cash saving, lease,
borrow?
Which is the best way to pay for my holidays, for my
house?
I’m thinking about starting a new business. Will it
reward me adequately?
Marocco has asked for major project financing.
Should my organization provide the funds?

5. Why study finance?
To manage your personal resources
To deal with the world of business
To pursue interesting and rewarding career
opportunities
To make informed public choices as a citizen
For the intellectual challenge

6.  Household
 Business Firms
 Government
 Foreign Sector
SURPLUS SPENDING
UNITS
DEFICIT SPENDING
UNITS

7.  Has more cash income flow than
expenditure on consumption and real
investments in a period of time. The
surplus is then allocated to the financial
sector.
 Other terms for surplus unit are saver,
lender, buyer of financial assets, financial
investor, supplier of loanable funds,
buyer of securities.

8.  The surplus unit may buy financial assets,
hold more money, or pay off financial
liabilities issued earlier when in a deficit
situation
 The household and foreign sectors are
usually a surplus sector

9.  Has more expenditures on consumption
and real goods (investment) in the real
sector than income during a period of
time
 The deficit unit must participate (borrow)
in the financial sector to balance cash
inflows with outflows

10.  Other terms for deficit expending unit
are borrower, demander of loanable
funds, and seller of securities.
 The deficit spending unit may issue
financial liabilities, reduce money
balances, and sell financial assets
acquired previously when in a surplus
situation

11.  Contracts related to the transfer of funds
from surplus to deficit budget units
 Financial claims are also called financial
assets and liabilities, securities, loans, and
financial investments.
 For every financial asset, there is an
offsetting financial liability.
 Total receivable equal total payable in the financial
system
 Loans outstanding match borrowers’ liabilities

12.  Financial markets offer opportunity for:
› Financing for DSUs (primary)
› Financial investing for SSUs (primary and
secondary)
› Providing liquidity via trading financial
claims in secondary markets

13. THE FLOW OF FUNDS DIAGRAM
Deficit Spending
Unit (DSU)
Surplus Spending
Unit (SSU)
FundsFunds
Financial Assets = Financial Claims

14. THE FLOW OF FUNDS DIAGRAM
Deficit Spending
Unit (DSU)
Surplus Spending
Unit (SSU)
FundsFunds
Financial Assets = Financial Claims
Borrower
demander of loanable funds
seller of securities
Saver, lender
buyer of financial assets
financial investor
supplier of loanable funds
buyer of securities.

15.  Assets: any possession that has value in
an exchange
› tangible: value depends on particular
physical properties (reproducible and non-
reproducible)
› intangible: legal claims to some future
benefit. Financial
assets

16.  Main properties of financial assets
› Rate of return (R): expected return
› Risk (r): credit risk, market risk
› Liquidity (L): how much sellers stand to
lose if they wish to sell immediately against
engaging in a costly and time-consuming
search (J.Tobin)

17. THE FLOW OF FUNDS DIAGRAM
DIRECT FINANCING (Markets)
Deficit Spending
Unit (DSU)
Surplus Spending
Unit (SSU)
INDIRECT FINANCIAL INVESTMENT
OR INTERMEDIATION FINANCING
Brokers
Dealers
Intermediaries
FundsFunds
Funds Funds

18. THE FLOW OF FUNDS DIAGRAM
DIRECT
Deficit Spending
Unit (DSU)
Surplus Spending
Unit (SSU)
INDIRECT
Brokers
Dealers
Intermediaries
FundsFunds
Funds Funds
Direct Financial Assets
Purchase
Indirect Financial Assets
Purchase
Direct Financial Assets
Issue
Direct Financial Assets
Issue

19.  What is Finance?
 Types of Finance definitions
› Lack of any specific definition
› Raising and spending funds
› Economic decisions with a time
component
› Micro/Macro: need for integration

20.  Finance is analytical.
 Finance is based on economic
principles.
 Finance uses accounting information as
an input for decision-making.
 Finance is international in perspective.
 Finance is constantly changing.
 Finance is the study of how to invest
and raise money productively
http://garnet.acns.fsu.edu/~ppeters/fin3403/

21.  Finance is the study of how people
allocate scarce resources over time
› costs and benefits are distributed over time
› but the actual timing and size of future
cash flows are often known only
probabilistically
 Understanding finance helps you
evaluate these uncertain cash flows
Bodie and Merton

22.  When implementing decisions, people
make use of the Financial System which
can be defined as the set of markets
and other institutions used for financial
contracting and exchange of assets
and risks
Bodie and Merton

23.  Financial theory consists of:
› the set of concepts that help to organize
one’s thinking about how to allocate
resources over time
› the set of quantitative models used to help
evaluate alternatives, make decisions, and
implement them
 These concepts and models apply at all
levels and scales of decision making
Bodie and Merton

24.  A basic tenet of finance is that the
existence of economic organizations
(e.g. firms and governments) facilitate
the satisfaction of people’s
consumption preferences
Bodie and Merton

25.  Finance Theory is the study of the behaviour
of individuals in the intertemporal allocation
(over time) of their resources in an uncertain
environment, and the study of the function
of economic institutions and markets in
making these allocations possible.
Economía Financiera
Marín, José M. / Rubio, Gonzalo
Antoni Bosch, Editor, Barcelona, 2001

26.  The practice of “finance” exists
for the creation of value
 Financial contracting brings
about the substitution of real
wealth (i.e. real business assets)
for financial wealth (i.e.
securities) Investing in financial securities has
better attributes that in real assets. Value is
created in tthe real assets held by businesses, and
then transmitted into the value of financial wealth
issued by businesses and held by investors.
Norton y Scott, “A new Paradigm: the value creation
function of finance”, january 2001

27. Finance is the process of transforming
existing assets into new, contractual
forms, as well as the analytical
techniques needed to support this
process, for the purpose of wealth
creation in modern, capitalistic
economies.
Norton y Scott, “A new Paradigm: the value creation
function of finance”, january 2001

28.  Financial management (Corporate finance)
deals with how firms raise and use funds to
make short-term and long-term investments.
 Investment deals with how the securities
markets work and how to evaluate and
manage investments in stocks and bonds.
 Financial Markets and Institutions includes the
study of the banking system and markets.
Peterson and Fabozzi

30. 1.1. Introduction
1.2. Defining finance
1.3. The Firm: a sistemic approach
1.4. Corporate Finance: the financial
function
1.5. The financial objective: value creation
1.6. Financial main principles
1.7. Finance: historic evolution
1.8. Main programmes in Finance

31. Subsistema de
recursos humanos
Subsistema de
dirección y gestión
Subsistema de
dirección y gestión
Subsistema
comercial
Subsistema de
operaciones
Dinero
Dinero
Personal
Personal
Bienes y servicios
Personal
Personal
Goods and
Services
Resourses Expenses Sales
Incomes
Subsistema de
recursos humanos
Human Resources
Subsystem
Subsistema de
dirección y gestión
Management
Subsystem
Subsistema de
dirección y gestión
Finance Subsystem
Commercial
Subsystem
Operations
Subsystem
Funds
Funds
Hum
an
resources
Hum
anresources
Goods and Services
Personnel
Human Resources
Resourses

32. FINANCIAL SUBSYTEM
Planificación FinancieraPlanificación Financiera
FINANCIACIÓN
Financiación
Externa
Autofinanciación
Beneficio
INVERSIÓN
Financiación en
activo fijo
Inversión en activo
circulante
Costes
Subsistema
de recursos
humanos
Subsistema
de
operaciones
Subsistema
comercial
Subsistema
de dirección
y gestión
Demanda de
créditos
Valores
Mercados
Financieros
Dividendos
Impuestos
E
N
T
O
R
N
O
Dinero
Recursos
Expenses
Resources
Amortización
Reservas
Planificación FinancieraPlanificación Financiera
FINANCIACIÓN
Financiación
Externa
Autofinanciación
Beneficio
INVERSIÓN
Financiación en
activo fijo
Inversión en activo
circulante
Costes
Subsistema
de recursos
humanos
Subsistema
de
operaciones
Subsistema
comercial
Subsistema
de dirección
y gestión
Demanda de
créditos
Valores
Mercados
Financieros
Dividendos
Impuestos
E
N
T
O
R
N
O
Dinero
Recursos
In
Amortización
Reservas
Planificación FinancieraFinancial Planning
FINANCIACIÓN
Financiación
Externa
Autofinanciación
FINANCING
External
Financing
Retained earnings
BeneficioBenefit
INVERSIÓN
Financiación en
activo fijo
Inversión en activo
circulante
Costes
INVERSIÓN
Financiación en
activo fijo
Inversión en activo
circulante
INVESTMENT
Fixed
Asset
Current
Assets
Costs
Subsistema
de recursos
humanos
Human
Recourses
Subsystem
Subsistema
de
operaciones
Operations
Subsystem
Subsistema
comercial
Commercial
Subsystem
Subsistema
de dirección
y gestión
Management
Subsytem
Demanda de
créditos
Valores
Mercados
Financieros
Dividendos
Impuestos
E
N
T
O
R
N
O
Debt
Securities
Financial
Market
Dividends
Taxes
E
N
V
I
R
O
N
M
E
N
T
Funds
Resources
Income
Empoloyees
Depreciation
Reserves

33. • Corporations face two broad financial questions:
- What investments should the firm make?
- How should it pay for those investments?
Financial managers are concerned with :
• Investment Decisions (use of funds):
– The buying, holding or selling of types of assets
• Financing Decisions (acquisitions of funds)

34. FINANCIAL
MANAGEMENT
(CORPORATE
FINANCE)
r ( r > k ) k
FINANCIAL SYSTEMREAL SYSTEM
INVESTMENT FINANCING
INVESTMENT / FINANCIAL SUBSYTEM
RETURN
REPAYMENT
AND RETURN
FINANCIAL
MARKETS
FIRM
OPERATIONS
(Real goods & services

35. • Goal of management: maximize the economic well-being, or
wealth, of the owners (current shareholders)
=> maximize the price of the stock
• Share price today = Present value of all future expected
dividends at required return
∑
∞
= 




+
=
1 1
.max.Pr..
i
i
i
k
d
iceShareMax

36. • Financial managers must create or generate value for their
shareholders.
• Economic Value Added (EVA) is a measure of a company's
financial performance based on the residual wealth calculated by
deducting cost of capital from its operating profit (adjusted for
taxes on a cash basis).
• The formula for calculating EVA is as follows:
EVA = Net Operating Profit After Taxes - (Capital * Cost of
Capital)

37. • Rational Financial behavior
• Risk aversion
• Budgetary diversification
• Existence of two parts in all financial transaction
• Measurement by cash flows
• Signaling and informative asymmetry
• Efficiency of financial markets
• Direct relation of risk and return
• Existence of valuable ideas
• Financial conduct initiative
• The Time Value of the money and value additivity.

38. Principles of century XX:
Beginning of the research in finance
EVENTS
Finance at the present
- Expansion of the Years 20
- The 29 Crises
- Economy military of the 40
- Expansion of the 50
- Crises of the petroleum of the 73

39. M
o
d
e
r
n
A
p
p
r
o
a
c
h
1900-
1950-
1970-
1980-
1990-
Classical Approach
APT Model
(Ross, 1970)
Options Valuation Models (Black y Scholes, 1973)
Portfolio selection Theory
(Markowitz, 1952,1959)
CAPM (widening and reformulation)
Dividends Policy (Modigliani, Miller, 1963)
Capital Assets Pricing Model
(CAPM) (Sharpe, 1963-4, Lintner,
1965)
Efficient
Market Theory
(Fama, 1970)
Financial Structure
(Modigliani, Miller, 1958)
Agency Theory
Information Theory
Financial Innovation
Methods based on Fuzzy Sets Theory
(Kaufmann y Gil, 1986-87)
Chaos Theory,
Non Linear Dynamics
Markets Efficiency
Paradigmyears70
Behavioral finance
2000-
Lecture 1: What is finance? (II)
1.10. Finance: historic evolution

40. • Managements of Investments- Capital Budgeting.
• Capital Structure and Dividend Policy.
• Market Efficiency.
• The Capital Asset Pricing Model.
• Options Theory
• Agency Theory
• Financial Planning
• Small Firms

41.  Kidwell, Peterson, Blackwell, Whidbee:
Financial Institutions, Markets, and Money,
Eighth Edition, John Wiley & Sons, 2003
 Fabozzi, Modigliani: Capital Markets.
Institutions and Instruments. Prentice Hall, 2003
 Bodie, Zvi and Merton, Robert C.: Finance.
Prentice Hall, 1999
 Pamela P. Peterson and Frank Fabozzi:
Financial Management and Analysis, 2nd
Edition, John Wiley & Sons, 2003