CHAPTER 1:

THE FINANCIAL ENVIRONMENT

LEARNING OUTCOMES

At the end of this chapter, you should be able to:

• define finance and financial management.
• describe the goal of a firm and the goal of a financial
manager.
• differentiate the alternatives form of business.
• explain the financial markets.
• explain the risk and return relationship.

INTRODUCTION TO FINANCE
• Finance can be defined as the art and science of
managing money or fund.
• Individual should manage well his money to
make sure that he will have sufficient money
whenever it is needed.
• For organization, managing money will be more
crucial since money is known as the important
factor which guaranteed the long-term survival
of an organization.
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• Finance is related to economics and accounting.

give an overview of have an effect on the

factors affecting the accounting data
environment which presented by an
will then accountant

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 AREAS IN FINANCE
Finance consists of three broad areas:
i. Financial Management
• Financial management is principally concerned
with making financial decisions that influence and
affect the worth of a firm.
• It relates to creation and sustenance of the
economic value or wealth of the firm.
• It focuses on the process of planning and
managing a firm’s long-term investment (capital
budgeting) and also the mixture of debt and
equity maintained by a firm (capital structure).
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• Financial management also can be defined as

the management of cash flows that runs
through a firm.
• A firm which unable to manage its cash flow
efficiently would end up with having
problems in:
meeting its short term obligations, and
financing its long term investment.

ii. Investment
• Investment is an asset or item that being
purchased with the hope that it will generate
income or appreciate in the future.

• Investment focuses on the decisions made by

both individual and institutional investor as
they choose securities for their investment.

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iii. Insurance and Risk Management
• Insurance is a contract (policy) in which an
individual or entity receives financial
protection or reimbursement against losses
from an insurance company.
• The insurance company pools clients' risks to
make payments more affordable for the
insured, while risk management is the process
of identification, analysis and either
acceptance or mitigation of uncertainty in
investment decision-making.

THE GOAL OF A FIRM AND THE

GOAL OF A FINANCIAL MANAGER
• The goal of a firm is to maximize shareholders’
wealth.
• Thus, the goal of a financial manager is always
the same with the goal of a firm that is to
maximize the wealth of shareholders.
• Financial managers must act in their
shareholders’ best interest by making decision
which will increase the value of the firm that is
translated by the increased in the firm’s share
price. 8

• Financial managers will also observe the firm’s

day to day operations and decide the best
methods of financing, investments and all
decisions that will affect the profits of the
firm.

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 FORMS OF BUSINESS
1) Sole Proprietorship
• Most common & simplest type of business.
• A business owned by a single individual.
• Owner maintains title to the firm’s assets.
• Owner has unlimited liability.

2) Partnership
• Similar to a sole proprietorship, except that
there are two or more owners.
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3) Company
• A business entity that legally functions
separate and apart from its owners.
• Owners’ liability is limited to the amount of
their investment in the firm.
• Owners hold common stock certificates, and
ownership can be transferred by selling the
certificates.

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FINANCIAL MARKET
• Financial market is a place in which financial
assets (i.e. securities, which can be defined as
documents that represent the right to receive
funds in the future, such as bonds, stock and
mutual funds) are traded. It may or may not
have a physical location.

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• It consists of organizations that are
responsible for the distribution of funds to
end user. Those organizations will collect
funds from the general public (saver) and
channel it to the user (borrower). They will
charged interest to the user and then
distribute a portion of it to the savers.

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THE CORPORATION AND

FINANCIAL MARKET

Corporation cash Investors

securities
reinvest
Secondary
markets
Cash flow dividends,
etc.

tax

Government
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TYPES OF FINANCIAL MARKET

1) Money Market
• Money market is a market in which short-term
securities (less than 1 year maturity) are
traded.
• Example: Common shares are traded in
money market.

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2) Capital Market
• Capital market is a market in which long-term
securities (more than 1 year maturity) are
traded.
• Example: Bonds are traded in capital market.

3) Primary Market
• Primary market is a market in which new
issues of a security are sold to initial buyers.
• Example: Initial Public Offering (IPO) are
traded in primary market.
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4) Secondary Market
• Secondary market is a market in which
previously issued securities are traded among
investors, without the involvement of the
issuing companies.
• Example: If you intends to buy Petronas stock,
you are dealing only with another investor
who owns shares in Petronas and willing to
sell his shares. Petronas is not directly
involved in the transaction.

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RISK AND RETURN RELATIONSHIP

1. Risk
• Risk can be defined as the degree of
uncertainty that thing will not happen as you
want/expected.
• Example: On your way to the class, you’ll face
a lot of risks that will either delay or stop you
from going to the class.
• In business, firms will face a lot of risk in trying
to make profits and to continue operation.
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2. Return
• Return is the reward/outcome or profit that
you get from your investment.
• Example: You invest in Public Mutual, so the
dividend that you get at the end of the year is
a return from your investment.

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Risk and Return Trade-Off

Risk and return have a positive relationship,

which means:
• the higher the risk you are willing to face, the
bigger the return you can expect, or
• the lower the risk you are willing to face, the
smaller the return you can expect.

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Required
rate of
return
Security Market
Line (SML)

9%

Risk-
free
6%

0 7% Risk 21

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Thank you

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