business finance v2

Investing

Investors allocate money or capital to work on a project or undertaking to generate positive returns, or profits.

Types of Investments

Stocks, Bonds, Funds, Investment Trusts, Alternative Investments, Options and Other Derivatives, Commodities

Stocks

buyer of a company's stock becomes a fractional owner of that company. Owners of a company's stock are known as its shareholders. They can participate in its growth and success through appreciation in the stock price and regular dividends paid out of the company's profits.

Bonds

are debt obligations of entities, such as governments, municipalities, and corporations.

Funds

are pooled instruments managed by investment managers that enable investors to invest in stocks, bonds, preferred shares, commodities, etc.

Investment Trust

are another type of pooled investment. Real Estate Investment Trusts (REITs) are one of the most popular in this category. REITs invest in commercial or residential properties and pay regular distributions to their investors from the rental income received from these properties.

Alternative Investment

a catch-all category that includes hedge funds and private equity. Hedge funds are so-called because they can limit (hedge) their investment risks by going long and short on stocks and other investments.

Options and Other Derivatives

are financial instruments that derive value from another instrument, such as a stock or index. Options contracts are a popular derivative that gives the buyer the right but not the obligation to buy or sell a security at a fixed price within a specific period.

Commodities

include metals, oil, grain, animal products, financial instruments, and currencies. They can either be traded through commodity futures-agreements to buy or sell a specific quantity of a commodity at a specified price on a particular future date-or ETFs.

Most common investing styles

Active Investing, Passive Investing Growth, Value

Active Investing

to "beat the index" by actively managing the investment portfolio

Passive Investing

advocates a passive approach, such as buying an index fund, in tacit recognition of the fact that it is difficult to beat the market consistently

Growth investors

prefer to invest in companies in their growth stages, which typically have higher valuation ratios than value companies.

Value investors

look for companies that are undervalued by the market and that meet their more strict investing criteria.

How to Invest

1. Do-It-Yourself Investing

2. Professionally Managed Investing 3. Robo-Advisor Investing

Statement of Financial Position (SFP)

also known as the balance sheet, is a financial statement that presents a company's assets, liabilities, and equity at a specific point in time.

assets, liabilities, equity

Key Elements of the SFP

assets= liabilities+ equity

equation

Assets

What the company owns that has future economic value.

Liabilities

What the company owes to other entities, such as creditors.

Equity

The owners' stake in the company, representing the residual value of assets after deducting liabilities. This is also sometimes referred to as capital or net assets.

Financial Health, Liquidity Solvency, Financial Performance

Purpose of the SFP

Statement of Financial Position (SFP)

is prepared using account titles organized under the classifications of assets, liabilities, and equity.

Statement of Comprehensive Income (SCI)

focuses on reporting a company's financial performance over a specific period, encompassing both revenues and expenses.

Statement of Comprehensive Income (SCI)

It outlines the company's profitability and includes both net income and other comprehensive income items.

Statement of Comprehensive Income (SCI)

provides a ___________ view of the company's financial health, including gains and losses, and is crucial for stakeholders to assess profitability and overall performance.

Revenues, Expenses, Gains, Losses, Net Income

Key Components of the Statement of Comprehensive Income

Losses

Decreases in equity from transactions that are peripheral or incidental to the entity's main operations.

Net Income

The difference between total revenues and total expenses.

Revenues

These are inflows of assets or reductions of liabilities from delivering or producing goods, rendering services, or other activities that constitute the entity's primary operations.

Expenses

These are outflows or using up of assets or incurrences of liabilities in the process of generating revenues.

Gains

Increases in equity from transactions that are peripheral or incidental to the entity's main operations.

Single step, Multi step

Different Presentation Methods

Single step

A simple presentation where all revenues are grouped together and all expenses are grouped together, with the difference being net income.

Multi step

A more detailed presentation that separates cost of goods sold from other operating expenses, leading to the calculation of gross profit before arriving at net income.

The Statement of Changes in Equity (SoCE)

prepared to meet the requirements of the readers to understand the transactions that caused the movements in aquity accounts.

sole proprietorship, partnership, corporation

forms of business organization

sole proprietorship

the simplest form of a business organization. This is only one owner reffered to as sole proprietor. oftentimes, the owner is also the manager.

partnership

has a legal personality separate from its owners. It is taxed separately from the partners except for those formed for the practice of the profession of the partners.

corporation

is the most complex form of business organization. A ________ is owned by many owners called stockholders or shareholders.

Financial statements

inform the readers of a company's financial position, results of operations, cash flows, and changes in equity.

financial statement analysis

is the process of evaluating risks, performance, financial health, and future prospects of a business using computational and analytical techniques with the objective of making economic decisions.

horizontal analysis, vertical analysis

two different techniques

horizontal analysis

is also known as trend analysis. It is a technique that involves the comparison of a line item over a number of period.

vertical analysis

is the preparation of common-size finantial statements. It is a technique that expresses each financial statement line item as a percentage of a base amount.

Statement of cash flow (SCF)

is the financial statement that explains the net change in cash for the year.

operating, investing, and financing

three major activities of the business

risk

refers to the possibility that the actual results of an investment or decision may turn out differently, often less favorably, than what was originally anticipated

Riskless Securities

While it is true that no investment is fully free of all possible risks, certain securities have so little practical risk that they are considered risk-free or riskless

Risk and Time Horizons

are often key factors influencing risk assessment and risk management

Types of Financial Risk

systematic risk and unsystematic risk.

Systematic risks

also known as market risks, are risks that can affect an entire economic market overall or a large percentage of the total market

Unsystematic risk

also known as specific risk or idiosyncratic risk, is a category of risk that only affects an industry or a particular company. market < Unsystematic risk is the risk of losing an investment due to company or industry-specific hazards

several specific types of risk

1. Business Risk

2. Credit or Default Risk

3. Country Risk

4. Foreign-Exchange Risk

5. Interest Rate Risk

6. Political Risk

7. Counterparty Risk 8. Liquidity Risk 9. Model Risk

Business risk

refers to the basic viability of a business-the question of whether a company will be able to make sufficient sales and generate sufficient revenues to cover its operational expenses and turn a profit

Credit or Default Risk

is the risk that a borrower will be unable to pay the contractual interest or principal on its debt obligations. This type of risk is particularly concerning to investors who hold bonds in their portfolios

Country risk

refers to the risk that a country won't be able to honor its financial commitments

Foreign-Exchange Risk

When investing in foreign countries, it's important to consider the fact that currency exchange rates can change the price of the asset as well. Foreign exchange risk (or exchange rate risk) applies to all financial instruments that are in a currency other than your domestic currency

Interest Rate Risk

the risk that an investment's value will change due to a change in the absolute level of interest rates, the spread between two rates, the shape of the yield curve, or any other interest rate relationship

Political Risk

the risk that an investment's returns could suffer because of political instability or changes in a country. This type of risk can stem from a change in government, legislative bodies, other foreign policy makers, or military control

Counterparty Risk

the likelihood or probability that one of those involved in a transaction might default on its contractual obligation. Counterparty risk can exist in credit, investment, and trading transactions, especially for those occurring in over-the-counter (OTC) markets.

Liquidity Risk

associated with an investor's ability to transact their investment for cash. Typically, investors will require some premium for illiquid assets, which compensates them for holding securities over time that cannot be easily liquidated

Model Risk

This type of risk arises from the use of financial models to make investment decisions, evaluate risks, or price financial instruments. Model risk can occur if the model is based on incorrect assumptions, data, or methodologies, leading to inaccurate predictions and potentially adverse financial consequences