finance exam 1

valuation principle

Balances costs and benefits using market prices; values cash sooner, larger, and with less risk

Sole Proprietorship

One-owner business with easy startup, pass-through taxes, but unlimited personal liability and limited life

General Partnership

Multi-owner business where all partners share management and have unlimited personal liability

Limited Partnership (LP)

General partners run the business with full liability; provide cash with limited liability and no control

Limited Liability Company (LLC)

Hybrid entity where all owners have limited liability and can actively manage the business

Corporation

Separate legal entity offering limited liability, unlimited life, and easy share trading, but subject to corporate regulations

Double Taxation

C corporation profits are taxed at the entity level, and dividends are taxed again on personal returns

S Corporation

Corporation with $\le$ 100 owners exempt from corporate tax; profits/losses pass directly to individual returns

Capital Budgeting

Evaluating and managing a firm's long-term investment decisions and project cash flows

Capital Structure

The mix of long-term debt and equity used to finance operations

Working Capital Management

Managing short-term cash needs and daily liquidity to pay current obligations

Financial Manager

Maximize shareholder wealth (stock value)

Agency Relationship & Problem

Occurs when owners hire managers (agents); problems arise when managers prioritize personal interests over shareholders

Primary Market

Company issues new securities to investors to raise capital

Secondary Market

Investors trade existing securities amongst themselves

Bid-Ask Spread

The gap between the sell price and buy price; represents trading cost and market-maker profit

Market Order

Executes immediately at current market price

Limit Order

Executes only at a set price or better

Financial Cycle

Savers provide capital to companies to fund projects, and profits/wages/interest flow back to savers

Move funds from savers to borrowers, transfer funds across time, and spread out risk

3 Roles of Financial Institutions

Cost-Benefit Analysis

Evaluating a decision by comparing benefits and costs; increases firm value if benefits exceed costs

Competitive Market

A market where goods can be bought and sold at the same price, which determines their true value

Law of One Price

In competitive markets, securities or assets with identical cash flows must sell at the same price

Time Value of Money

The difference in value between money today and money in the future; a dollar today is worth more than a dollar later

Interest Rate

The price of using money; the rate at which money can be borrowed or lent over a specific period; the exchange rate across time

Interest Rate Factor

(1 + r); converts cash flows from today into equivalent dollars one period into the future

Opportunity Cost of Capital

The return given up by investing money in an asset rather than leaving it in an alternative risk-equivalent investment

Discount Rate

1/(1 + r); the value today of receiving one dollar in the future

Rule 1 of Time Travel

Values can only be compared or combined if they occur at the exact same point in time

Rule 2 of Time Travel

To move a cash flow forward in time, compound it

Compound Interest

Earning "interest on interest" over time in addition to interest on the original principal deposit

Rule 3 of Time Travel

To move a cash flow backward to an earlier time, discount it

Stream of Cash Flows

A series of multiple cash receipts or disbursements occurring over different points in time

Perpetuity

A stream of identical, equally spaced cash flows that continues forever

Annuity

A stream of equal cash flows paid at regular intervals that ends after a fixed number of periods

Annual Percentage Rate (APR)

Simple annual interest quote that ignores compounding; used to calculate the periodic rate but not entered directly into TVM formulas

Effective Annual Rate (EAR / APY)

The actual total interest earned or paid in one year, including the full effect of compounding; used to compare rates across different frequencies

Nominal Interest Rate

The quoted rate at which invested money grows, before adjusting for changes in purchasing power

Inflation Rate

The rate at which the general prices of goods and services rise over a given period

Pure Discount Loan

A loan where the borrower receives cash upfront and makes a single lump-sum repayment of principal and interest at maturity

Interest-Only Loan

A loan where the borrower pays only periodic interest expenses and repays the full original principal at maturity

Amortized Loan

A loan repaid via equal periodic payments where each payment covers accrued interest and reduces a portion of the principal balance

Outstanding Loan Balance

The remaining balance of an amortized loan at any date; equals the present value of all remaining future scheduled loan payments

hedge funds

open to wealthy investors

mutual funds

pools money from many investors to buy a basket of assets like stocks and bonds; low risk

pension funds

large pool of money set aside by employers, unions, or governments to pay workers a steady monthly income after they retire

venture capital funds

pooled investment vehicles that finance high-risk, high-return startups and early-stage companies in exchange for equity

private equity funds

pooled investment vehicle that raises capital from institutional and accredited investors to buy ownership stakes in private companies or take public companies private

banks

a licensed financial business that accepts deposits from the public and makes loans

credit unions

a not-for-profit financial institution owned and controlled by the people who use its services

financial conglomerates

a large corporate group that offers services across at least two different financial sectors, such as banking, insurance, and securities

financial institutions

banks, credit unions, insurance companies, mutual funds, pension funds, hedge funds, venture capital funds, private equity funds, financial conglomerates

insurance companies

a financial business that protects people and organizations from money loss