There are many similarities between project analysis and investment analysis. For example, both rely on estimating future cash flows and discounting these future cash flows to the present. However, there are also many differences between these two types of analysis. Therefore, specific tools are needed in financial asset investment analysis that are not needed in project analysis.

     Corporate finance typically covers issues such as project analysis capital structure, capital budgeting, and working capital management. Project analysis is concerned with determining whether a project should be undertaken; for example, whether a new warehouse should be built. Capital structure addresses the question of what type of long-term financing is best. Capital budgeting addresses the question of what long-term investments to undertake. Working capital management addresses how to manage a firm’s day-to-day cash flow. Corporate finance is also concerned with how to allocate profits. Profits are divided among the government (through taxes), shareholders (through dividends), and the firm itself (through retained earnings).

    Firms raise money by issuing stocks and bonds. These securities are subsequently traded in the financial market, where they are bought and sold by investors. Thus, both investors and the firm have an interest in the workings of financial markets. Corporate finance involves the interaction between firms and financial market, whereas the field of investments addresses the interaction between investors and financial markets. Investors bring to the financial market a set of objectives (for example, to earn, on average, a 12% return) and constraints (for example, to strive to preserve original capital in down markets).

    Investment is the use of financial capital in an effort to create more financial capital in the future. That is, an investor forgoes consumption today in an attempt to achieve an even higher level of consumption in the future. Investment in the money market (securities with maturities of less than 1 year) can be distinguished from investment in the capital market (securities with maturities greater than 1 year). Generally, investment in the money market is less risky than investment in the capital market because of the relatively short maturities of these securities. One exception is the case of derivative securities, such as put and call options. The examples of the securities in each of three market categories are as follows.

Money market securities

Treasury Bills

Commercial paper

Negotiable certificates of deposit

Eurodollars

Banker’s acceptances

Repurchase agreements

Capital market securities

Fixed-income securities : Debt instruments issued by the U.S. Treasury, federal agencies (e.g., Fannie Mae), municipalities and comporations

Equity securities : Common stock and preferred stock

Derivative market securities

Options

Futures contracts

    Investment also refers to a vehicle used to make more money. Some investments are speculative, meaning they involve a high degree of risk. However, many investors in speculative vehicles undertake strategies to hedge against the risk of a major loss. Hedging is a technique used to limit loss potential. Risk reduction can also be achieved by holding a portfolio of assets. A portfolio is a group of securities that are held together in an effort to achieve some future consumption (or rate of return) and risk desire.

    The primary focus of this book is on the relationship between financial markets and investors. Hence, issues related to corporate finance will be addressed only to the extent that they influence prices and perceptions of riskiness in financial markets. The basic formulas employed in both areas – corporate finance and investments – are covered. In fact, some of the same techniques used to evaluate assets in project analysis are used in financial assets analysis.