Fundamentals of Finance - Lecture 1: The Corporation and Financial Markets

Comprehensive vocabulary flash

Finance

Financial measures for planning, managing, and controlling cash flows within a firm.

Financing Decisions

The financial management task of raising funds through equity from owners or debt through loans and bonds.

Investment Decisions

The financial management task of weighing the costs and benefits of projects to allocate shareholders' capital toward uses that add value to the firm.

Cash Management

The management of working capital to ensure that a firm maintains sufficient cash to meet its day-to-day obligations.

Cash Flow

A movement of money into (inflow) or out of (outflow) a firm, which is conceptually distinct from accounting profit.

Sole Proprietorship (Einzelkaufmann/-frau)

A business form owned by exactly one person, characterized by no minimum capital requirement, full management authority by the owner, and unlimited personal liability.

Partnership (Offene Handelsgesellschaft / OHG)

A commercial partnership requiring at least two owners, having no minimum capital requirement, managed by the partners, where all partners face unlimited personal liability.

Limited Partnership (Kommanditgesellschaft / KG)

A partnership form requiring at least two owners with no minimum capital requirement, consisting of managing general partners with unlimited personal liability and non-managing limited partners with limited liability.

General Partner (Komplementär)

A partner in a limited partnership who holds management authority and bears unlimited personal liability for the firm's obligations.

Limited Partner (Kommanditist)

A partner in a limited partnership whose liability is strictly limited to their capital contribution and who does not exercise day-to-day management authority.

Limited Liability Company (LLC / GmbH)

A corporate entity requiring at least one owner and a minimum capital of $\text{EUR } 25,000$, managed by a managing director (Geschäftsführer), where owners have limited liability and equity lacks an organized secondary market.

Stock Company (Aktiengesellschaft / AG)

A corporate legal form requiring at least one owner and a minimum capital of $\text{EUR } 50,000$, governed by a management board and supervisory board, offering limited liability, and providing an organized secondary market if listed.

Societas Europaea (SE)

A European stock company requiring at least one owner and a minimum capital of $\text{EUR } 120,000$, offering limited liability and allowing either a monistic or dualistic governance system.

Unlimited Personal Liability

A legal condition in which an owner or partner is personally liable for all debts and obligations of the firm beyond the capital initially contributed.

Limited Liability

A legal protection where owners or shareholders are not personally liable for the firm's debts, restricting their financial downside to the amount of capital contributed.

Management Board (Vorstand)

The executive body in a stock company (AG) holding ultimate decision-making authority in running the corporation's operations.

Supervisory Board (Aufsichtsrat)

The oversight body in a stock company (AG), elected by shareholders at the general assembly, responsible for appointing, dismissing, and compensating the management board, as well as overseeing corporate auditing.

Dualistic Governance System

A two-tier corporate governance structure that strictly separates corporate management (Management Board) from corporate oversight (Supervisory Board).

Monistic Governance System

A single-tier corporate governance structure where both management and supervisory responsibilities are unified under a single Board of Directors.

Equity

Financing supplied by owners that represents residual ownership, generally carries voting rights, has no fixed maturity or repayment schedule, and ranks last in insolvency.

Debt

Financing supplied by creditors that represents a fixed contractual claim for interest and principal repayment, carries a defined maturity, can be collateralized, ranks senior to equity in insolvency, and generally conveys no voting rights.

Residual Claim

The financial claim of equity holders, receiving only what earnings or liquidation value remain after all prior claims, such as debt service, are completely satisfied.

Fixed Claim

The financial claim held by creditors specifying predetermined, contractually binding interest payments and repayment of principal.

Mezzanine Capital

A hybrid form of financing possessing structural characteristics situated between traditional equity and senior debt.

Retained Earnings

The portion of net earnings retained inside the corporation to finance investments rather than being paid out as distributions to equity holders.

Principal (Debt)

The original baseline capital borrowed by a debtor that must be returned to the creditor, distinct from interest payments.

Shareholder-Value Approach

A classical financial framework positing that the primary objective of corporate management is to maximize firm value for shareholders, subordinating other stakeholder goals.

Stakeholders

All individuals or groups that can affect or be affected by a corporation's operations, including shareholders, employees, customers, society, and the environment.

Principal-Agent Problem

A governance conflict occurring when an agent (e.g., a corporate manager) entrusted to act in the interests of a principal (e.g., shareholders) instead pursues self-interested incentives.

Asymmetric Information

An information disparity where one party (such as management) possesses private information that the other party (such as shareholders) does not have, making monitoring difficult.

Liquid Asset

An asset capable of being sold rapidly and easily at a price close to the price at which it could simultaneously be purchased.

Bid-Ask Spread

The numeric difference between the ask price (price to buy) and the bid price (price to sell), serving as a direct measure of liquidity and dealer compensation.

Primary Market

The capital market segment where companies issue and sell brand new securities directly to investors to raise new funds.

Secondary Market

The financial market where existing securities are traded among investors, providing liquidity without directly generating new capital for the issuing corporation.

Initial Public Offering (IPO)

A company's first public offering and sale of newly issued shares to outside investors in the primary market.

Secondary Public Offering (SPO)

A subsequent primary-market equity offering in which an already listed corporation issues additional new shares to raise further funds.

Over-the-Counter (OTC)

Trading carried out directly between counterparties or facilitated by dealers outside of an organized formal stock exchange.

Market Maker

A liquidity provider on financial exchanges that continuously quotes two-way bid and ask prices, earning revenue through the bid-ask spread.

Limit Order

An order instructing a broker to buy shares at or below a specified maximum price, or to sell shares at or above a specified minimum price.

Market Order

An unconstrained trading order instructing a broker to buy or sell immediately at the best currently available market prices without a price cap.

Principle of Highest Volume Transacted

The auction pricing rule requiring the single clearing price to be set where the executable volume of shares, calculated as $V(p) = \min[D(p), S(p)]$, is maximized.

Market Index

A benchmark tracking and reporting the aggregate financial value and performance of a selected portfolio of securities.

Price Index

A market index calculated exclusively from changes in underlying share prices, omitting dividend payments and cash distributions.

Total Return Index

A market index that tracks price fluctuations while assuming that cash dividends and distributions are reinvested into the index.

Price-Weighted Index

An index structure where member securities are weighted purely by their per-share price levels, exemplified by the Dow Jones Industrial Average.

Value-Weighted Index

An index weighting methodology where each member security's weight is proportional to its market capitalization, exemplified by the S&P 500 and DAX 40.

Market Capitalization

The aggregate market valuation of a firm's equity, computed as the share price multiplied by the total number of outstanding shares ($\text{Market Cap} = p_i \times N_i$).

FinTech

The application of modern or advanced technological solutions to deliver and improve financial products and services.

Internal Financing

Corporate funding derived directly from operations generated within the firm, specifically via retained earnings.

External Financing

Capital brought into the firm from external sources, encompassing newly raised equity contributions and debt issuance such as bank loans and bonds.