FIN 320F Exam 3 Unit 8

Balance Sheet Model of the Firm

The assets of the firm must be supported by the firm obtaining financing (borrowing or issue equity).

- 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.

finance

the management of money

- money used through capital budgeting decision (what assets should firm purchase and whats their economic value)

- money obtained through capital structure decision (market value of debt and equity)

- market value of securities (stocks and bonds) based on future cash flows produced by companys assets

financing the company

what financial instruments used to get money

1. debt (bonds and bank loans)

2. equity (shares of stock)

4 types of financial securities

1. bond

2. bank loans

3. preferred stock

4. common stock

Bond

A security representing the long-term debt of a company (a long-term promissory note)

- pays a fixed interest rate

formal loan

Bank loan

Indirect financing where the company borrows funds from a bank, which gets those funds from savers.

- 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.

- Preferred shareholders receive dividends before common shareholders.

- dividends are generally fixed and do not have voting rights in the corporation.

- dividends not guaranteed

Common stock

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

- represents ownership in a company: the right to all residual cash flows after the claims of the company's stakeholders have been satisfied.

-control the company through election of the board of directors.

- dividends not guaranteed

Institutional investors

These organizations pool large sums of money and invest those sums in securities, real property securities, and other investment assets.

- role in the economy is to act as highly specialized investors on behalf of others.

Privately held company

A company that raises capital by selling their securities directly to investors rather than the general public. (ex: HEB stock)

- not registered with SEC (do not provide info to public, cannot sell securities to public, sales negotiated btwn company and potential buyers)

- small number of shareholders (have inside info abt company, decisions/plans private, quick decisions)

- may not be able to raise as much capital

Publicly traded Corporations

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

- registered with the SEC (provide info to public, sell securities to public)

- primary and secondary market transactions

- can buy and sell your own to public

- face more public scrutiny

- raises large amounts of capital

Primary market transaction

Corporations and other organizations, with the assistance of investment banks, create financial securities and issue them to the investing public.

- how companies raise capital.

- ex of when a company "goes public"

-examples:

1. IPO

2. SEO

3. rights offer

4. crowd funding

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.

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.

- prices goes up if company is doing well (means stock price has information)

Direct financing

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

- companies pay interest and dividends in exchange for money

- exchanges, brokers, OTC markets, dealers

Exchanges

Organized public markets where companies list their securities for trading by investors.

- must follow securities laws and regulations to be traded on public markets.

- generally organized as profit-seeking companies.

Broker

An entity that brings security buyers and sellers together but does not maintain an inventory (does not own traded asset)

- makes a profit via a commission paid for services rendered in facilitating the trade.

ex: real estate broker

Dealer

A market maker that maintains an inventory and stands ready to buy and sell at any time (owned traded asset)

- makes a profit through the bid-asl spread: by buying an asset at one price and selling the asset at a higher price.

-ex: used car dealer

Over-the-Counter (OTC) markets

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

- digital store

- ex: Nasdaq

Indirect financing

involves financial institutions that are intermediaries between savers and borrowers.

- financial institutions: commercial banks, investment funds, insurance companies, pension funds

auction markets

NYSE

physical location where brokers and agents meet to buy and sell securities

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.

Commercial Bank

A financial intermediary that serves as an interface with savers and borrowers.

-accept deposits from savers that offer safety and a rate of return.

- lend these funds out to individuals and businesses who need to borrow.

- make a profit by lending out funds at an interest rate that is higher than the rate they pay to their depositors.

Intermediary

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

Financial markets

Markets in which financial securities are issued and traded.

financing options for startups

crowdfunding, bootstrapping, and venture capital

Crowdfunding

Websites in which companies needing capital post information about their company and invite individuals to invest.

- new way to raise money for companies

- bypasses the traditional financial intermediaries such as investment banks and commercial banks.

ex: gofundme

Bootstrapping

involves using personal savings, selling personal assets, borrowing against assets, using credit cards, and taking 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.

- most will fail

market

place where buying and selling hapepens

- means of trading property rights

- information processors

Efficient Market Hypothesis (EMH)

States that prices of securities fully reflect available information.

- investors seek info that will make them wealthier

- 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.

- price changes reflect supply and demand

market elements that do not contribute to market efficiency

1. different interpretations (pessimistic vs optimistic)

2. irrational investors

3. fraud

4. different goals

markets are dominated by rational investors

Efficient market

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

1. investors: no strategy will create excess returns; hold a diversifable portfolio

2. companies: market can eval company performance; decisions guided by stock price changes

3. government: markets allocate scarce resources; limit interactions with markets

inefficent markets

1. investors: market price does not reflect economic value; can be exploited

2. companies: look at things other than price to tell us how we are doing

3. government: use fiscal and monetary policy to guide economy

3 types of information

1. historic info: economic mkt info from the past (prices, trading volumes, movements of prices); tech analysis

2. public info

3. private info

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.

- ex: golden cross

Public information

Information available to the investing public.

- company reports, analyst reports, blogs/videos

- fundamental analysis

- total return = Expected return (Predictable information) + Unexpected return (surprises)

surprises= market risk and unique risk

Fundamental analysis

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

Private information

Information that is not available to most investors.

- insider trading, special technical knowledge, political info, insights into way society operates --> very unique and only we have

Insider trading

An insider is anyone with nonpublic specific information.

- cannot use their information to take unfair advantage when trading with outsiders.

Weak-form efficient market

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

- tech analysis is waste of time

- cannot beat market with just historical data

Semi-strong efficient market

Theory that a market is efficient with respect to public information.

- public AND historic (cant beat with just this)

- fundamental analysis=waste of time

Strong-form efficient market

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

- cant consistently beat mkt by looking at any amt of info