cob 300 b exam 1

finance

management, creation, and study of money and investments involving use of credit and debt, securities and investments

3 important quesitons for finance

how much do we need

where do we get it and what form

what do we do once we get it

3 areas of finance

business finance, investments, and financial institutions

investments

trading and portfolio of management of securities ( looks at stocks, bonds, portfolios, and risk)

business finance ( corporate finance)

financial management of a business enterprise

financial institutions

management of banks, credit unions, and other financial service enterprises

fiance within org

board of directors —> ceo —> coo and cfo

who reports to coo

marketing, production, hr, and other operating

who reports to cfo

accounting, treasury, credit, legal, capital budgeting, and investor relations

sarbanes oxley act

law passed by congress in 2002 that requires ceo and cfo to certify that their firms financial statement are accurate

forms of business organization

proprietorship, partnership, and corporation

sole proprietorship

business owned and run by one person

partnership

business arrangement where two or more people own and operate a company, either general partnership or limited liability partnership

distinction between general partnership and llc

A general partnership gives all partners equal management control but unlimited personal liability for business debts, whereas a limited liability partnership (LLP) protects partners from the personal negligence or debts of other partners

sole proprietorship pros

easiest to start

least regulated

single owner keeps all profit

taxed once as personal income

sole proprietorship cons

limited to life of owner

equity capital limited to owners personal wealth

unlimited personal liability

difficult to sell ownership interest

partnership pros

two or more partner

more capital available

relatively easy to start

income taxed once as personal income

partnership cons

unlimited liability

partnership dissolves when one partner dies or wishes to sell

difficult to transfer ownership

corporation

business organized as a separate legal entity under corporate law, with ownership divided into transferable shares

corporation characteristics

owners= shareholders

shareholders elect members of board

separation of management and ownership

governance structure of large companies

3 main types of corps

c corp

s corp

limited liability corp

c corp

legal structure for corporation in which owners, or shareholders, are taxed separate from entity

s corp

special designation that allows small businesses that meet qualifications to be taxed as if they were a proprietorship or partnership

limited liability corp

popular type of organization that is hybrid between partnership and corp

b corp

businesses that meet the highest standards of verified social and environmental performance, public transparency, and legal accountability to balance profit and purpose ( Patagonia)

corp pros

limited liability

unlimited life

separation of ownership and management

transfer of ownership is easy

easier to raise capital

corp disadvatanges

double taxation ( income taxed at corporate rate and then dividends taxed at personal rate)

separation of ownership and management

s corp pros

do not pay federal income taxes

income passed through to shareholders

limited liability

perpetual life

s corp cons

limited shareholders no more than 100

ability to raise capital is limited

llc pros

do not pay federal income taxes

income passed through to shareholders

limited liability

no limit to shareholders

perpetual life

llc cons

separation of owners and management

ability to raise capital is limited

goals of business enterprise

increase the value of the firm , measured by maximizing companys stock price over time

stakeholders examples

shareholders

creditors ( bondholders, loan holders)

employees

vendors

customer s

a stocks price should be equal to

instrinsic or true value

agency relationship ( role of management )

principal ( stockholders) hire agent ( managers) to represent interests

problems with agency

conflict of interest between the principal and the agent ( companys management and companys stockholders conflict of interest)

ways to manage managers

managerial compensation

corporate control

other stakeholders ( bond holders, preferred stock holders, vendors, etc)

managerial compensation

incentives to align management and stockholder interests (salary, bonus, stock options)

corporate control

threat of takeover may result in better management

stockholders vs bondholders

those who own stock in compay vs those who own bonds issued by company

• both offer opportunity to make money but different risks

stockholder debtholder conflicts

stockholders prefer riskier projects because of potential pros of project ( if it succeeds) while bondholders receive fixed payments ( so prefer limited risk)

bondholders are concerned with use of additional debt

bondholders attempt to protect themselves by including convenants in bond agreements that limit use of additional debt and constrains managers action

market cap

total value of publicly traded companys shares

link between stock value and instrinsic value

intrinsic value is measure of what a stock is worth

major financial decisions

capital budgeting

capital structure

working capital management

capital budgeting

deciding which long project to invest in

capital structure

deciding how to finace the firm ( debt vs equity)

working capital management

day to day operations like managing cash and inventory

financial markets plays

crucial role in

• allocating capital efficently

• allows firm to raise money

• investors to buy and sell securities

primary market vs secondary market

where new securities are issued vs where existing securities are traded ( nyse )

corporate governance

includes systems, rules, and processes that guide how companies are directed and controlled, including the board and transparency practices

capital allocation process

capital flows from those who supply capital to those who demand it

suppliers of capital

individuals and institutions with excess funds ( saving money and looking for a rate of return on investment)

demanders of capital

individuls who need to raise funds to finance their investment opportunities, willing to pay rate of return on what they borrow

how is capital transferred between savers and borrowers

direct transfers, investment banks, and financial intermediaries

market

venue where goods and services are exchanged

financial market

where individuals and orgs wanting to borrow funds are brought together with those who have surplus of funds

importance of financial markets

provide savers with returns on money saved

provide users of capital with necessary funds to finance their projects

promotes economic growth

well developed markets perform better

increase liqudity

reduce transaction costs

physical asset markets

physical products such as wheat, cars

financial asset markets

stocks, bonds, notes, and mortgages

spot markets

assets are bought on the spot ( purchasing foreign currency at exhcange booth)

futures markets

people agree to buy and sell asset at some future data ( farmer locking in price for corn to be delivered in a month)

money markets

funds are borrowed or loaned for one year or less

primary markets

corporations raise capital by issuing new securities

secondary markets

securities and other financial assets are traded among investors after they have been issued by corporations

private markets

transactions are worked out direclty between two or more parties

public markets

standardized contracts are traded on organized exchanges

ipo ( initial public offering)

company issues stock in public market for first time ( going public allows owners to raise capital from investors but are subject to regulations)

security

negotiable financial instrument that is evidence of indebtedness or ownership ( stocks, bonds, mutual funds, exchange traded funds you can buy or sell)

money market examples

us treasury bills

commerical paper

certificate of deposits

money market mutual funds

consumer credit

• think short term

capital market examples

us treasury notes and bonds

mortgages

state and local govt bonds

corporate bonds

leases

preferred and common stocks

types of financial institutions

investment and commerical banks

financial services corps

credit unions

life insurance companies

private equity

hedge, mutual, exchange-traded, and pension funds

derivative security value

derived from price of another security that is used to reduce risk ( purchasing currency futures that do well when dollar weakens)

approximatley what % of us stocks are owned by long term investors vs owned by short term investors

75, 25

physical location stock exchanges

tangible entities, brokerage departments ( purchase seats on exchange and designate one or more members)

• Security exchanges facilitate communication between buyers and sellers

how do stock exchanges work

auction markets, dealer markets, electronic exchanges, and otc exchange

auction markets

buyers and sellers of single security are matched before trade is facilitated

dealer markets

dealers facilitate transactions using their own money ( increase liquidity of market)

electronic exchanges

automate electronic communication network enables buy and sell orders for stock to be made without dealers

otc exchanges

securities that arent listed on major exchanges

bid ask spread

amount by whihc ask price exceeds bid price for asset in market ( difference between highest price buyer is willing to pay for and lowest price seller is willing to accept)

• bid represents demand and ask represents supply

market for common stock

closely held corporations ( smaller) and publicly owned corporations ( large number of individual owners)

type of stock market transactions

outstnading shares traded on secondary market

additional shares sold by companies in private market

iPO MADE BY privately held firms

equity securities

small cap < 2 bill

mid cap > 2 bill < 10 bil

large cap >10 bill

regulations

federal reserve system establishes margin requirements, requires disclosures regarding consumer lending , and assesses reserve requirements of member banks and non depository institutions

sec protects investors , maintains fair, ordelry, and efficient markets , and facilitates capital formation

market efficiency

securities are in equilibrium and fairly priced

investors cannot beat market unless lucky or expert

highly efficient vs highly inefficient

large companies with lots of analysts and good communciation with investors vs small companies with not any analysts and not much contact with investors

weak form efficiency

prices reflect past information

semi strong form efficiency

prices reflect public info ( news )

strong form efficieny

prices reflect all info ( public and private )

commercial banks

accept deposits and make loans

credit unions

nonprofit financial institutions owned by members and have lower fees and intetest rates

savings institutions

focuses on consumer savings and mortgage lending

investment banks

help companies raise capital and probide advisory services

insurance companes

pool risk and invest collected premiums

pension funds

manage retirment savigns for employees

financial instruments

legal contracts that represent a claim to future cahs flows ( stocks, bonds and derivaties )

financial statements

accounting reports issued periodically that present past performance information and snapshot of firms assets and the financing of them

which parties are interested in financial statements

investors, financial analysts, managers, creditors

disclosure of financial info

file results with the sec on quarterly basis (10-q) or annual basis (10k)

• annual report sent to shareholders yearly

why are financial statements important

window to company

lets us know what company is doing, how they have performed, what we can expect for future