10 Axioms

Ten Axioms/Principles of Basic Financial Management • The Risk-Return Trade-off - We Won’t Take on Additional Risk Unless We Expect to Be Compensated with Additional Return. • The Time Value of Money - A Dollar Required Today is Worth More Than A Dollar Received in the Future • Cash - Not Profit - Is King • Consider Incremental Cash Flows - It’s Only What Changes that Counts • The Curse of Competitive Markets - Why Its Hard to Find Exceptionally Profitable Projects Key: Invest in Markets That Are Not Perfectly Competitive How? 1. Differentiate your product. 2. Achieve a cost advantage over competitors.

Ten Axioms/Principles of Basic Financial Management • Efficient Capital Markets - The Markets Are Quick and The Prices Are Right - Efficient Market - market in which the values of all assets and securities at any instant in time fully reflect all available public information. The market price of a security is a consensus among market players. - Characteristics: 1. Security prices should reflect all available public information about the economy, about financial markets and about the specific co. involved. 2. Market prices of individual securities adjust very rapidly to new information which can result in a change in the “intrinsic” value of a security but subsequent security price movements will follow what is known as “random walk”.

Ten Axioms/Principles of Basic Financial Management

- Characteristics of Efficient Capital Market (Cont’d): 3. One simply cannot use past security prices to predict future prices in such a way as to profit on average. 4. Unanticipated portion of return (expected return actual return) earned on a security is unpredictable and does not systematically differ from zero over a sufficient no. of observations. It is also not correlated to any information be it publicly available or insider. 5. There is sufficiently large number of market participants who in their attempts to earn profits promptly receive and analyze all information that is publicly available concerning companies whose securities they follow.

Ten Axioms/Principles of Basic Financial Management • The Agency Problem - Managers Won’t Work for the Owners Unless Its in Their Best Interest • Taxes Bias Business Decisions • All Risk is Not Equal - Some Risk Can Be Diversified Away and Some Cannot Diversification - allows good and bad events or observations to cancel each other out thereby reducing total variability without affecting expected return.

Ten Axioms/Principles of Basic Financial Management Two Types of Risk: 1. Systematic/Market/Unavoidable Risks. Ex: changes in nation’s economy, tax reform by Congress. These are risk that affect securities overall and consequently, cannot be diversified away. 2. Unsystematic/Diversifiable/Avoidable Risks. Ex: wildcat stirke, entry of new competitor, technological breakthrough that make product obsolete. These risks are unique to a particular company, being independent of economic, political and other factors that affect securities in a systematic manner.

• Ethical Behavior is Doing the Right Thing and Ethical Dilemmas are Everywhere in Finance

Financial Institutions: •Commercial Banks •Mutual Savings Bank •Savings and Loan Associations •Pension Funds •Life Insurance Cos. •Investment Banking Houses (or Brokerage Houses)

Financial Markets: •Money Markets •Capital Markets

Suppliers and Users of Funds: •Individuals •Businesses •Governments

Financial Markets - place where entities demanding funds are brought together with those having surplus funds. Money Markets - market for short-term (< 1 yr.) debt securities. Capital Markets - market for long-term debt and corporate stocks.