fin3403

Goal of the firm

Maximizing firm value and stock price

Sole proprietorship

a business owned by a single individual where the owner is entitled to profits, but also losses, and no limit on liability

General partnership

Two or more owners. Each owner is fully responsible for liabilities.

Limited partnership

1 or more partners

Limited liability (up to amount of capital invested in the business)

Corporation

A business that functions separate and apart from its owners, all owners have limited liability.

• Can't sue shareholders

• Disadvantage- double taxed

S-Corporation

Provides limited liability but taxed like a partnership

Limited liability company (LLC)

Provides limited liability, but taxed like a partnership, but more flexible than an S-corporation

Public offering

All investors have the opportunity to acquire a portion of the financial claims being sold

Private placement

Not all investors have the opportunity to acquire a portion of the financial claims being sold.

Primary Market

A market in which securities are offered for the first time for sale to potential investors

Secondary Market

Investors buy and sell existing securities

•Trading

Money Market

Market for short term = (less than 1 year)

Debt instruments such as treasury bills, negotiable CDs, commercial paper.

Capital Market

For long-term financial instruments such as loans, stocks, bonds, mortgages

Spot Market

Market where something sells today, also called the cash market

Futures Market

Market where you can buy or sell something at some future date, the price, quantity and date are set

Organized Security Exchange

formal organizations that facilitate the trading of securities

ex: NYSE, AMEX, regional exchanges

Over-the-counter Market

all security markets except organized security exchanges, a network of brokers and dealers linked by computer such as NASDAQ

NASDAQ

National association of security dealers automated quotation system (electronic stock exchange)

Nominal rate of interest

krf: the interest rate paid on debt securities without an adjustment for any loss in purchasing power

Real risk-free interest rate

the required rate of return on a fixed income security that has no risk in an economic environment of zero inflation

Real rate of interest

k*: the nominal rate of interest less any loss in purchasing power of the dollar during the time of the investment

Yield curve

the relationship between interest rates and the term to maturity, where the risk of default is half constant.

Unbiased expectations theory

the term structure is determined by expectations of future rates

Liquidity preference theory

investors require maturity premiums to invest in longer term securities

Market segmentation theory

there are separate markets for long and short term investments

Form 10-K

an annual report required by the sec that provides such information as history, audited financial statements, etc.

Income statement

an accounting statement that measures the results of a firm's operations over a specific period, the bottom line is the profit or loss for that period.

Cost of goods sold

the cost of producing a product to be sold in ordinary course of business

Gross profit

sales - cost of goods sold

Operating expenses

marketing + selling expenses, general + administrative expenses, +depreciation expenses

Operating income (same as EBIT)

gross profit - operating expenses

Earnings before taxes (same as taxable income)

EBT

operating income - interest expense

Net income

the earnings available to the firms common + preferred stockholders * net profit or earnings available to common stockholders

Earnings per share

net income on a per share basis

Common-sized income statement

an income statement in which a firm's expenses + profits are expressed as a % of its sales

Gross profit margin

gross profit / net sales

Balance sheet

statement that shows the firms assets, liabilities and equity at any given point in time

Book value

value of an asset as shown on a firm's balance sheet which represent the depreciated historical cost of an asset.

Debt

liabilities such as credit extended by suppliers or a loan from a bank

Equity

stockholders investments in the firm on the balance sheet

Current assets

Assets that are relatively liquid, such as cash, AR, inventories, pre-paid expenses and marketable securities

Accounts receivable

money owed by customers who purchased goods or services from the firm on credit

Inventories

raw materials, work in progress + finished goods or services from the firm on credit.

Fixed assets

assets such as equipment, buildings and lands

Depreciation

a non cash expense to allocate the cost of depreciable assets, over the life of the asset

Accumulated depreciation

the sum of all depreciation taken over the entire life of a depreciable asset

Accounts payable

credit provided by suppliers when a firm purchases inventory on credit

Accrued expenses

expenses that have been incurred by not yet paid in cash

Short-term notes

amount borrowed from lenders where the loan is to be repaid within 12 months

Long-term debt

loans from banks or other sources that lend money for longer than 12 months

Mortgage

a loan to financial real estate where the lender has first claim on the property in the case the borrower is unable to repay the loan

Preferred stockholders

stockholders who have claims on the income + assets after creditor but before common stockholders

Common stockholders

investors who own the firm's common stock

Residual owners of the firm

Par value

the arbitrary value a firm puts on each of the stock prior to its being offered for sale

Paid-in-capital

the amount of company receives above par value for selling stock to investors

Retained earnings

cumulative profits retained in the business on the balance sheet

Common-sized balance sheet

a balance sheet in which a firm's assets + source of debt + equity are expressed as a % of its total assets

Liquidity

The ability to convert an asset into cash quickly without a significant loss of its value

Total stockholders' equity

common equity (shareholders) in balance sheet, which is the sum par value paid in capital, retained earnings, and less any treasury stock.

Price/earnings ratio

the price the market places on $1 of a firms earnings

Price/book ratio

the market value of a share of the firms stock divided by the book value per share of the firm reported equity in the balance sheet

Which of the of the term structure theories would support the argument that the yield curve is upward sloping because investors expect future interest rates to rise?

the unbiased expectations theory.

Suppose your firm selects an investment banking firm to assist with your firm's $10 million stock issue. The investment banker will act as a broker and will attempt to sell each new share of stock for a commission for each share sold. This distribution method is referred to as:

Best Efforts

Profit maximization does not adequately describe the goal of the firm because:

profit maximization does not consider the riskiness of returns.

profit maximization ignores the timing of returns.

Which of the following is true regarding a sole proprietorship?

The owner has unlimited liability.

The goal of the firm is best described as:

maximizing the value of the firm's common stock

Bypassing SEC registration to sell securities directly to a pension fund or insurance company is an example of

private placement

The law that established the SEC is:

the Securities Exchange Act of 1934.

Money market instruments include all of the following except:

preferred stocks

Suppose your firm selects an investment banking firm to assist with your firm's $50 million bond issue. The investment bank will buy the entire issue and sell each new bond to investors. This distribution method is referred to as:

a negotiated purchase.

Which of the term structure theories claims that legal restrictions and personal preferences limit choices for investors to certain ranges of maturities?

the market segmentation theory.

Which of the following is true regarding the over-the-counter market?

The OTC brokers and dealers are linked by NASDAQ.

When a new issue of securities is marketed to a definite and select group of investors, such as the firm's employees or current stockholders, the issue is called a(n):

privileged subscription.

If a syndicate of investment banks purchases a common stock issue from a corporation, this transaction takes place in:

the primary capital market.