RSM230 - week 1

the process of making and managing expenditures on long-lived assets

define capital budgeting / capital expenditure

the proportions of the firm's financing from current and long-term debt and equity

define capital structure

current assets minus current liabilities

define net working capital

1. In what long-lived assets should the firm invest?

2. How can the firm raise cash for required capital expenditure?

3. How should short-term operating cash flows be managed?

state the 3 basic questions of corporate finance

- identification of cash flows (extracting cash flow information from accounting statements)

- timing of cash flows (one dollar today worth more than one dollar tomorrow)

- risk of cash flows

reasons why value creation is difficult (3-)

claims whose value is directly dependent on, or is contingent on, the value of their underlying assets

define contingent claims

a business owned by a single individual (pays no corporate income tax but has unlimited liability for business debts and obligations)

define sole proprietorship

form of business organisation in which two or more co-owners form a business (general partnership - each partner is liable for the debts of the partnership. limited partnership - permits some partners to have limited liability)

define partnership

form of business organisation that is created as a distinct "legal person" composed of one or more actual individuals or legal entities

define corporation

the rules to be used by the corporation to regulate its own existance

define bylaws

a non-corporate form of business organisation (has limited liability protection and is taxed like corporations)

define income trust

the firm can be viewed as nothing more than a set of contracts

state the set-of-contracts viewpoint

the costs of resolving the conflicts of interest between managers and shareholders

define agency costs

- the monitoring costs of the shareholders

- the inventive fee paid to the managers

state the 2 types of agency costs

the lost wealth of the shareholders due to divergent behaviour of the managers

define residual losses

- shareholders determine the membership of the board of directors by voting, and the board of directors select the management team

- shareholders sign contract with managers and arrange for compensation like giving managers stock option plans and arranging for compensations

- the fear of takeover gives managers an incentive to take actions that will maximize stock prices

- some firms compensate managers based on the value they create for shareholders, luring good managers in the labour market

How are managers bonded to shareholders? (4-)

1. survival - management must always command sufficient resources to support the firm's activities

2. independence - the freedom to make decisions and take action without encountering external parties or depending on outside financial markets

3. self-sufficiency - managers do not want to depend on external parties

What are some managerial goals? (3.)

investing by screening and selecting securities based on social or environmental criteria

define socially responsible investing

- money market

- value market

state the 2 types of financial market that depends on their maturity (2-)

financial markets for debt securities that pay off in the short term (usually less than one year) (e.g. bank acceptance)

define money market

financial markets for long-term debt and for equity shares (e.g. Toronto Stock Exchange)

define capital market

- primary market

- secondary market

state the 2 types of financial market that depends on the newness of the securities (2-)

markets containing the original sale of securities by governments and corporations

define primary market

markets where these securities are bought and sold after the original sale

define secondary market

- public offerings

- private offerings

state the 2 types of transaction in the primary market

selling securities to the general public

define public offerings in the primary market

negotiated sale involving a specific buyer

define private offerings in the primary market

the process through which an individual or institution takes on financial risk for a fee

define underwriting

an investment dealer or a group of investment dealers

define a syndicate

the Toronto Stock Exchange (TSX)

what is the largest stock market in Canada?

- dealer market or over-the-counter market

- auction market

state the 2 types of secondary market

- no central location (dealers connected electronically)

- most buying and selling is done by the dealer

features of dealer markets / OTC markets (2-)

- has a physical location

- primary purpose is to match those who wish to sell with those who wish to buy (dealers play a limited role - unlike OTC markets)

features of auction markets (2-)

the action of putting stocks on an organised exchange

define listing

- chartered banks

- trust companies

- credit unions

- investment dealers

- insurance companies

- pension funds

- mutual funds

list the principal types of financial institutions in Canada (7-)

could be both

is chartered banks direct or indirect finance?

indirect finance

is trust companies direct or indirect finance?

indirect finance

is credit unions direct or indirect finance?

direct finance

is investment dealers direct or indirect finance?

indirect finance

is insurance companies direct or indirect finance?

direct finance

is pension funds direct or indirect finance?

direct finance

is mutual funds direct or indirect finance?

managing assets for estates, registered retirement saving plans, etc.

define fiduciary activities

- importers converting their domestic currency to foreign currency to pay for goods from foreign countries

- exporters receiving foreign currency and wanting to convert to the domestic currency

- portfolio managers buying and selling foreign stocks and bonds

- foreign exchange brokers matching buy and sell orders

- traders marking the market in foreign exchange

different types of participants in the foreign exchange market (5-)

statement showing a firm's accounting value on a particular date

define statement of financial position

assets = liabilities + shareholders' equity

state the statement of financial position equation

- liquidity

- debt versus equity

- value versus cost

3 things to keep in mind when looking at a statement of financial position

the ease and speed with which assets can be converted to cash

define liquidity

obligations of the firm that require a payout of cash within a stipulated time period

define liabilities

liabilities frequently associated with normally fixed cash burdens

define debt service

a claim against the firm;s assets that is residual and not fixed

define shareholders' equity

the accounting value of a firm's assets

define carrying value / book value

a set of international accounting standards stating how particular types of transactions and other events should be reported in financial statements (publicly traded firms in Canada using IFRS)

define the International Financial Reporting Standards

the price at which willing buyers and sellers trade the assets

define market value

financial report that summarizes a firm's performance over a specific time period

define statement of comprehensive income

income = revenue - expense

state the statement of comprehensive income equation

- IFRS (International Financial Reporting Standards)

- non-cash expenses

- time and costs

3 things to keep in mind when looking at the statement of comprehensive income

expenses against revenue but do not affect cash flow directly (e.g. depreciation, amortization, and deferred taxes)

define non-cash items / non-cash expenses

the accountant's estimate of the cost of equipment used up in the production process

define depreciation

the difference between the accounting income and the true taxable income

define deferred taxes

costs that are allocated to a time period (selling/general/administrative expense)

define period costs

net working capital = current assets - current liabilities

formula of net working capital

difference in net working capital from one period to another

define change in net working capital

earnings before interest and depreciation - taxes

formula of cash flow from operations

cash generated by the firm and paid to creditors and shareholders

define cash flow

- cash flow from operations

- cash flow from changes in fixed assets / long-term assets

- cash flow from changes in net working capital

list the 3 types of cash flows (3-)

the cash flow generated by business activity, including sales of goods and services, not including financial cash flow, capital spending, or changes in net working capital

define operating cash flow

cash that the firm is free to distribute to creditors and shareholders because it is not needed for working capital or fixed asset investment

define free cash flow

total cash inflow minus total cash outflow

define total cash flow of the firm

total cash flow of the firm = total cash inflow - total cash outflow

formula of total cash flow of the firm

cash flow is cash based while net income is accrual based

state the main difference between total cash flow and net income

cash flow from assets = cash flow to bondholders and shareholders

state the cash flow identity

CF(A) = CF(B) + CF(S)

the formula of the cash flow identity

- bond features

- credit risk

- interest rates

- liquidity

what does the value of bond depends on (4-)

lending money

buying bonds = lending or borrowing money

borrowing money

issuing bonds = lending or borrowing money

- face value (the principal)

- coupon

- maturity

- issuer

- many other features

important features of bonds (5-)

coupon = coupon rate x face value

formula of coupon

- discount bond

- premium bond

- par bond

state the 3 types of bonds with different coupon rates (3-)

- coupon rate > yield

- bond price > face value

- interest paid > interest expense

- attractive to borrowers

features of premium bond (4-)

- coupon rate < yield

- bond price < face value

- interest paid < interest expense

- not attractive to borrowers

features of par discount bond (4-)

- coupon rate = yield

- bond selling price = face value

- interest paid = interest expense

features of par bond (3-)

the fair interest rate that determines the market price of the bond

define yieldthe

the bond when the coupon rate is zero

define zero coupon bond

- supplies capital

- claims on cash flow

- fixed (contractual) cash flow

- senior claim

features of bonds/debt (4-)

- supplies capital

- claims on cash flow

- discretionary cash flow

- regular claim

- voting rights

- direct ownership

- mutual funds

- exchange traded funds (ETF)

features of stock/equity (8-)

What is a bond?

A piece of paper that basically says that I owe you money

-Normally done by bigger Corporations

-Lots of Legalities

-How long till it matures?

-Bond is both a loan and the sale of piece of better(Canada burrowing a lot of money, and buying Canada bonds is the same thing)

What is the principal of the bond?

The original burrowing amount

But this is not really how you think about it principal is normally higher

What is the coupon of the bond?

The interest of the bond but it is not normally the full dollar on the 20 it is more or less depending on the coupon amount.

Why is the coupon less?

This is due to credit risk

Government risks

A government that prints it’s own money has 0 percent credit risk, however if you go to europe, or onthario; that carries more or less

Why will there never be ea perfect bond with 0 % interest as well?

Due to banks charging a higher interest rate

Credit risk fluctations?

Burrower/issuer becomes more credit worthy bond values go up, and burrower/issuer becomes less credit worthy bond values go down

Interest rate on bond fluctuations

If the interest rates go down, bond values go up, if interest rates go up, bond values go down; it is an inverse mechanism

What do companies do sometimes?

Cmopanies give variable amounts as paybacks, 1 percent of profits; but they dont know how much that is worth; need to give some sort of esetimate; share of stock is not very different;

Bonds and Shares

Companies use them to raise capital, then bonds and stocks trade it, the last one holding it gets lump of money, legally bonds and shares are very different things, bonds are liabilities to company, shares are ownership to this class; from an economics perspective they’re the same thing, you give them money and have a claim on future cashflow.

How is the value of the bond effected by

-Value Is effected by interest rates, NOT THE COUPON RATE, specifically the market inflation rate, what are banks [aying, those things that are going on in the economy,  interest rates out there. Interest rate high bond goes higher

what is the face value, or principal

coupon

maturity- how long till you get it back

isssuer- who is the man lending bond, why does it matter, credit risk!!!

What determines the value of the bond

-features, big or little copone , big or little principal

-credit risks, chance of pay back

--liquidity, effects the value, this is a big deal, some investments are liquid, the most liquid investment is the US treasury bill, what you can do is buy and sell and buy and sell very fast, less liquid means that its hard to find buyers, illiquid is like house, people finding a buyer for a house is very hard, buy and sell gets you killed by fees.

How do bonds pay out?

Bonds normally pay out semi-annually, and the coupon rates show for annual

How do governments sell bonds?

the way governments sell bonds is through an auction; who ever is willing to pay the most wins the auction and gets the bonds, who participates? BOFA, RBC, CITI bank, largest institutions

Case of paying 990k for a million dollar bond

highest bidder was willing to pay 990k, 

what was the interest rate back in 1977?  So was it worth I?

what was the currency though? USD

who was the burrower? US government

What is the length of the laod? 30 year loan in 1977

What is the interest rate of 1977? Not gonna be the same interest rate? 

Paid less than 1 million for the bond, which means that the interest rate was higher than the rate they were given, FAIR INTEREST RATE WS 7.81, which means 7.625 was too long, which means the buyer gave less. The fair interest rate was a little bit above.  If you bought the bond for 990k what’s your return, 76k is more than 7.625 percent and on top of that you’d be given a bonus of 10k