Core Components of Finance and Banking

Flashcards covering core principles of financial management, short-term and long-term financing, the money supply, the Federal Reserve, banking institutions, and modern financial technology.

What is the definition of financial management?

The job of acquiring funds for a firm and managing them to accomplish the firm's objectives.

What is the risk-return trade-off in financial management?

The process of continually balancing the firm's investment risk with the expected return, or payoffs, from its investments.

What two overarching purposes guide the activities of financial managers?

Solvency (being able to pay debts when they become due) and efficiency (managing money in the optimum way).

What are the three main components of a firm's financial plan?

Forecasting, budgeting, and financial controls.

What are the three types of financial forecasts used in financial planning?

Cash flow forecasts, short-term forecasts, and long-term forecasts.

What are the four principal types of budgets developed by firms?

Operating budgets, capital budgets, cash budgets, and master budgets.

What is financial control (monitoring)?

A process in which a company periodically compares its actual revenues and expenses with those predicted in its budget.

What are the four primary reasons why firms borrow money?

Managing everyday business activities, extending credit to customers, keeping enough product (inventory) available, and making major investments.

What is trade credit?

A short-term financing method where a firm purchases a product, receives an invoice from the supplier, and pays later, usually within $30$ to $90\,\text{days}$.

What is a promissory note?

A written contract prepared by a buyer agreeing to pay the seller a specific amount of money by a designated time.

What distinguishes a secured loan from an unsecured loan?

A secured loan requires the borrower to pledge collateral that is forfeited if unpaid, whereas an unsecured loan does not require collateral.

What three types of short-term loans do commercial banks typically offer to businesses?

A line of credit, a revolving credit agreement, and a transaction loan.

How do pledging and factoring differ as methods of generating funds from accounts receivable?

Pledging uses accounts receivable as collateral to secure a loan, while factoring involves selling accounts receivable at a discount to a financial institution.

What is commercial paper?

Unsecured, short-term promissory notes exceeding $\$100,000$ issued by major corporations and banks, typically maturing in $30$ to $90\,\text{days}$ and no longer than $270\,\text{days}$.

What are the three main sources of long-term financing for a business?

Long-term loans, debt financing, and equity financing.

What are corporate bonds?

Contracts between an issuing firm and a buyer representing a loan from the buyer, on which the firm pays interest.

What are the three methods used to obtain equity financing?

Selling stock (via private placements or public offerings), retaining and reinvesting earnings, and obtaining venture investment capital.

What is financial leverage?

The technique of using borrowed funds to increase a firm's rate of return.

What is the cost of capital?

The rate of return a firm must earn to cover the cost of generating funds in the marketplace.

What is peer-to-peer (P2P) lending?

A form of social financing that enables individuals to lend and borrow money directly from one another while bypassing traditional financial institutions.

What are the five key characteristics of money?

Portability, divisibility, durability, uniqueness, and stability.

What are the expected lifespans of U.S. paper dollar bills and coins?

U.S. paper bills generally last $12$ to $18\,\text{months}$, while coins typically last $30\,\text{years}$ or more.

What are the three core functions of money?

A medium of exchange, a store of wealth, and a standard of value (unit of account).

What is the difference between the M1 and M2 classifications of the money supply?

M1 includes money that can be accessed quickly and easily, whereas M2 includes all of M1 plus assets that take more time to access.

In what year was the Federal Reserve System established, and what is its role?

Formed in $1913$, it serves as the central bank of the United States and controls the U.S. money supply.

What economic hazards occur if the Federal Reserve provides too much or too little money?

Supplying too much money leads to inflation, while supplying too little money leads to deflation and recession.

What three policy tools does the Federal Reserve use to regulate the money supply?

The reserve requirement, open-market operations, and the discount rate.

What is the reserve requirement?

The percentage of checking and savings deposits a bank must hold as cash in its vault or in a non-interest-bearing account at its regional Federal Reserve bank.

What are open-market operations?

The process by which the Federal Reserve controls the money supply through buying and selling U.S. Treasury securities (government bonds) to the public.

What is the discount rate?

The interest rate charged by the Federal Reserve when making short-term loans to member banks.

How does a NOW (negotiable order of withdrawal) account differ from a standard checking account?

A standard checking account pays no interest, whereas a NOW account requires a minimum balance, pays interest, and permits unlimited check writing.

What is a Certificate of Deposit (CD)?

A savings instrument that pays interest to the depositor upon reaching a specified maturity date.

What are the three ways commercial banks generate revenue?

By charging higher interest rates on loans than paid on deposits, charging service fees, and offering non-lending products like insurance and brokerage services.

What is the operational distinction between mutual savings banks and savings and loan associations?

Mutual savings banks are for-profit institutions owned by their depositors rather than by private shareholders.

What is a credit union?

A depositor-owned, nonprofit financial cooperative that offers banking services exclusively to its members.

What role do finance companies serve in the financial landscape?

They are nondeposit companies that offer short-term loans at elevated interest rates to borrowers lacking standard bank credit qualifications.

What maximum deposit insurance amount is provided by the FDIC and SAIF?

Up to $\$250,000$ per depositor.

What is blockchain technology?

A digital ledger system that securely records transactions across multiple computers to prevent retroactive alterations to recorded data.

What four major considerations or risks are associated with cryptocurrencies?

Market volatility, shifting regulatory frameworks, security concerns (cyber threats and fraud), and technological complexity.