D775 - Section 1

Accounting

focus on systematic recording, reporting and analysis of financial transactions

finance

concerned with the management of assets and liabilities, planning and strategizing for future growth and stability

finance

activities: investment analysis, risk management, capital raising, budgeting

what are 3 main area of finance

personal

public

business

personal finance

magmt of individual financial activities

public finance

mgmt of governments revenues, expenditures, and debt load through various govt and quasi=govt institution

tax collection, govt spending, budgeting, public debt issuance

primary objective of public finance

allocate resources efficiently

promote economic stability

provide public goods and services

business finance

focuses on financial activities and strategies of companies

involves capital investment decisions, financing methods, divident policies, risk management

business finance goal

maximize shareholder value by ensuring efficient use of financial resources, securing funding, managing risks

Business finance is the area of the business in which

1 - financial measures are used to help mgmt make decisions (ratio analysis)

2 - financial analysts use mathematical models to select what prjojects to invest in (capital budgeting)

3 - financial analysts usethe cost of capital to determine whether these projects should be financed with either debt or equity, and which type of each

3 primary rols of business finance

1 - using finanical ratios to manage the business

2 - applying skills with time value of money to determine which projects to invest in

3 - controlling the risk associated wit projects by computing the cost of capital to determin how to fund the chosen projects

What does capital budgeting in business finance involve?

evaluating potential investment projects

what is the role of financial ratios in business finance?

to analyze and interpret business performance

what is another term for business finance

corporate finance

which is a characteristic of business finance

strategic future planning

stocks

A certificate of ownership in a corporation

2 main types of stocks

Common stock

preferred stock

common stock

represents ownership with voting rights and variable dividends

preferred stockolders

receive fixed dividends and have priority over common stockholders in asset claims, but usually do not have voting rights

common stock

recorded under owner equity on the balance sheet

common stock

very liquid in publicly traded firms

liquid

asset that can be quickly and easily converted into cash without significantly affecting market price

Market Capitalization

number of common shares of stock multiplied by the price per share

dividends

portion of company's earnings shared with stakeholders usually in form of cask or additional stock

capital appreciation

when a stock is bought at a lower price than what it is sold

subtracting the lower purchase price from the higher price is the appreciation

preferred stock

class of ownership in a corporation that has higher claim on assets and earnings than common stock, typically with fixed dividends and no voting rights

preferred stock

recorded under the owner equity portion of hte balance sheet

is relatively rare in publicly traded stocks

mostly utilities, or startups funded by private investors

bonds

debt securities issued by corporations or governments to raise capital, where the issuer agrees to pay back the principal along with interest on specified dates

coupon rate

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

maturity

date on which principal amount of a bond or other debt instrument is to be paid in full

Entities issue bonds to secure long-term funding without diluting ownership

Governments issue bonds to finance public projects and manage fiscal policies

Corporations issue bonds to raise funds for business operations and growth

yield

interest rate earned by the investor for lending the money to the firm issuing the bond

junk bonds

High-yield, high-risk bonds issued by companies with lower credit ratings, typically offering higher interest rates to attract investors.

What are 2 main types of bonds?

Corporate

Public

Corporate bond

Bonds issued by corporations to fund operations, expansions, or other activities, offering investors periodic interest payments and repayment of principal at maturity.

public bond

Bonds issued by government entities to finance public projects and operations, often considered low-risk investments.

coupon

The periodic interest payment made to bondholders during the life of the bond.

municipal bonds

Bonds issued by state, municipal, or county governments to finance public projects, typically offering tax-exempt interest income to investors.

Treasury bonds aka treasuries

Debt securities issued by the U.S. Department of the Treasury, considered among the safest investments due to their backing by the full faith and credit of the U.S. government.

what is a muncipal bond and how does it differ from a corporate bond?

municipal bond is issued by local government to finance public projects and often has tax advantages.

Corporate bond is issued by a company to raise funds and typically carries higher yield due to higher risk

how do companies raise capital through debt and equity financing

companies can issue bonds (debt financing) which must be repaid with interest, or sell stock (equity financing), which gives ownership to investors but does not require repayment

financial derivatives

Financial instruments whose value is derived from the performance of underlying assets, indexes, or interest rates.

options

Financial contracts that give the holder the right, but not the obligation, to buy or sell an asset at a specified price before a certain date.

strike price

The predetermined price at which the holder of an option can buy (call) or sell (put) the underlying asset.

futures

Financial contracts obligating the buyer to purchase, or the seller to sell, an asset at a predetermined future date and price.

2 main types of financial derivatives

options

futures

investment funds

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 the fund can issue, allowing for continuous buying and selling of shares.

net asset value (NAV

The per-share value of a mutual fund or ETF, calculated by dividing the total value of the fund's assets by the number of outstanding shares.

Exchange-traded funds (ETFs)

Investment funds that are traded on stock exchanges, holding assets such as stocks, commodities, or bonds, and generally tracking an index.

Hedge funds

Private investment funds that employ various strategies to earn active returns for their investors, often with higher risk and less regulation compared to mutual funds.

pension funds

Investment pools established by employers to provide retirement income for their employees, typically managed by professional managers to ensure long-term growth and stability.

how do financial derivatives 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.

3 main financial instruments

stocks

bonds

financial derivatives

how is preferred stock sometimes described

hybrid security

What do investors seek from bonds?

Steady and predictable income

What are municipal bonds used for?

Funding public infrastructure projects

What is the main purpose of pension funds?

To ensure growth and sustainability of retirement savings

financial markets

A marketplace where buyers and sellers trade financial assets, such as stocks, bonds, currencies, and derivatives, facilitating the allocation of resources and risk.

public market

A marketplace where securities are traded openly, allowing the general public to buy and sell stocks, bonds, and other financial instruments

private market

A marketplace where the buying and selling of securities that are not publicly traded, typically involving transactions between private investors, institutions, and companies.

primary market

The financial market where new securities are issued and sold directly to investors by the issuer.

securities

Financial instruments that represent an ownership position, a creditor relationship, or rights to ownership, such as stocks, bonds, and options.

underwrite

The process in which an investment bank or financial institution analyzes and takes the risk of a new securities issuance, ensuring the issuer raises the required capital, usually by purchasing the securities and reselling them to investors.

initial public offering (IPO)

The process by which a private company offers its shares to the public for the first time, allowing it to raise capital from a broad base of investors.

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.

secondary market

The financial market where previously issued securities are traded among investors, providing liquidity and price discovery.

What is the difference between primary and secondary financial markets?

The primary market is where companies issue new securities to raise capital (e.g., IPOs). The secondary market is where investors trade existing securities, such as on the New York Stock Exchange (NYSE).

dealers

Market participants who buy and sell securities for their own accounts, providing liquidity to the market.

auction markets

Financial markets in which buyers and sellers submit competitive bids and offers, with transactions occurring at prices that match the highest bid with the lowest offer.

open outcry

A method of trading on exchange floors where traders shout bids and offers, facilitating immediate communication and price discovery.

financial institutions

Organizations that provide financial services, including banks, credit unions, insurance companies, and investment firms.

depository institutions (DIs)

Financial institutions that accept deposits from the public and provide loans, such as commercial banks, savings banks, and credit unions.

investment institutions

Organizations that invest pooled funds from clients into securities and other assets, aiming to generate returns on the investments.

investment banks

Financial institutions that assist companies in raising capital, advising on mergers and acquisitions, and providing various financial services, such as underwriting and trading.

public equity raising

The process of obtaining capital by issuing shares of stock to the public, typically through an IPO or additional stock offerings.

private equity raising

he process of obtaining capital by selling shares or ownership stakes in a company privately, often to institutional investors or accredited individuals.

What is the function of financial markets in the economy?

To facilitate the flow of capital from savers to borrowers

What role do investment banks play in the primary market?

What role do major international exchanges like the London Stock Exchange (LSE) play in the global financial system?

They facilitate the trading of securities and support global capital formation.

economic indicators

Statistics and data points that provide information about the overall health and direction of an economy, such as GDP, unemployment rates, and inflation.

Gross Domestic Product (GDP)

The total market value of all goods and services produced within a country in a specific period, serving as a broad measure of economic activity.

Consumer Price Index (CPI)

An index that measures the average change in prices paid by consumers for a basket of goods and services over time, used to gauge inflation.

market baskets

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

major market baskets

housing

transportation

food

medical care

recreation

education & communication

apparel

other goods & services

Producer Price Index (PPI)

measure that examines the average change over time in the selling prices received by domestic producers for their goods and services.

inflation

The increase in prices over time, which decreases the purchasing power of money. Inflation is an important factor in time value of money calculations because it erodes the value of future cash flows, making a dollar in the future worth less than a dollar today.

demand-pull inflation

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

cost-push inflation

Inflation resulting from increased production costs, such as wages and raw materials, leading to higher prices for final goods and services.

Producer Price Index (PPI) includes

finished goods

intermediate goods

raw materials

manufacturing

agriculture

mining, services

Fed lowers rates

encourages borrowing and spending, stimulating economic activity and job creation

Fed raises rates

Fed is able to slow down the economy and curb inflation.

moderate inflations is generally considered good for economy

moderate inflation

steady and predictabe increase in the general price level of goods and services within an economy

moderate inflation

prevents economy from falling into deflation which can lead to reduced consumer spending and investment, potentially triggering a recession

high inflation

negative effects such as reducing value of money, increasing uncertainty, harming savings.

lead to wage-price spirals

How does inflation impact interest rates and financial decision-making?

Inflation reduces the purchasing power of money, prompting the Federal Reserve to adjust interest rates. Higher interest rates slow inflation but increase borrowing costs, while lower interest rates encourage spending and investment.