topic 1 â introduction to finance
TOPIC 1 – INTRODUCTION TO FINANCE Finance: the art of science & managing money. It involves the process, institutions, markets, and instruments involved in the transfer of money between individuals, businesses & governments. CAREER OPPORTUNITIES Financial services – design & delivery of advice & financial products Managerial finance – manage private/public, non/financial, non/profit financial affairs (budgeting, forecasting, cash management, credit admin, investment analysis, funds procurement) TYPES OF ORGANISATIONS 1. Sole proprietorship – unlimited liability, limited life 2. Partnerships – unlimited liability, limited life 3. Corporations – limited liability (not liable for company debts), unlimited life, largest capital Ltd companies – generally public companies whose shares may be listed on stock exchange & ownership is easily transferrable. There are figures of shareholder wealth, current share price to show quality of performance. Pty Ltd companies – private entities & shares can only be transferred privately & shareholder wealth is not readily measurable Parties in a corporation: Shareholders – true owners of a firm by virtue of their equity in the form of preference & ordinary shares. They earn return by (1) receiving dividends (periodic distribution of earnings) or (2) realising gains through increase in share price Individual investors – buy few shares to reach personal goals Institutional investors – investment professionals (banks, insurance companies, mutual & pension funds) that are paid to manage others’ money & trade many securities Board of directors – a group elected by the firm’s shareholders & having ultimate authority to guide corporate affairs & make general policy Managing director/CEO – manages day-‐to-‐day operations & carries out the board’s policies CFO – oversees financial planning, company strategic planning, control company cash flow head of Treasurer & Financial Controller CORPORATE FINANCE DECISIONS: 1. Investment decision – capital funds are employed productively & aimed to generate future cash flows for return 2. Financing decision – relates to proportion of equity & debt in the funding for capital markets 3. Dividend decision – the form that dividend returns are given to equity holders In getting cash (F), company wants to acquire real assets (I) to generate cash to shareholders (D). Owner wealth is aimed to be maximised in a business & is measured by the ‘market capitalisation’ of securities, eg. The total value of shares in a company ASX – Australian Securities Exchange: Operates Australia’s primary securities exchange, it is a company itself, facilitating trades between buyers & sellers in both secondary & primary market ASIC – Australian Securities & Investments Commission: Independent Commonwealth Government body that regulates Australia’s markets & financial services, enforcing company & financial services law to ensure market intergrity. ASIC prevent corporate crime & protect investors. News Corporation Traded on ASX 30 June 2010 SECURITY ASX STOCK CODE NO. ISSUED Class A common stock NWSLV Class B common stock NWS Total
1824.12 798.52
LAST SALE PRICE ($) 14.38 16.75
MARKET CAPITALISATION ($B) 26.23 13.38 39.61
Methods to increase the wealth of shareholders: Remuneration packages promote good decision-‐making by giving bonuses when the company’s value increases. The market for corporate control (takeover market/discipline of the capital market) involves corporate raiders purchasing the majority of shares in a poorly managed market & using their voting power to replace existing management Voting power of shareholders to sack management The principle-‐agent problem: the managers of a corporation (agents) have control over the shareholders’ funds (principle) & may not act in their best interest CORPORTATE GOVERNANCE: the system used to direct & control a corporation by defining rights & responsibilities of key corporate participants (shareholders, directors, managers) & rules & procedures for making decisions. 8 principles to ensure good governance policy include: 1. Lay solid foundations for management & oversight 2. Structure the board to add value 3. Promote ethical & responsible decision making 4. Safeguard integrity in financial reporting 5. Make timely & balanced disclosure 6. Respect the rights of shareholders 7. Recognise & manage risk 8. Remunerate fairly & responsibly 2 main issues that corporate governance does not cover: False disclosures in financial reporting & other info Undisclosed conflicts of interest between corporations & their analysts, auditors & lawyers OR between corporate directors, officers, shareholders Business ethics – standards of conduct or moral judgement, which help maintain a positive image & build shareholder confidence. Violations may include fraud, bribery, options backdating, creative accounting, etc. Agency problem – the likelihood that managers may place personal goals ahead of corporate goals & may not take risks. Market forces & agency costs act to prevent or minimise agency problems. Market forces: Major shareholders use voting power to replace management Threat of takeover by another firm that believes it can enhance firm’s value by restructuring Agency costs: costs that shareholders incur to minimise agency problems, eg. Costs to monitor management, prevent dishonest acts The most popular cost is for structure management compensation, which gives incentives to management to maximise wealth & attracts great managers. The two main compensation plans are: 1. Incentive plans – management compensation corresponds with share price, eg. Share options is the most popular – allows managers to purchase shares at the exercise price set at the time of the grant & encourages them to perform to increase share price 2. Performance plans – management compensation corresponds with earnings per share (EPS), growth in EPS & in other return ratios. Performance shares & cash bonuses are used for compensation when goals are met. Financial institution – an intermediary that channels the savings of individuals, businesses & governments into loans or investments (lend/invest money), eg. Banks, life insurance companies, superannuation & pension funds, fund managers Net suppliers – save more money than borrowing (individuals & households) Net demanders – borrow more money than they save (businesses, governments)
FINANCIAL REGULATORS IN AUSTRALIA – have rules, principles & standards for companies listed on the exchange to prevent deregulation Australian Prudential Regulation Authority (APRA) Australian Securities & Investments Commission (ASIC) Reserve Bank of Australia (RBA) The Australian Treasury Financial markets: forums where suppliers of funds & demanders of loans & investments can transact business directly (suppliers know where funds are being lent & invested unlike in financial institutions) Primary market (initial issue): where securities are initially invested – the only market where the issuer is directly involved in transaction! Secondary market (resale): where pre-‐owned securities (not new issues) are traded To raise money, firms may use: Private placement – the sale of a new security issue directly to investors, eg. Insurance companies or pension funds Public offering – non-‐exclusive sale of securities to general public MAIN FINANCIAL MARKETS: MONEY MARKET – transactions of short-‐term funds Official – dealers are backed by RBA to manage liquidity Unofficial – many financial institutions borrow & invest Most money market transactions are made in marketable securities – a short-‐term debt instrument, such as commercial paper & negotiable certificates issued by the government or financial institutions. Eg. Treasury notes Commonwealth bonds Commercial bills – short-‐term discount instrument issued to raise working funds Promissory notes – short-‐term discount security issued by debtors with a high credit rating (similar to bills, they are sold at a discount to provide income to investors, except don’t require another party’s acceptance to ensure their marketability) When a firm issues a money market instrument, they are demanding short-‐term funds AND when a firm purchases a money market instrument, they are suppling short-‐term funds. Individuals sell marketable securities in the money market to liquidate securities prior to maturity, not as issuers like business, governments or financial institutions. EUROCURRENCY MARKET – international equivalent of the domestic money market for short-‐term bank deposits denominated by convertible currencies, eg. Person deposits US Dollars in London bank Time deposits – bank promises to repay deposit with fixed interest by a certain date & is free to lend the money of different currency to others CAPITAL MARKET – transactions of long-‐term funds, such as security issues of the business & government. The key securities being traded are bonds & shares. Bond – long-‐term debt instrument used by business & government to raise large sums of money, generally from a diverse group of lenders Corporate bonds – pay interest every 6 months at a stated coupon interest rate, initial maturity of approx. 10 yrs, face value of $10 000 paid at maturity
TAX
Outcomes of the taxation system: 1. The provision of revenues to fund government expenditures 2. The achievement of socially desirable goals, eg. Low income pay less
3. Business incentives & economic stabilisation, eg. Tax reduced to spend money on IT which increases employment
Taxpayers in the Australian tax system: 1. Individuals income reported on personal income tax return, eg. Partnership & sole business owners 2. Companies reports income & business expenses & pays tax at company rates on net income (shareholders pay these rates on dividends) 3. Fiduciaries report net income on income tax return & paid by trust or individual, eg. trusts CALCULATION TAXABLE INCOME Taxable income = assessable income – allowable deductions Assessable income: receipts of the taxpayer that are taxable, such as dividends, salary, rent, interest & annuities (similar to total revenue of firm) Allowable deductions: expenses that are incurred gaining assessable income (similar to operating expenses, however may calculate expenses differently, eg. Lower depreciation rate) The income tax to be paid to the Australian government can then be calculated, based on 3 factors: The amount of taxable income calculated The type of taxpayer The income tax rate applicable for the type of taxpayer Marginal tax rates – rates applied to the next dollar of income, eg. Individual & company tax rates Average tax rate = tax payable/total amount tax is paid on x 100 Companies typically pay a fixed tax rate of 30% on income earned Individual taxpayer rates:
1824.12 798.52
LAST SALE PRICE ($) 14.38 16.75
MARKET CAPITALISATION ($B) 26.23 13.38 39.61
Methods to increase the wealth of shareholders: Remuneration packages promote good decision-‐making by giving bonuses when the company’s value increases. The market for corporate control (takeover market/discipline of the capital market) involves corporate raiders purchasing the majority of shares in a poorly managed market & using their voting power to replace existing management Voting power of shareholders to sack management The principle-‐agent problem: the managers of a corporation (agents) have control over the shareholders’ funds (principle) & may not act in their best interest CORPORTATE GOVERNANCE: the system used to direct & control a corporation by defining rights & responsibilities of key corporate participants (shareholders, directors, managers) & rules & procedures for making decisions. 8 principles to ensure good governance policy include: 1. Lay solid foundations for management & oversight 2. Structure the board to add value 3. Promote ethical & responsible decision making 4. Safeguard integrity in financial reporting 5. Make timely & balanced disclosure 6. Respect the rights of shareholders 7. Recognise & manage risk 8. Remunerate fairly & responsibly 2 main issues that corporate governance does not cover: False disclosures in financial reporting & other info Undisclosed conflicts of interest between corporations & their analysts, auditors & lawyers OR between corporate directors, officers, shareholders Business ethics – standards of conduct or moral judgement, which help maintain a positive image & build shareholder confidence. Violations may include fraud, bribery, options backdating, creative accounting, etc. Agency problem – the likelihood that managers may place personal goals ahead of corporate goals & may not take risks. Market forces & agency costs act to prevent or minimise agency problems. Market forces: Major shareholders use voting power to replace management Threat of takeover by another firm that believes it can enhance firm’s value by restructuring Agency costs: costs that shareholders incur to minimise agency problems, eg. Costs to monitor management, prevent dishonest acts The most popular cost is for structure management compensation, which gives incentives to management to maximise wealth & attracts great managers. The two main compensation plans are: 1. Incentive plans – management compensation corresponds with share price, eg. Share options is the most popular – allows managers to purchase shares at the exercise price set at the time of the grant & encourages them to perform to increase share price 2. Performance plans – management compensation corresponds with earnings per share (EPS), growth in EPS & in other return ratios. Performance shares & cash bonuses are used for compensation when goals are met. Financial institution – an intermediary that channels the savings of individuals, businesses & governments into loans or investments (lend/invest money), eg. Banks, life insurance companies, superannuation & pension funds, fund managers Net suppliers – save more money than borrowing (individuals & households) Net demanders – borrow more money than they save (businesses, governments)
FINANCIAL REGULATORS IN AUSTRALIA – have rules, principles & standards for companies listed on the exchange to prevent deregulation Australian Prudential Regulation Authority (APRA) Australian Securities & Investments Commission (ASIC) Reserve Bank of Australia (RBA) The Australian Treasury Financial markets: forums where suppliers of funds & demanders of loans & investments can transact business directly (suppliers know where funds are being lent & invested unlike in financial institutions) Primary market (initial issue): where securities are initially invested – the only market where the issuer is directly involved in transaction! Secondary market (resale): where pre-‐owned securities (not new issues) are traded To raise money, firms may use: Private placement – the sale of a new security issue directly to investors, eg. Insurance companies or pension funds Public offering – non-‐exclusive sale of securities to general public MAIN FINANCIAL MARKETS: MONEY MARKET – transactions of short-‐term funds Official – dealers are backed by RBA to manage liquidity Unofficial – many financial institutions borrow & invest Most money market transactions are made in marketable securities – a short-‐term debt instrument, such as commercial paper & negotiable certificates issued by the government or financial institutions. Eg. Treasury notes Commonwealth bonds Commercial bills – short-‐term discount instrument issued to raise working funds Promissory notes – short-‐term discount security issued by debtors with a high credit rating (similar to bills, they are sold at a discount to provide income to investors, except don’t require another party’s acceptance to ensure their marketability) When a firm issues a money market instrument, they are demanding short-‐term funds AND when a firm purchases a money market instrument, they are suppling short-‐term funds. Individuals sell marketable securities in the money market to liquidate securities prior to maturity, not as issuers like business, governments or financial institutions. EUROCURRENCY MARKET – international equivalent of the domestic money market for short-‐term bank deposits denominated by convertible currencies, eg. Person deposits US Dollars in London bank Time deposits – bank promises to repay deposit with fixed interest by a certain date & is free to lend the money of different currency to others CAPITAL MARKET – transactions of long-‐term funds, such as security issues of the business & government. The key securities being traded are bonds & shares. Bond – long-‐term debt instrument used by business & government to raise large sums of money, generally from a diverse group of lenders Corporate bonds – pay interest every 6 months at a stated coupon interest rate, initial maturity of approx. 10 yrs, face value of $10 000 paid at maturity
TAX
Outcomes of the taxation system: 1. The provision of revenues to fund government expenditures 2. The achievement of socially desirable goals, eg. Low income pay less
3. Business incentives & economic stabilisation, eg. Tax reduced to spend money on IT which increases employment
Taxpayers in the Australian tax system: 1. Individuals income reported on personal income tax return, eg. Partnership & sole business owners 2. Companies reports income & business expenses & pays tax at company rates on net income (shareholders pay these rates on dividends) 3. Fiduciaries report net income on income tax return & paid by trust or individual, eg. trusts CALCULATION TAXABLE INCOME Taxable income = assessable income – allowable deductions Assessable income: receipts of the taxpayer that are taxable, such as dividends, salary, rent, interest & annuities (similar to total revenue of firm) Allowable deductions: expenses that are incurred gaining assessable income (similar to operating expenses, however may calculate expenses differently, eg. Lower depreciation rate) The income tax to be paid to the Australian government can then be calculated, based on 3 factors: The amount of taxable income calculated The type of taxpayer The income tax rate applicable for the type of taxpayer Marginal tax rates – rates applied to the next dollar of income, eg. Individual & company tax rates Average tax rate = tax payable/total amount tax is paid on x 100 Companies typically pay a fixed tax rate of 30% on income earned Individual taxpayer rates:
