Unit 1: Introduction to Finance & Corporate Finance

Corporate Finance

Corporate Finance is a branch of finance that deals with how companies manage their money, make investments, and raise capital (funds). It helps businesses make decisions that maximize their value.

Scope of Corporate Finance

Capital Budgeting: Deciding which long-term projects or investments a company should take (e.g., buying new machinery or expanding to a new location).
Capital Structure: Deciding the right mix of debt (loans) and equity (shares) to fund operations.
Working Capital Management: Managing daily financial operations like cash, inventory, and accounts receivable/payable.
Dividend Policy: Deciding how much profit to keep in the business and how much to distribute to shareholders as dividends.

Corporate finance focuses on financial decisions made by businesses to maximize shareholder value. Its scope includes all financial activities that help a company manage its funds effectively.

Key Areas Covered Under the Scope

Corporate Governance and Agency Problem

Corporate Governance refers to the system of rules, practices, and processes by which a company is directed and controlled. It ensures that the company is managed in a way that is ethical, transparent, and accountable to its stakeholders (shareholders, employees, customers, etc.).

🎯 Objectives of Corporate Governance

Protect the interests of shareholders and other stakeholders.
Promote transparency and accountability in decision-making.
Improve management performance and company reputation.
Prevent fraud, corruption, and misuse of company resources.

👥 Key Participants in Corporate Governance

Principles of Good Corporate Governance

Importance of Corporate Governance

Builds investor confidence and attracts capital.
Enhances company value and long-term sustainability.
Reduces chances of fraud, corruption, and management abuse.
Helps in legal compliance and managing risk.

Agency Problem

It arises when there is a conflict of interest between the owners (shareholders) and managers (agents) of the company. Example: Managers may take decisions that benefit themselves (like luxury trips) but are not in the best interest of the shareholders.

The Agency Problem arises when there is a conflict of interest between the owner (principal) and the person managing the business (agent).
In a company, shareholders are the principals (they own the company).
Managers or executives are the agents (they run the company on behalf of the shareholders).

Solution: Corporate governance mechanisms like board of directors, performance-based compensation, audits, etc.

What Causes the Agency Problem?

Managers may pursue personal goals (like job security, perks, bonuses) rather than maximizing shareholder wealth.
Shareholders want profitability, growth, and returns.
But managers may not always act in the best interest of the owners, especially when their performance isn’t monitored closely.

Types of Agency Problems

How to Reduce the Agency Problem

Finance & Corporate Strategy

Corporate Strategy is the overall plan that defines a company's long-term vision, goals, and the path to achieve them & Finance plays a critical role in supporting and enabling corporate strategy by ensuring that financial resources are used efficiently to maximize value and achieve business objectives.

Ensuring funds are available to support business plans.
Helping choose the most profitable projects.
Managing financial risks.
Ensuring shareholder value is maximized.
Finance and strategy work hand in hand — a good financial plan ensures the business strategy is practical and sustainable.

Relationship Between Finance and Corporate Strategy

How Finance Supports Corporate Strategy

Time Value of Money (TVM)

TVM is a fundamental finance concept that says “money today is worth more than the same amount in the future” because it can earn interest or be invested.

Key Concepts:

Present Value (PV): What future money is worth today.
Future Value (FV): What money today will be worth in the future.
Discounting: Converting future money to present value.
Compounding: Growing today’s money into future value.

Key TVM Concepts and Formulas

1. Future Value (FV): It tells you how much your money will grow in the future when invested.

Formula:

PV = Present Value

r = Interest rate per period

n = Number of periods

Example: You invest ₹1,000 at 10% for 2 years

2. Present Value (PV): It tells you how much a future amount is worth today.

Formula:

Example: You’ll get ₹1,210 in 2 years. If interest is 10%,

3. Annuity: An annuity is a series of equal payments made at regular intervals (e.g., EMIs, pension payments).

Future Value of Annuity (FVA):

Present Value of Annuity (PVA):

Where: P = Payment per period

4. Compounding: Earning interest on both the principal and interest already earned.

Annual Compounding
Quarterly or Monthly Compounding (more frequent compounding = more returns)

5. Discounting: The reverse of compounding — bringing future money to present value.

Example: ₹100 today is more valuable than ₹100 a year from now because if you invest it at 10% interest, you will have ₹110 in a year.

Real-Life Applications of TVM

Risk and Return

This concept explains the relationship between the potential risk of an investment and the expected return.

Risk is the possibility that the actual return on an investment will be different from the expected return, including the chance of losing some or all of the original investment.
Return is the gain or loss made on an investment over a period.

📌 Key Idea

Higher the risk, higher the potential return — but also higher chances of loss.

🎯 Why Is Risk & Return Important?

Helps investors and businesses make informed decisions.
Allows comparison between safe vs. risky investments.
Forms the base of portfolio management, capital budgeting, and stock market investment.

Types of Risks

Types of Return

Formula for Return (Simple)

Relationship Between Risk and Return

Tools to Measure Risk

Tools to Measure Risk and Return

Standard Deviation: Measures risk (how much returns fluctuate).
Beta: Measures sensitivity of a stock to market movements.
Expected Return: Weighted average of possible returns.

Types of Financial Market

Financial Market is a marketplace where financial instruments like shares, bonds, currencies, etc., are traded. It helps in the flow of funds from investors (savers) to borrowers (businesses/governments).

Types of Financial Markets

Capital Market Components

Primary Market: New securities are issued (IPO – Initial Public Offering).
Secondary Market: Existing securities are traded (Stock Exchange like NSE, BSE).

Factors Affecting Financial Markets

Financial markets are dynamic and are affected by various internal and external factors:

Linkages between Economy & Financial Markets

There is a strong interdependence between the economy and financial markets:

How the Economy Affects Financial Markets:

When GDP grows, companies earn more → stock prices rise.
Higher inflation leads to interest rate hikes → bond prices fall.
Unemployment rises → reduces spending → negative for markets.

How Financial Markets Affect the Economy:

Strong markets increase investor wealth → boosts spending and investment.
Companies raise capital from markets → expand business → economic growth.
Financial market crashes can lead to economic slowdown (e.g., 2008 crisis).

In simple terms, financial markets reflect the health of the economy, and the economy influences market performance.

Integration of Indian Financial Markets with Global Financial Markets

Global Financial Integration means India’s markets are now connected with global markets — any event in the US, Europe, or China can affect Indian stock prices, currency, and economy.

Key Features of Integration:

Foreign Institutional Investors (FIIs): Invest in Indian stocks/bonds — bringing global capital.
Globalization of Trade: Indian companies export/import — linked to global demand and prices.
Currency Movements: INR is affected by USD/Euro trends, oil prices, and global policies.
International Listings: Indian companies list abroad (e.g., ADRs in US).
Global Policy Impact: US Fed decisions on interest rates impact Indian market liquidity and prices.

Benefits

More capital inflow.
Better liquidity and price discovery.
Diversification opportunities for investors.

Risks:

Exposure to global shocks (recession, war, inflation).
Sudden outflows of foreign capital.