FINANCIAL

MANAGEMENT

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 TABLE OF CONTENTS
Introduction 3-7
Risk & Return 8-11

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 you invest with that insurance
FINANCIAL MANAGEMENT “2-in-1”)
o Brokerage Firms: stocks
Topic: Introduction
 Job Opportunities
Basic Areas of Finance o Broker
o Branch Manager
1. Corporate Finance: Finance in large
corporations (Treasury Department) o Insurance Advisor
2. Investments: Banking Institutions, International Finance
Insurance
 This is an area of specializations
3. Financial Institutions: Banking
Institutions within each of the areas discussed
4. International Finance so far.
 It may allow you to work in other
Investments countries or at least travel on a
regular basis.
 Work with financial assets such as o Example: If a Filipino CPA
stocks and bonds (Important for this decided to enter the field of
to generate HIGH returns) International Finance, they
o You can invest directly (BDO can be an ASEAN Certified
Nomura) or indirectly (banks) Public Accountant wherein
 Value of financial assets, risk versus they can adopt the
return, and asset allocation International Finance
 Job opportunities because of the ASEAN
o Stockbroker or financial integration.
advisor  Need to be familiar with exchange
o Portfolio manager rates and political risk
o Security analyst  Need to understand the customs of
other countries; speaking a foreign
Financial Institutions language fluently also helps.

 Companies that specialize in Why Study Finance?

financial matters
o Banks: commercial and  Marketing
investment, credit unions, o Budgets, marketing research,
savings and loans marketing financial products
o Insurance Companies:  Accounting
insurance innovations such o Dual accounting and finance
Variable Universal Life function, preparation of
Insurance or VUL (wherein financial statements
 Management

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 o Strategic thinking, job  Capital Structure
performance, profitability o How should we pay for our
 Personal Finance assets?
o Budgeting, retirement o Should we use debt or
planning, college planning, equity?
day-to-day cash flow issues  Working Capital Management
o How do we manage the day-
Business Finance to-day finances of the firm?
Forms of Business Organization
 Important questions answered by
finance:  Sole Proprietorship (under DTI)
o What long term investments  Partnership (under SEC)
should the firm take on? o General
o Where will we get the long
o Limited
term financing to pay for the
 Corporation (mandated by law)
investments?
 Cooperative
o How will we manage the
everyday financial activities Goal of Financial Management
of the firm?
1. Maximize profit
Financial Manager 2. Minimize cost
3. Maximize market share
 They try to answer some, or all, of
4. Maximize the current value of the
the questions presented above.
company’s stock
 Chief Financial Officer (CFO): the
top financial manager within a firm Sarbanes-Oxley Act
 Under the CFO are the ff.:
o Treasurer: oversees cash  Purpose: to protect investors,
management, credit employees, and the public from
management, capital fraudulent financial reporting by
expenditures, and financial corporations.
planning  Passed in the year 2002
o Controller: oversees taxes,  Key provision: disclosure
cost accounting, financial
accounting, and data The Agency Problem
processing
o Accountant  Agency relationship
o Principal hires an agent to
Financial Management Decisions represent its interest
o Stockholders (principal) hire
 Capital Budgeting managers (agent) to run the
o What long term investments company
or projects should the  Agency problem
business take on?

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 o Conflict of interest between  Financial Institutions (Banks,
principal and agent Insurance Companies)
 Management goals and agency cost  Price discovery mechanism
 Reduces cost of information and
Managing Managers research
 Structures:
 Managerial compensation
o Capital Market: where long
o Incentives can be used to
term capital funds in debt and
align management and
equity are transacted
stockholders interest
o Money Market: where short
o The incentives need to be
term capital is obtained
structured carefully to make
 Specific Classifications:
sure that they achieve their
o Debt/Bond market (Domestic
goals
& Foreign)
 Corporate control
o Equities market
o The threat of takeover may
o Futures market (part of
result in better management
derivatives)
 Other stakeholders
o Forwards market (part of
Financial Management in a Nutshell derivatives)
o Options market
 What is the cost and benefit of  Major Players:
operating, investing, and financial o Institutional players and
management decisions? Statement investors
of Cash Flow o Investment banker and
 What are the risks and returns underwriters
associated with these management o Banks and Insurance
decisions? companies
o Fund managers
Understanding Financial Markets
 In summary,
 What is the financial market?
 What are the structures of the
market?
 What are its functions?
 What are the determinants of
financial market conditions?

Financial Market

 Venue for financial exchange

between suppliers of capital and
users of capital. Users may be
suppliers and suppliers may be user  Determinants of Market
of capital. Condition:

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 o Environmental Factors: o Types of financial
political/regulatory, products
economic, social, o Price and valuation
technological,
environment, legal Financial Models and Frameworks
(PESTEL Analysis, more
on external)  IPO Model
o Industry factors: rivalry o Emphasis on the Corporate
among firms, threat of Value which is the
new entrants, threat of Stakeholders.
substitutes, bargaining o Corporate Value (or Firm
power of the buyers, and Value Creation): tangible and
bargaining power of the intangible objects to create
suppliers (Porter’s 5 value. (due care)
Forces)
 External Factors that Affects
Financial Markets:
o Global Issues
 Geopolitics
o International finance &
trade
 Capital and fund
transfers
 International trade
o Government intervention
 Government fiscal  Functional Chart Model
policy  Intermediation Model
 Taxation
 Gov’t.
spending
 Government
monetary policy
 Interest
 ForEx
 Inflation
 Impact of Factors on Financial
Market
o Risks
o Returns and cash flow  CAM Model
o Liquidity
o Cost of financing
o Access to financing

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Financial Management Objectives

Corporate Value

 Components of Goodwill
o Brand equity
o Future earning potential
o Market dominance
o Location
o Track record
o Organizational capital
o Human/intellectual capital

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Topic: Risk & Return Total Risk = Unsystematic Risk +
Systematic Risk
Purpose of IPO
1. Unsystematic Risk (Diversifiable, Firm-
 To increase funds/capital specific)
 To increase market shares/stocks
 An entity's president died
Time Value of Money  Strike by employees
 Low cost competitor enters the
 Your money today is not equal to market
your money in the next years.  Oil is discovered on a firm’s property
 Why is money decreasing?
o Inflation 2. Systematic Risk
 Factors to Consider:
 Oil producing countries institute
o Risk
boycott
o Return
 Congress votes for massive tax cut
Under What Conditions Are Investments  Restrictive monetary policy
Decisions Made  Precipitous rise in interest rates

1. Conditions of Certainty What are the Types of Risk Associated with

Investments?
Example:
1. Price Risk: Value of an asset will decline
Jollibee increases the price of their in the future
stocks because they buy their
competitors. 2. Credit Risk: Inability to make timely
principal payments and interest
2. Conditions of Uncertainty
3. Market Risk: Adverse economic
Example: conditions
Internal - Converge is a new 4. Cash Flow Risk: Cash flow inadequacy to
company which implies that return is meet obligations
unpredictable compared to PLDT,
which is already established. 5. Inflation: Decline in real return due to
purchasing power risk
External - Because of COVID-19,
stocks are decreasing. 6. Foreign Exchange: Value change due to
foreign exchange fluctuations
Risk
7. Reinvestment Risk: Future investments
 Hazard, peril will earn lower return
 Exposure to loss or injury
8. Call Risk: Instruments are callable thus
How is Total Risk Defined? exposing investors to uncertainty and
reinvestment risks

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9. Liquidity Risk: Marketability of the assets  Expected Rate of Return: the
weighted average of possible returns
from a given investments, weights
Attitudes Associated With Risk being probabilities. Mathematically:

1. Desire for Risk r = En ri pi

2. Indifference to Risk Where: ri = ith possible return

pi = probability of the ith
3. Aversion to Risk return
n = number of possible return
In terms of risk, there is an effect of the
diminishing marginal utility of wealth.  Measuring Risk: The Standard
*Note: This implies that “if you Deviation
acquire something, you are not contented o Measured the dispersion of the
with it, so you want more.” probability distribution.
o Commonly used to measure risk
Markowitz Two Parameter Model o LOWER Standard Deviation =
TIGHTER probability distribution,
 It assumes that there are only two
LOWER risk of investment
parameters that investors consider
o To calculate,
in making decisions both for single
asset or portfolio assets:
o the expected return
o the variance from expected
return which measures the
risk
 In terms of conservatism, you have
to invest in portfolio assets.
 It also posits the risk-aversion
principle HIGH RETURN-HIGH RISK
How Risk is measured in Two Asset
PAYOFF.
Portfolio
How can this be used for Investment
Decisions?

 Deciding between single assets on a Where: COV (RiRj) = covariance

mutually exclusive basis between return for assets i&j
 Deciding a portfolio investment
 Covariance: degree to which the
Probability return on two assets vary or change
together
 To evaluate the risk  Correlation: covariance of two
assets divided by the product of their
How Risk is measured in Single Asset standard deviations
Decision

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 o Positive Correlation: denotes  Portfolio Diversification: construction
perfect co-movement in the of portfolio in such a way as to
same direction reduce to portfolio risk without
o Negative Correlation: sacrificing return.
denotes perfect co-  Expected Return on a Portfolio: the
movement in the opposite weighted average return of the
direction individual assets in the portfolio
 Mathematically,
Coefficient of Variance
rp = w1r1 + w2r2 +…+ wnrn
 Use when comparing securities that
have different expected returns Where: r = expected return on each
 Computed by dividing the Standard individual asset
Deviation for a security by Expected w = fraction for each
Value respective asset investment
 The HIGHER the Coefficient, the n = number of assets in the
HIGHER the risk of the security. portfolio

Difference Between Standard Deviation and Strategies Related to Diversification

Coefficient Variance
1. Naive Diversification
 Simply invests in a number of
stocks or assets type and hopes
that the variance of the expected
return on the portfolio is lowered.
2. Markowitz Diversification
 Concerned with degree of
covariance between asset return
in a portfolio
 Combine assets with returns that
are less than perfectly positively
correlated in an effort to lower
portfolio risk without sacrificing
Portfolio Risk & Capital Asset Pricing Model return.

 Most financial assets are no held in Other Ways to Minimize Risk

isolation; rather, they are held as
parts of PORTFOLIOS.  Sensitivity analysis
 Therefore, risk-return analysis  Range determination
should not be confined to single  Insurance
assets only.  Hedging
 Important to look at portfolios and  Forward covers & contracts
the gains from DIVERSIFICATION.  Derivatives Management
 What's important is the return on the
Capital Asset Pricing Model
portfolio, and not only on one asset.

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  Security consists of two components  This equation shows that the
o Diversifiable required (expected) rate of return on
o Non-diversifiable a given security is equal to the return
 Diversifiable (Controllable or required for securities that have no
Unsystematic Risk) risk plus a risk premium required by
o internal and can be controlled investors for assuming a given level
through diversification of risk.
o the type of risk is unique to a  Relates the risk measured by BETA
given security to the level of expected or required
o Example: Business Liquidity, rate of return on a security.
death of CEO  HIGHER Beta, HIGHER risk,
 Non-Diversifiable (Non-controllable HIGHER return
or Systematic Risk)  Focuses on Non-diversifiable Risk
o Results from forces outside (Uncontrollable or Systematic Risk)
of a firm’s control because it is unpredictable.
o Not unique to a given
security
o Example: Purchasing Power,
interest rate
o Assessed relative to the risk
of a diversified portfolio of
securities or the MARKET
PORTFOLIO
o Measure by BETA coefficient
 This model is also called as the
Security Market Line
 Mathematically,

rj = rf + [β(rm – rf)]

Where: rj = expected (or required)

return on security j
rf = the risk-free security
(such as T-Bill)
rm = expected return on the
market portfolio
β = beta, an index of non
diversifiable (noncontrollable,
systematic risk)
*Note: Beta (β) is a measure of the
security’s volatility/ instability/
unpredictability relative to that of an average
security.

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