Ch1-Key Principles of Finance

Question 1

What is the aim of the financial reports?

Answer 1

~ help make decisions
~ they provide information about the financial position and the performance of an entity
~ high standards of reporting and audit promote investor confidence, enable the capital markets to operate efficiently and therefore help drive economic growth

Question 2

What are the principles of the code?

1. Board Leadership and company purpose

Answer 2

1. A successful company is led by an effective board, promoting the long-term sustainable success
2. The board must set the company’s purpose, values, and strategy
3. The board has to assess and manage risk with the framework of prudent and effective control
4. Ensure effective engagement with shareholders and its stakeholders
5. Ensure workforce policies and practices adhere to the company’s values and support

Question 3

What are the principles of the code?

2. Division of responsibilities

Answer 3

~ the principles set out the responsibilities of the chair

1. Effective contribution of all non-executive directors
2. Provision of accurate, timely, and clear information to the directors
3. no domination in the board’s decision making
4. non-executive directors having sufficient time to carry out their duties

Question 4

What are the principles of the code?

3. Composition, succession, and evaluation

Answer 4

1. rigorous procedures for board appointments, based on the merit and objective criteria
2. an effective succession plan for board and senior management
3. Promotion of diversity of gender and ethnic backgrounds
4. Formal and rigorous annual evaluation of the board’s effectiveness

Question 5

What are the principles of the code?

4. Audit, risk, and internal control

Answer 5

~ The board should present a fair, balanced, and understandable assessment of the company’s position and prospects.
~ The board needs to put in place appropriate formal and transparent policies to ensure the effectiveness of the internal and external audits.
~ The board has to assess the risks involved in achieving its long-term strategic objectives

Question 5

What are the principles of the code?

4. Audit, risk, and internal control

Answer 5

~ The board should present a fair, balanced, and understandable assessment of the company’s position and prospects.
~ The board needs to put in place appropriate formal and transparent policies to ensure the effectiveness of the internal and external audits.
~ The board has to assess the risks involved in achieving its long-term strategic objectives

Question 5

What are the principles of the code?

4. Audit, risk, and internal control

Answer 5

~ The board should present a fair, balanced, and understandable assessment of the company’s position and prospects.
~ The board needs to put in place appropriate formal and transparent policies to ensure the effectiveness of the internal and external audits.
~ The board has to assess the risks involved in achieving its long-term strategic objectives

Question 6

What are the principles of the code?

5. Remuneration

Answer 6

~ The board must not be involved in deciding their own remuneration.
~ The board must put in place a formal and transparent procedure to determine policy on the executive, director, and senior management remuneration.

Question 7

What are the 2 basic issues of finance?

What is the importance of capital budgeting?

Answer 7

1. Capital Budgeting decision
   ~what assets should the firm invest in?
   ~this is determined by the chief financial officer
   this is tied to the plans for product development, production, and marketing
2. Financing decision
   ~it is the responsibility of the treasurer who looks after the company’s cash- which includes raising new capital and maintaining the relationship with the banks, shareholders, and investors.

The importance is due to the complexity of the analysis involved and the cost of poor decisions
Progress in management depends on applying logic to experiences to known facts to enhance understanding
Financial analysis involves bringing together ideas from variety of disciplines

Question 8

The relationship between stakeholders

Answer 8

~Contractual theory specifies the roles of the various participants in the organization and defines their rights, obligations, and pay-offs under multiple conditions.

~most participants bargain fixed pay-offs, whereas the firm’s owners are liable for any residual risk
~there is a potential conflict between shareholders and its creditors
~ if the riskiness is altered, the shareholders will benefit greatly
~however, if the risky investments fail, it will reduce the security of debt-holders and lessen the debt values. The firm must pay high interest to compensate debt holders against the possible adverse policy change.

Question 9

The Capital market.
How does the stock market value a company?
What happens if the assets are not managed effectively?

Answer 9

~ The stock market serves as a performance monitor for publicly quoted companies. The share price is the market’s perception of the particular firm’s current and expected future performance.

~ this will be reflected in the share price since it will be lower. This will result in a takeover bid.

~ The markets determine the value of the firm’s securities. This provides the measures of the firm’s performance
~ Such assessments stimulate efficiency and provide incentives to business managers to improve their performance.

Question 10

What are the effects of the capital markets on a firm’s decision?

Answer 10

~ Sound investment decisions need an accurate measurement of the cost of capital.
~ Limits in the supply of capital lead to other methods of raising finance.
~ Mergers and takeovers create threats and opportunities to be exploited
~ Externalities require managers to determine the appropriate role of organisations

Question 11

The Maximisation of the shareholder wealth

Answer 11

~ The company’s objective is to maximise shareholder wealth within external constraints.
~ Managers are duty bound to act in the shareholders’ interests and to protect the investors

Question 12

What is Agency Theory?

Answer 12

~ The relationship between a principal and an agent, includes the nature of agency costa, conflicts of interest(and how to avoid them), and how the agents may be motivated and incentivised.

Question 13

What are the principle agent problems?

What are Agency costs?

Answer 13

~ if the interest of the owners and managers diverge, leads to principal-agent problems

~ the costs associated with monitoring the actions of others and seeking to influence their actions.

~ Managers may be motivated by the objectives that are different from the desires of the shareholders

Question 14

The Agency theory

Answer 14

~ The conflict may arise between providers of finance, notably lenders(banks), and the providers of the equity capital(shareholders)

~ Information asymmetries will exist between various classes of shareholders

Question 15

Determinants of value and manager actions

Answer 15

~ The value of an asset is the present value of its expected returns
~ To convert the stream of returns over the life of the security to a value of a security, they must be discounted at the required rate of return for the security.

The valuation requires
~ stream of expected returns
~ the required rate of return on the investment