FIN3403 ch1+2

Goal of the firm

to maximize shareholder wealth

Sole Proprietorship

a business owned by one individual; the owner is entitled to all profits and losses; no limit on liability

General partnership

two or more owners; each owner is fully responsible for liabilities

Limited partnership

one or more partners has limited liability (up to the amount of capital invested in the business)

Corporation

a business that functions separate and apart from its owners; all owners have limited liability

S-Corporation

corporation taxed as though it were a partnership with restrictions on shareholders

Limited Liability Company (LLC)

a cross between a partnership and a corporation under which owners retain limited liability but the company is taxed and run like a partnership

Public Offering

securities available to all individuals and investors

Private placement

securities are offered and sold directly to a limited number of investors

Primary market

the market in which new securities are originally sold to investors; the corporation receives money

Secondary market

investors buy and sell existing securities; corporation does not receive money

Money market

market for short term (less than 1 year) debt instruments; liquid; EX: Treasury bills, negotiable CDs, commercial paper

Capital market

market for long-term financial instruments. EX: Loans, stocks, bonds.

Spot market

market where goods are traded for immediate payment and delivery (cash market)

Futures market

market where you can buy or sell something at a future date; price, quantity, and date are already set

Organized security exchange

formal organization for buying and selling securities; EX: NYSE, AMEX, regional exchanges.

Over-the-counter market

all security markets with the exception; a network of brokers and dealers linked by computer; not as formal; EX: NASDAQ, where most corporate bonds are

NASDAQ

2nd largest stock exchange

Nominal rate of interest

interest rate paid on debt securities without an adjustment for any loss in purchasing power

Real risk-free interest rate

the required rate of return on a fixed-income security that has no risk in an economic environment of zero inflation

Real rate of interest

the nominal (quoted) rate of interest less any loss in purchasing power of the dollar during the time of the investment

Yield curve

a graph showing the relationship between bond yields and maturities; usually upward sloping; LT has a higher rate of return; can be inverted or flat

Unbiased expectations theory

the term structure is determined by expectations of future rates

Liquidity preference theory

the theory that investors demand a risk premium on long-term bonds

Market segmentation theory

separate markets for long term and short term investments

Fisher effect

the one-for-one adjustment of the nominal interest rate to the inflation rate

Fisher effect (formula)

(1+Krf)= (1+k*)+(1+IRP)

Fisher effect (conceptual)

Nominal risk-free interest rate= Real risk-free interest rate + Inflation risk premium

Treasury Bills/Bonds

risk free securities; issued by federal government; bill is <1yr anf bond is >1yr

Municipal bonds

issued by local or state government; not risk-free; exempt from federal income taxes

Risk and Return

The higher the risk, the higher the potential return of any money you invest. The lower the risk, the lower the potential return.

Preferred stock

shoes on balance sheet as equity; higher dividend; gets money back before common stock but after a bond holder