Midterm 1 Study Guide

Flashcards covering key vocabulary terms and concepts from Chapter 1, 2, and 3 of the midterm study guide, including business organization forms, financial markets, financial institutions, and financial statements.

Sole Proprietorship

A business owned by one individual, offering ease of formation but unlimited liability and limited life.

Partnership

A business owned by two or more individuals, offering ease of formation but unlimited liability and limited life for owners.

Corporation

A legal entity separate from its owners, offering limited liability, ease of transferring ownership, and unlimited life, but subject to double taxation.

Primary Objective for Firm Managers

To maximize shareholder wealth, often reflected in the stock price.

Agency Problem (Stockholders vs. Managers)

Potential conflicts of interest between a company's shareholders (principals) and its management (agents) due to differing goals.

Agency Problem (Stockholders vs. Bondholders)

Potential conflicts of interest between shareholders (who prefer riskier projects for higher returns) and bondholders (who prefer less risk to ensure debt repayment).

Capital Allocation Process

The system by which capital moves from those with surplus funds to those needing funds for investment.

Direct Transfer

A firm sells its securities directly to savers without any intermediary.

Indirect Transfer (Investment Bank)

A firm sells its securities to an investment bank, which then resells them to savers.

Indirect Transfer (Financial Intermediary)

A financial intermediary (like a bank) collects funds from savers and then issues its own securities to the firm.

Primary Market

The market in which new securities are issued for the first time by corporations to raise capital.

Secondary Market

Existing, already issued securities are traded among investors.

Money Market

A market for short-term, highly liquid debt instruments with maturities generally less than one year.

Capital Market

A market for intermediate-term and long-term debt and corporate stocks, with maturities greater than one year.

Spot Market

Markets where assets are bought or sold for 'on-the-spot' delivery.

Futures Market

Markets where participants agree today to buy or sell an asset at a future date at an agreed-upon price.

Auction Market

A market where buyers and sellers physically meet and shout out prices, like the New York Stock Exchange.

Dealers Market (OTC Market)

A network of dealers who buy and sell securities for their own accounts, such as NASDAQ.

Investment Bank

A financial institution that helps companies raise capital by underwriting and distributing new securities.

Commercial Bank

A financial institution that accepts deposits, makes loans, and offers other financial services.

Mutual Fund

An investment vehicle that pools money from many investors to purchase a diversified portfolio of securities.

ETF (Exchange-Traded Fund)

An investment fund that holds assets like stocks, bonds, or commodities and trades like a common stock on a stock exchange.

Hedge Fund

Lightly regulated private investment funds that employ a variety of strategies to earn active returns for their investors.

Closed Held Corporation

A corporation whose common stock is largely owned by a few individuals or a family and is not publicly traded.

Publicly Owned Corporation

A corporation whose common stock is owned by a large number of investors and is traded on a public stock exchange.

IPO (Initial Public Offering)

The first time a company sells its stock to the public to raise capital.

Annual Report

A report issued annually by a corporation to its stockholders, containing financial statements and a discussion of operating activities.

Financial Statements

Key financial summaries including the Balance Sheet, Income Statement, Statement of Cash Flows, and Statement of Stockholders' Equity.

Current Assets

Assets that are expected to be converted into cash within one year.

Current Liabilities

Liabilities that must be paid off within one year.

EBIT (Earnings Before Interest and Taxes)

A measure of a firm's operating profit before accounting for interest expenses and taxes.

Net Income

The 'bottom line' profit of a firm after all expenses, including taxes and interest, have been deducted.

Limitations of Financial Statements

Include reliance on historical data, impact of accounting policy choices, and capturing a static snapshot rather than dynamic performance.

Cash Inflow

Funds entering a firm, such as from sales, borrowing, or asset disposal.

Cash Outflow

Funds leaving a firm, such as for expenses, debt repayment, or asset purchases.

Impact of Increase in Asset on Cash

Generally results in a cash outflow (e.g., buying new equipment).

Impact of Decrease in Asset on Cash

Generally results in a cash inflow (e.g., selling old equipment).

Impact of Increase in Liability on Cash

Generally results in a cash inflow (e.g., taking out a new loan).

Impact of Decrease in Liability on Cash

Generally results in a cash outflow (e.g., paying off a loan).

Impact of Depreciation on Cash Position

A non-cash expense that is added back to net income when calculating operating cash flow.

Impact of Financing on Cash Position

Involves cash inflows from issuing debt or equity, and cash outflows from paying dividends or repurchasing shares.