Business Finance and Economics Vocabulary

Vocabulary flashcards covering core concepts of business finance, financial instruments, stock/bond markets, derivatives, and macroeconomic indicators.

Three Roles of Business Finance

1) Using financial ratios to manage the business, 2) applying skills with time value of money to determine which projects to invest in, and 3) controlling risk associated with projects by computing the cost of capital to determine how to fund chosen projects.

Common Stock

The most common type of stock, recorded under owner equity on the balance sheet, which grants voting rights to stockholders.

Market Capitalization

The total market value of a company's outstanding shares of stock, calculated as $\text{Market Capitalization} = \text{Number of Common Shares} \times \text{Price per Share}$.

Preferred Stock

Stock whose holders receive fixed dividends; it is relatively rare in publicly traded companies (most likely utilities like electric and gas companies) and is recorded under owner's equity on the balance sheet.

Coupon Rate

The annual interest rate paid by a bond issuer on the bond's face value, expressed as a percentage.

Coupon

The periodic interest payment made to bondholders during the life of a bond (e.g., every $6$ months).

Junk Bonds

High-yield, high-risk bonds issued by companies with lower credit ratings to attract investors by offering a higher return rate.

Treasuries

Bonds digitally issued by the U.S. federal government that are considered low-risk, short-term investments backed by the full faith and credit of the U.S. government.

Financial Derivatives

Financial instruments that derive their value from the performance of underlying assets, indexes, or rates.

Options

Financial contracts that give the buyer the right, but not the obligation, to buy or sell an asset at a predetermined price (strike price) before a specified date.

Futures

Standardized contracts obligating the buyer to purchase or the seller to sell an asset at a predetermined price on a specific future date.

Corn Futures

Contracts where buyers agree to take delivery on a future date of a fixed amount of corn at a given time, where original contract price and ultimate corn price are fixed while contract value fluctuates.

Mutual Funds

Investment vehicles that pool funds from multiple investors to buy a diversified portfolio of securities managed by professional fund managers.

Open-End Investment

A type of mutual fund that does not have restrictions on the amount of shares it can issue, allowing continuous buying and selling of shares.

Net Asset Value (NAV)

The per-share value of a mutual fund or ETF, calculated as $\text{NAV} = \frac{\text{Total Value of Fund's Assets}}{\text{Number of Outstanding Shares}}$.

Exchange-Traded Funds (ETFs)

Investment funds that trade on stock exchanges like individual stocks and can be bought and sold throughout the trading day.

Hedge Funds

Private investment partnerships for accredited investors that employ diverse strategies to generate high returns, often with higher risk.

New York Stock Exchange (NYSE)

A stock exchange known for its strict requirements and operating as an auction market for trading securities.

NASDAQ

A stock exchange recognized for its electronic trading platform and focus on technology stocks.

Securities and Exchange Commission (SEC)

A regulatory agency that regulates securities markets and enforces laws to protect investors and maintain functioning markets.

Underwrite

The process in which an investment bank or financial institution analyzes and takes the risk of a new securities issuance.

Initial Public Offering (IPO)

The process by which a private company offers its shares to the public for the first time to raise capital, expand operations, and increase market presence.

Primary Market

The financial market where companies issue new securities to raise capital, such as through Initial Public Offerings (IPOs).

Secondary Market

The financial market where investors trade existing securities (e.g., NYSE, NASDAQ), with prices determined by supply and demand dynamics.

Open Outcry

A method of trading on exchange floors where traders shout bids and offers to facilitate immediate communication and price discovery without holding securities into inventory.

Depository Institutions (DIs)

Financial intermediaries such as commercial banks, savings and loan associations, and credit unions that accept deposits from people and businesses and provide loans.

Equity Raising

A method companies implement to secure funding through two distinct options: public equity raising (via IPO) and private equity raising (securing funds from private investors).

Gross Domestic Product (GDP)

A key measure of economic performance representing the total value of all goods and services produced within a country over a specific period.

Market Basket

A collection of goods and services used to track the performance of a specific market and measure inflation or economic trends.

Producer Price Index (PPI)

An index that tracks prices at the wholesale level, reflecting cost changes from the perspective of the producer.

Demand-Pull Inflation

Inflation that occurs when aggregate demand in an economy outpaces aggregate supply, leading to higher prices.

Cost-Push Inflation

Inflation caused by increased production costs (wages, raw materials) leading to higher prices for final goods and services.

Full Employment

The lowest level of unemployment in an economy, typically around $4\text{ to }4.5\text{\%}$.

Inverted Yield Curve

A yield curve condition where short-term interest rates exceed long-term rates, often viewed as a predictor of an economic recession.

Yield Curve

A financial metric curve where long-term investments yield higher rates than short-term investments.

Recession

An economic state defined by GDP growth being negative for $2$ consecutive quarters.

Offshoring

The practice of relocating business processes or production to countries with lower labor costs.

Ratio Analysis

An analytical method used to inform investment decisions by providing key information about a business's financial health.

There are two main types of stock

Common and preferred

Why do investors buy bonds?

Predictable income and lower risk compared to stocks and portfolio diversification

How many bonds are there?

Corporate and public

The difference between a bond and stock investors

is that bond investors can force a firm into bankruptcy for failure to pay back the loan, whereas shareholders have no ability to force a firm into bankruptcy

What are the 2 types of public bonds?

Municipal (MUNIS) and treasuries

What are the two main types of financial derivatives ?

Options and Futures

When a bond is taken out where should it be recorded?

Under liabilities on the balance sheet

How do financial derivates like options and futures help businesses manage risk? 

-Options give the right to buy or sell an asset at a fixed price while futures require buying or selling at a predetermined price. Businesses use them to hedge against price fluctuations in commodities, stocks or currencies.

What is an initial public offering (IPO) and why do companies use it?

An IPO is when a company sells shares to the public for the first time companies use IPOs to raise capital, expand operations and increase their market presence 

What are some examples of secondary markets?

Stock exchanges like the NYSE and NASDAQ are examples of secondary markets the prices of securities in the secondary market are determined by supply and demand dynamics as well as other factors

What is the difference between primary and secondary financial markets?

-The primary market is where companies issue new securities to raise capital (IPOS) the secondary market is where investors trade existing securities (NYSE)

Financial institutions

are intermediaries that facilitate the flow of funds in the financial system they can be categorized into depository institutions (DIs) investment institutions, insurance companies, and pension funds

Investment institutions

including investment banks, mutual funds and hedge funds help individuals and organizations invest in securities and other assets

Public Equity Raising

Involves selling shares of the company to the public through stock exchanges a process known as an initial public offering (IPO)

-Private equity raising

involves securing funds from private investors (used by growing companies that preferred a more flexible and less regulated

What are the contents of the market basket?

-their value is updated periodically to reflect changes in consumer spending habits (the bureau of labor statistics (bls) conducts the consumer expenditure survey (CE) to determine the items that should be included in the basket

Moderate inflation

is generally considered beneficial for the economy 2 or 3%

How does inflation impact interest rates and financial decision making? 

-Inflation reduces the purchasing power of money making the gov to adjust interest rates higher interest rates slow inflation but increase borrowing costs while lower interest rates encourage spending and investment.

What is the main function of the NEW YORK STOCK EXCHANGE (NYSE)

-To operate as an auction market for trading securities 

What is the main advantage of having a centralized trading mechanism in an auction market?

-it provides a transparent price discovery process a centralized trading mechanism in an auction market provides a transparent price discovery process determined the price by matching the highest price a bidder is willing to pay

Financial ratios

help business owners understand their company's financial health, make informed decisions, diagnose a firm’s strengths and weaknesses, future performance and identify areas of improvement

Can we use Financial ratios by themselves?

by themselves do not tell us much instead we have to compare these ratios to something usually they are compared to the ratios of another firm

Cross-sectional analysis

Comparing the financial ratios of one company to the same financial ratios of another company

Time series analysis

comparing a financial ratio across time this analysis allows us to identify trends in a particular ratio and may help with prognosis or treatment

How do you conduct cross-sectional analysis using financial ratios?

By comparing the financial ratios of one company to the same financial ratios of another company 

How do you conduct time-series analysis using financial ratios?

By comparing a particular financial ratio for a company across time

Liquidity Ratios

measure a company's ability to pay its short-term obligations using its most liquid assets and if a firm can covert assets into cash to pay off its liabilities

Liquidity Ratios

Current ratio, Quick ratio, average collection period, accounts receivable turnover, and inventory turnover

High liquidity ratios

Indicate a strong capacity to cover short-term debts

Low ratios

might indicate that a company may have a problem with paying its bills

Activity Ratios (efficiency ratios)

how well a company is utilizing its assets and resources to generate sales or revenue how the company and how well it manages its overall asset base the efficient management of assets

how many activity ratios are there?

total asset turnover and the fixed asset turnover ratio

Lower activity ratios

might have assets that do not generate sources of revenue

Leverage Ratios

Measure how a firm uses debt to finance its operations and growth the company’s structure examines the company’s long term financial viability by comparing its debt levels to its assets, equity or earnings

How many leverage ratios are there?

Debt-to-assets ratio and the debt-to-equity ratio and the times interest earned ratio

What does a high leverage ratio indicate?

indicates a greater financial risk, as the company might struggle to meet its debt obligations during economic downturns

Moderate leverage can enhance returns on equity when managed properly

What is capital structure?

Capital structure refers to the way a company finances its operations and growth through a combination of debt and equity components.

Profitability Ratios

evaluate a company's ability to generate income or earnings relative to its revenue (indication of the firm’s capacity to produce profits)

Higher profitability ratios

suggest a well-managed company with effective cost control and strong revenue-generation capabilities.

Market ratios

company's financial performance in relation to its stock price are used to assess the share price of a public company's stock

the price-earnings ratio

to evaluate the firm's market performance market valuation of the firm they help in understanding how the market values the company's earning, growth prospects and risk profile

interpretation of market ratios

Favorable market ratios generally reflect positive investor sentiment and confidence in the company's future performance  

Unfavorable market ratios sometimes indicate that a company might be overvalued by market participants

The ratios are only meaningful when

They are placed in a comparative framework

What are the 5 financial ratios

liquidity, activity, leverage, profitability and market ratios

What do the financial ratios do?

diagnose the financial health of the company, Forecast the financial health of the firm (prognosis) and identify changes to improve the financial health of the firm (treatment)

What is the accounting equation?

Assets= Liabilities + Shareholders' equity

Current assets

cash, inventory, receivables

Fixed assets

Tangible long-term assets that a company uses to generate revenue (equipment)

Current liabilities

due within one year

long-term liabilities

due after one year

Shareholders' Equity

Reflects the owners' claim on the company's assets after all liabilities have been settled

The balance sheet helps us

understand the company's liquidity

Depreciation

is a non-cash expense meaning that while we list depreciation as an expense no actual cash is used to pay the expense

Earnings before interest and taxes (EBIT)

are equal to revenue minus COGS, SG&A R&D expenses minus depreciation

What does depreciation do to a company’s taxes

Depreciation lowers a company's tax liability 

What is paid first taxes or interest ? 

Interest is paid before taxes are paid this suggests that using debt to finance the operations or assets of the company contains a tax benefit because paid interest is taken out of revenue before taxes are paid 

How many Liquidity ratios are there?

There are three primary liquidity ratios: current ratio, quick ratio (acid test), and cash ratio

Current ratio

This formula measures a company's ability to satisfy its short-term liabilities with its short-term assets. 

interpret current ratio

higher margin indicates that the company has sufficient assets to meet its short-term obligations 

-A value less than one indicates that the company may struggle to meet its short-term liabilities 

Quick ratio (acid test-ratio)

Assesses a company's ability to fulfill its short-term obligations without relying on the sale of inventory describes the liquidity of a firm outside of the liquidation of the company's inventory

interpret quick ratio

A quick ratio above one is desirable, indicating strong liquidity without depending on inventory liquidation

A comparison between current and quick ratios

indicates that the company might be holding more inventory than its competitors