Finance Test #3

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Dividends

Regular payments to the shareholders that generally represent a distribution of profits. These payments are not guaranteed: the Board of Directors will declare—issue a dividend—only if they believe the company has enough cash or profits

Capital Gains

An increase in the value of an asset over its purchase price

Stock buybacks

A company can buy back its shares from the stockholders. This gives the shareholders hopefully capital gain and cash. It also reduces the number of shares outstanding

Preferred Stock

Form of equity that has preference over common stock in the payment of dividends. Preferred shareholders receive dividends before common shareholders. Preferred stock dividends are generally fixed and do not have voting rights in the corporation

Common Stock

A financial security that represents ownership in a company: the right to all residual cash flows after the claims of the company’s stakeholders have been satisfied. Common shareholders control the company through their election of the board of directors.

Investment Horizon

The time period that the investor plans hold the stock

Return on Equity (ROE)

The rate of return that shareholder get on their investment in the corporation

Retention Ratio

The proportion of earnings that is retained and reinvested in the company

Clientele Effect

Holds that same investors prefer companies with steady dividend payments, while other investors prefer grwoth in the stock price rather than the income from dividends

Price/Earnings Ratio (P/E)

Ratio of the stock price dividend by the company’s Earning per Share (EPS)

Earnings per Share (EPS)

The net income of the company divided by the number of shares. This states the income of the company on a per-share basis, which is useful when we’re evaluating the price of a single share of stock.

Balance Sheet Model of the Firm

The assets of the firm must be supported by the firm obtaining financing. The accounting balance sheet follows the cost principle and records asset and claims at their historic costs when added to the balance sheet. The economic balance sheet also looks at assets and claims, but uses current market values

Bond

A security representing the long-term debt of a company

Bank Loan

Indirect financing where the company borrows funds from a bank, which gets those funds from savers. These claims are not traded in the financial markets

Preferred Stock

A type of stock whose holders are given certain priority over common shareholders in the payment of dividends. Usually the dividend rate is fixed at the time of issue and no voting rights are given

Common Stock

Equity claims held by the “residual owners” of the firm who are the last to receive any distribution of earnings or assets

Privately held company

A company that raises capital by selling their securities directly to investors rather than the general public

Publicly Traded Corporations

Corporations who fulfill registration and reporting requirements and are authorized to sell financial securities to the general public

Primary Market Transaction

Corporations and other organizations, with the assistance of investment banks, create financial securities and issue them to the investing public. This is how companies raise capital.

Initial Public Offering (IPO)

The original sale of a company’s securities to the public. Also called an unseasoned new issue.

Seasoned security offering (SEO)

A new public stock issued after the company’s stock has been previously issued publicly. Also called a seasoned new issue.

Rights offer

An offer that gives a current shareholder the opportunity to maintain a proportionate interest in the company before shares are offered to the public

Crowdfunding

Websites in which companies needing capital post information about their company and invite individuals to invest. Crowdfunding bypasses the traditional financial intermediaries such as investment banks and commercial banks

Institutional Investors

These organizations pool large sums of money and invest those sums in securities, real property securities, and other investment assets. Their role in the economy is to act as highly specialized investors on behalf of others

Secondary Market Transaction

An investor holding a publicly traded security sells the security to another investor. The company issuing the security is not part of this transaction. Once issued, these securities are traded among investors.

Direct Financing

Involves companies issuing financial securities through the financial markets to expand and build their operations

Indirect Financing

Involves financial institutions that are intermediaries between savers and borrowers.

Investment Bank

A financial intermediary who provides a variety of services including aiding in the sale of securities, facilitating mergers and other corporate reorganizations, acting as brokers to both individuals and institutional clients, and trading for their own account.

Intermediary

An institution that acts as a middleman, providing services to those with funds to invest and those who need funds

Commercial Bank

A financial intermediary that serves as an interface with savers and borrowers. These banks accept deposits from savers that offer safety and a rate of return. They then lend these funds out to individuals and businesses who need to borrow. Banks make a profit by lending out funds at an interest rate that is higher than the rate they pay to their depositors

Financial Markets

Markets in which financial securities are issued and traded

Exchanges

Organized public markets where companies list their securities for trading by investors. These listed securities must adhere to securities laws and regulations to be traded on these public markets. The exchanges provide a legal platform to ensure that the commitments made by participants are realized. Exchanges are generally organized as profit-seeking companies.

Over-the-Counter Markets

Are not centralized trading places but rather systems by which dealers can offer to buy and sell securities among themselves and to their customers

Dealer

A market maker that maintains an inventory and stands ready to buy and sell at any time. The dealer makes a profit through the spread: by buying an asset at one price and selling the asset at a higher price.

Broker

An entity that brings security buyers and sellers together but does not maintain an inventory. The broker makes a profit via a commission paid for services rendered in facilitating the trade.

Bootstrapping

Involves using personal savings, selling personal assets, borrowing against assets, using credit cards, and tkaing on personal loans to raise capital.

Venture Capital

Venture capitalists develop businesses into viable, profitable companies through their investment of capital that more traditional investors may not make.

Efficient Market

A market in which the price of the asset reflects its economic value

Efficient Market Hypothesis (EMH)

States that prices of securities fully reflect available information. Investors buying bonds and stocks should expect to obtain an equilibrium rate of return. Firms should expect to receive the fair value for the securities they sell

Technical Analysis

Seeks to predict future price movements by identifying patterns and relationships in historic market information and then using these patterns to predict future prices.

Weak-form Efficient Market

Theory that a market is efficient with respect to historical price information.

Public Information

Information available to the investing public

Fundamental Analysis

Evaluates relevant economic, financial, political, and other qualitaive and quantitative information in order to determine an asset’s intrinsic/economic value

Semi-strong Efficient Market

Theory that a market is efficient with respect to public information

Private Information

Information that is not available to most investors

Insider Trading

An insider is anyone with nonpublic, specific information. They cannot use their information to make unfair advantage when trading with outsiders

Strong-form Efficient Market

Theory that a market is efficient with respect to all available information, public, or private

Market Value

Of a bond is its economic value: the present value of the promised payments taken at the bond’s opportunity cost

Coupon Payment

The amount of regular, per-period interest payments promised by the company issuing the bond

Principal/Face Value

The amount borrowed and the amount bondholders should receive when the bond matures. The face value of bonds is generally set at $1,000 per bond

Opportunity Cost

The rate the bondholders expect to earn given the risk of the bond. It is the opportunity cost of the bond in that it is the rate of return the investor should earn on other similar bonds

Maturity

The length of time the bond will exist and when the bond should repay the principal to the bondholder

Coupon Rate

The annual stated rate of interest paid on the bond. This rate is set when the bond is issued and does not change. This rate will set up the cash flows of the bond’s time line

Yield to Maturity (YTM)

The current opportunity cost on all bonds of equivalent risk and maturity. It is the rate required by market participants to invest in the bond. The yield will change with changes in economic conditions and the risk of the bond. This is the discount rate that will be used to discount the bond’s cash flows to determine its economic value.

Interest only bond

A bond that makes regular periodic interest payments and pays the entire principal upon maturity

Zero-coupon bond/discount bond

A bond that pays no interest and has a 0% coupon rate! At maturity it pays the face value plus accumulated interest

Convertible bonds

A type of bond that can be exchanged for common stock offered by the bond-issuing company. This feature provides the stable income and fixed payment of the debt, but also allows the bondholder to share in a company’s growth and profitability.

Call provision

Part of a bond indenture that allows the issuer to buy back the bond under certain conditions

Indenture

Written agreement between the corporate debt issuer and the lender. Sets forth maturity date, interest rate, and other terms

Protective covenant

Part of the indenture that protects bondholders by limiting certain actions a company might otherwise take

Collateral

Assets that are pledged as security for payment of debt

Debenture

A bond that is not secured by an underlying asset

Amortized Loan

A loan with a scheduled number of equal patments, with each payment including both interest payments and a partial payment on the amount on the loan’s principal

Interest Rate Risk

The market price of a bond varies inversely with the current required rate of return

Discount

A bond that sells at a discount when its market price is less than its face value. This occurs when the coupon rate is less than the current YTM

Premium

A bond sells at a premium when its market price is greater than its face value. This occurs when the coupon rate is greater than the current YTM

Default Risk

The risk that a bond issuer may not honor the provisions of the bond indenture, causing a loss in value of the bond

Investment Grade Bonds

Bonds are rated to have a relatively low probability of default and are acceptable to prudent investors such as pension funds

Speculative Bonds/junk bonds

Bonds are rated to have a higher probability of default. These bonds would be attractive to investors who have a high tolerance for risk, but would not be held by companies with fiduciary obligations, such as pension funds

Price Discovery

Investors decide how much to pay for a security based on how much money they think the investment will make and how risky it is

Index Funds

Offer lower cost way to make money. High diversification of money, track performance of underlying stock index, tiny piece of hundred/thousands of companies in 1 investment. Staple of passive investing because doesn’t involve stock picking.

Tax Take

Passively managed funds are more tax efficient than actively managed ones

Golden Cross

Moving average of given set of prices over a specific number of days in the past

Market Makers

Individuals and firms that assist others in completing market transactions. Broker and dealers.

Insurance Company

Assist retirement, life insurance to protect family financial loss, insure properties from damage

Pension Fund

Assist companies, government and other organizations in providing retirement income for their employees

Investment Fund

Sell their own shares to investors and use proceeds to invest in financial securities on behalf of investors. Allow small businesses to hold diversified portfolio of assets and geography

Markets

Involve the trading of property rights and are information processors