Although each form of organization offers advantages and disadvantages, corpo-
rations conduct most business in the United States because this organiza-
tional form maximizes larger firms’ values.
The primary objective of management should be to maximize stockholders’
wealth, and this means maximizing the stock price. Legal actions that maximize
stock prices usually increase social welfare.
Firms increase cash flows by creating value for customers, suppliers, and em-
ployees.
Three factors determine cash flows: (1) sales, (2) after-tax operating profit mar-
gins, and (3) capital requirements.
The price of a firm’s stock depends on the size of the firm’s cash flows, the
timing of those flows, and their risk. The size and risk of the cash flows are af-
fected by the financial environment as well as the investment, financing, and
dividend policy decisions made by financial managers.
There are many different types of financial markets.Each market serves a differ-
ent region or deals with a different type of security.
Physical asset markets,also called tangible or real asset markets, are those for
such products as wheat, autos, and real estate.
Financial asset marketsdeal with stocks, bonds, notes, mortgages, and other
claims on real assets.
Spot marketsand futures marketsare terms that refer to whether the assets are
bought or sold for “on-the-spot” delivery or for delivery at some future date.
Money marketsare the markets for debt securities with maturities of less than
one year.
Capital marketsare the markets for long-term debt and corporate stocks.
Primary marketsare the markets in which corporations raise new capital.
Secondary marketsare markets in which existing, already outstanding, securities
are traded among investors.
A derivativeis a security whose value is derived from the price of some other “un-
derlying” asset.
Transfers of capital between borrowers and savers take place (1) by direct trans-
fersof money and securities; (2) by transfers through investment banking
houses,which act as middlemen; and (3) by transfers through financial interme-
diaries,which create new securities.
The major intermediaries include commercial banks, savings and loan associa-
tions, mutual savings banks, credit unions, pension funds, life insurance
companies,and mutual funds.
One result of ongoing regulatory changes has been a blurring of the distinctions
between the different financial institutions. The trend in the United States has
been toward financial service corporationsthat offer a wide range of financial
services, including investment banking, brokerage operations, insurance, and com-
mercial banking.
The stock marketis an especially important market because this is where stock
prices (which are used to “grade” managers’ performances) are established.
There are two basic types of stock markets—the physical location exchanges
(such as NYSE) and computer/telephone networks(such as Nasdaq).
Orders from buyers and sellers can be matched in one of three ways: (1) in an open
outcry auction;(2) through dealers; and (3) automatically through an electronic
communications network (ECN).
Capital is allocated through the price system—a price must be paid to “rent”
money. Lenders charge intereston funds they lend, while equity investors receive
dividends and capital gainsin return for letting firms use their money.
48 CHAPTER 1 An Overview of Corporate Finance and the Financial Environment
46 An Overview of Corporate Finance and the Financial Environment
