Chapter One: Introduction to Finance

Key Terms and Review Questions

Brokers

Individuals or a firm that brings together potential buyers and sellers of a product and receives a commission at transaction.

Business Finance

The study and application of how managers can apply financial principles to maximize the value of a firm in a risky environment.

Capital Budgeting

The process of determining which long-term or fixed assets to acquire to maximize shareholder value.

Capital Market

Market for longer-term financial instruments, such as stocks and bonds, used to finance long-term projects for organizations.

Capital Structure

The mix of financing, usually debt and equity, used by a firm.

Chief Financial Officer (CFO)

An executive-level officer who sets policy for working capital management, determines optimal capital structure for the firm, and makes the final decision in matters of capital budgeting.

Commercial Paper (CP)

Short-term, unsecured financial obligations issued by firms as a means of short-term financing for items such as inventory or payables.

Comptroller

Also referred to as controller, individual in charge of financial reporting and the oversight of the accounting activities necessary to develop financial reports.

Dealers

Facilitate a market and the trading of securities by holding a portfolio of the underlying asset for easy purchase and sale; earn money on the spread between ask and bid prices for the asset.

Default Risk

The risk that the issuer of a financial security will be unable to make payments as specified in the terms of a financial contractT

Diversifiable Risk

Also called unsystematic risk, a risk that can be eliminated without the loss of expected return by holding a portfolio of securities.

Economic Value

The amount a consumer is willing to pay for a particular asset or service, usually greater than or equal to the current market price or present value of the asset.

Federal Funds Rate

The rate targeted by the Federal Reserve in the implementation of monetary policy.

Financial Industry Regulatory Authority (FINRA)

An independent, nongovernmental organization that writes and enforces the rules governing registered brokers and broker- dealer firms in the United States.

Financial Intermediary

A commercial bank or a mutual fund investment company that serves as an intermediary to enable easier and more efficient exchanges among transacting parties, often accepting one form of financial asset from which they create another, such as taking demand deposits to create mortgage loans.

Financial Markets and Institutions

One of the three main areas of the field of finance; firms and regulatory agencies that oversee our financial system.

Inflation Risk

The risk of reduced purchasing power of goods and services due to rising prices.

Investments

One of the three main areas of finance; products and processes used to create individual and institutional portfolios with the intent of growing wealth.

Money Market

The market for short-term, low-risk, highly liquid, homogeneous financial securities; common money market securities include T-bills, NCDs, and commercial paper.

Money Market Mutual Funds

Created by investment companies to pool the money of many investors to purchase and then manage short-term, low-risk, liquid financial portfolios of securities.

Municipal Bonds (munis)

Long-term debt obligations issued by state or local governments that often have important tax advantages relative to corporate bonds.

Negotiable Certificate of Deposit

Very large CDs issued by financial institutions, redeemable only at maturity but can and often do trade prior to maturity in a broad secondary market; also called jumbo CDs because they sell in increments of $100,000 or more.

Non-Diversifiable Risk

Risk that cannot be eliminated by simply holding a portfolio of securities; also known as systematic risk.

Political Risk

The risk of local, state, or national governments “changing the rules” and disrupting firm cash flows.

Primary Market

A term used in financial markets to identify the market for the purchase and sale of new securities.

Secondary Market

A term used in financial markets to represent the purchase or sale of used securities that trade after the initial sale by the offering firm.

Secondary Market

A term used in financial markets to represent the purchase or sale of used securities that trade after the initial sale by the offering firm.

Securities Investor Protection Corporation (SIPC)

A nonprofit corporation that provides brokerage customers up to $500,000 coverage for cash and securities held by the firm.

Treasurer

Position responsible for monitoring cash flow at a firm and frequently is the contact person for bankers, underwriters, and other outside sources of financing.

Treasury Bills (T-bills)

Short-term debt obligations of one year or less issued by the US government.

Treasury Bonds

Long-term debt obligations issued by the US government characterized by having maturities of greater than 10 years and making periodic interest payments as well as principal payment at maturity.

Treasury Notes

Long-term debt obligations issued by the US government characterized by having maturities of 2 to 10 years and making periodic interest payment as well as principal payment at maturity.

Working Capital Management

The development, oversight, and management of a firm’s short-term assets and liabilities.