FINC 310 ch.1-3

Finance Exam 1

Finance

the system that includes the circulation of money, granting of credit, making of investments, and provision of banking facilities

financial management

also called corporate finance. Focuses on how much and what type of assets to acquire and raise capital for purchasing assets

capital markets

markets where interest rates, stock prices, and bond prices are determined

security analysis

finding proper values of individual securities (stocks and bonds). part of investment activities

portfolio theory

figuring out best way to structure portfolio (baskets) of stocks & bonds. Want diversified portfolios (limit risk & balance portfolios). part of investment activities

market analysis

figuring out if whether stock and bond markets are too high, low or right. part of investment activities

behavioral finance

investor psychology examined to determine if stock prices are bid up to unreasonable heights or down (due to irrational pessimism)

Sarbanes-Oxely Act

A law passed by Congress that requires the CEO and CFO to certify that their firms’ financial statements are accurate.

proprietorships

an unincorporated business owned by one individual

pros about proprietorships

1. they are easy and inexpensive to form

2. they are subject to few government regulations

3. they have lower income taxes

cons about a proprietorship

1. they have unlimited personal liability

2. the life of the business is limited to the individual who created it

3. it is hard to obtain large sums of capital and bank loans

partnership

an unincorporated business owned by two or more persons

pros of a partnership

1. easy and inexpensive to form

2. fewer government regulations

3. subject to lower income tax

4. based on a pro rata basis so firms income is allocated and taxed individually

cons of a partnership

1. unlimited personal liability, partner subject to paying

2. limited life

3. harder to obtain capital

corporations

a legal entity created by a state, separate and distinct from its owners and managers

pros for a corporation

1. separation from owner and managers (limited liability)

2. unlimited life and easier to transfer shares of stock

3. easier to raise capital and get bank loans

cons of a corporation

1. double taxation

2. harder to get enough capital to start out

S-corporation

a special designation that allows small businesses that meet qualifications to be taxed as if they were a proprietorship/partnership rather than a corporation

C-corporation

another name for a larger corporation

LLC (limited liability companies)

a type of organization that is a hybrid between a partnership and corporation

LLP (limited liability partnership)

similar to an LLC, but is used for professional firms in the fields of accounting, law and architecture. provides personal asset protection from business debts and liabilities but is taxed as a partnership/ proprietorship (avoids double taxation)

Main financial goal

create and increase value for investors

intrinsic value

an estimate of a stocks “true” value based on accurate risk and return data. Based on the future cash flows expected and risk of stock. Can be estimated, but not measured

market price

the perceived stock value based on information that is public

marginal investor

an investor whose views determine the actual stock price

when intrinsic = market price (equilibrium)

when the actual market price equals the intrinsic value, investors are indifferent between buying and selling a stock (no pressure for change in stock price_

financial management goal

maximize intrinsic value of a firms stock price

corporate governance

establishment of rules and practices by a Board of Directors to ensure that managers act in shareholder’s interests while balancing needs of other key constituencies

Tools to help managers personal goals align with shareholder wealth maximization (goal of company/ financial management)

1. reasonable compensation packages

2. firing under-perfoming managers

3. threat of hostile takeover

ESG (environmental, social, and governance)

shareholders belief in activist investing which can pressure companies to become more socially responsible

corporate raiders

individuals who target corporations for a takeover because they are undervalued

hostile takeover

the acquisition of a company over the opposition of its management

B-Corps (benefit corporations)

companies certified that focus on making a profit while being committed to putting stakeholders, etc. on equal footing with shareholders

shareholders

investors that own a portion of the stock, own a share of the company, and have a goal of maximizing shareholder value

stakeholders

anyone interested or has stake in the company. this includes workers (can be both stakeholder and shareholder), suppliers, customers, and society

direct transfer (of money and securities)

when a business sells its stocks or bonds directly to savers w/out any financial institution. often done by small firms and relatively little capital is raised

primary market transaction

transferring through investment banking (ex. morgan stanley) which underwrites the issue of the money and facilitates the issuance of securities. the company sells its stocks/ bonds to the IB which is then sold to savers. The IB works as a pass through that takes on the risk of these securities

financial intermediary

this is a transfer done through a bank, insurance company, or mutual fund. The intermediary obtains funds from savers in exchange for its securities. The intermediary uses the money and buys/ holds business securities and the savers hold the intermediaries securities

financial markets

a place where people and organizations wanting to borrow money are brought with those who have a surplus of funds

physical market

market for tangible/ real asset markets for products such as wheat, real estate, computers, machinery, etc.

financial markets

market for financial assets for things like bonds, stocks, notes, mortgages, etc. Also deal with derivative securities whose values are derived from changes in the prices of other assets

spot markets

market in which assets are bought or sold for on the spot delivery

future markets

the markets in which participants agree today to buy or sell an asset at some future date

money markets

the financial markets in which funds are borrowed or loaned for a short period (less than one year, highly liquid debt securities)

capital markets

financial markets for stocks and intermediate/ long term debt (1+ years) ex. NYSE

primary market

markets in which corporations raise capital by issuing new securities

secondary market

markets in which securities and other financial assets are traded among investors after they have been issued by corporations

private market

market in which transactions are worked out directly between two or more parties (bank loans, private debt placements w/ insurance companies) transactions are private and done in a structured manner

public markets

markets in which standardized contracts are traded on organized exchanges. the securities traded publicly being common stock or corporate bonds are held by a lot of individuals, need contractual features due to many investors and is more liquid than tailor made negotiated securities

securities

financial assets/ tools that can be traded in financial markets such as stocks, bonds, CD’s, common stock, leases, etc.

crowdfunding

tech that allows individuals and firms to bypass intermediaries and directly raise money from investors to help fund projects

high-frequency trading (HFT)

trading tech that uses computer algorithms to buy and sell securities

robo-advisors

algorithmic tech to create low-cost optimal investment portfolios for investors

paying in transactions

increased tech such as credit and debit cards used over cash

derivatives

any financial asset whose value is derived from the value of some other “underlying asset”

credit default swaps (CDS)

create default swaps, are contracts that offer protection against the default of a particular security

financial institutions

small companies and institutions that use direct funds transfers most often but for large businesses in developed economies its more efficient to enlist services of financial institutions when it comes to raising capital

investment banks

an organization that underwrites and distributes new investment securities and helps businesses obtain financing

• traditionally helps companies raise capital

• help corporations with designing securities w/ features that are attractive to investors

• buys these securities from corporations and resells them to savers.

• also called underwriters

commercial banks

the traditional department store of finance serving a variety of savers and borrowers

financial services corporations

a firm that offers a wide range of financial services including IB, brokerage operations, insurance, and commercial banking

• conglomerate combination of different institutions within a single corporation

credit unions

cooperative associations whose members are supposed to have a common bond. Members money is only loaned to other members which are often used for auto purchases, home improvement loans, or mortgages

pension funds

retirement plans funded by corporations or gov. agencies for their workers

life insurance companies

takes savings in the form of annual premiums, invest these funds into stocks, bonds, real estate, and mortgages and makes payments to the beneficiaries of the insured parties

mutual funds

organizations that pool investors funds to purchase financial instruments and thus reduce risks through diversificaiton

exchange-traded funds (ETFs)

similar to regular mutual funds and often operated by mutual fund companies. These are bought portfolios of stock and then sold shares to the public

hedge funds

similar to mutual funds because they accept money from savers and use funds to buy various securities, but are different as they are largely unregulated and requires a minimum investment (people w/ high net worth).

arbitrage

the practice of buying and selling the same asset in different markets to profit from price differences

private equity companies

organizations that operate like hedge funds, but rather than purchasing some of the stock of a firm, they buy and manage the entire firm

venture capital (part of private equity)

private firms getting capital to grow/ expand (startup sold in the public market once it gets bigger)

buyout market (part of private equity)

financial firms that go out and buys publicly owned shares of a corporation and make it private to fix, merge, or improve the company and resell it to get a higher buyout

actively managed funds

trying to outperform the overall markets

indexed funds

trying to replicate performance of a specific market index (tracking)

securitization

act of turning something into a security

stock markets

places that prices of stocks are made

physical location exchanges (regional stock exchanges)

formal organizations having tangible physical locations that conduct auction markets in designated “listed” securities

• example of NYSE

• allows limited number of people to trade on its floor

• board of governors elected

• most large companies trade on this market

electronic dealer-based markets

less formal over the counter market

• example NASDAQ

• electronic communication networks (ECNs)

over the counter (OTC) markets

a large collection of brokers and dealers, connected electronically by telephones and computers that provides for trading in unlisted securities

• operates as auction markets

• buy and sell orders come at the same time

• done by brokerage firms that maintain an inventory of stocks and are prepared to make a market for them

dealer markets

includes all facilities that are needed to conduct security transactions not conducted on the physical location exchanges

• relatively few dealers who hold inventories of these securities

• thousands of brokers who act as agents in bringing dealers together w/ investors

• dealers: make a market in a particular stock quote (price paid and bid price)

closely held corporations

a corporation that is owned by a few individuals who are typically associated with the firms management

• when a company is small so their common stock is not actively traded and is owned by a few people

publicly owned corporations

a corporation that is owned by a relatively large number of individuals who are not actively involved in the firms management

• stocks are often held by thousands of investors

outstanding shares of established publicly owned companies that are traded (secondary market)

used shares (outstanding stocks) and if they are sold, the company received has no new money when sales occur

additional shares sold by established public owned companies (primary market)

when a company issues or decides to sell additional shares to raise new equity capital

initial public offering made by a privately held firm (IPO market)

whenever stock in a closely held corporation is offered to the public for the first time

• called going public: act of selling stock to the public at large

• initial public offering (IPO): market of stocks of companies that are in the process of going public

efficient market hypothesis (EMH)

a theory that implies that on average asset prices are about equal to their intrinsic value

financial statements purpose

these things help financial managers answer things about a company’s strengthsm weaknesses and expected impact on various proposals

balance sheet

a statement of a firms financial position at a specific point in time

current assets

assets that are converted into cash within one year (cash and cash equivalents, accounts receivable, inventory)

long term assets

assets expected to be used for more than one year (plant and equipment, intellectual property- patents and copyrights)

liabilities

money company owes to others

current liabilities

claims that must be paid off within one year (accounts payable, accruals, total accrued wages and taxes, notes)

long term debt

bonds that mature in more than one year

stockholders equity

represents the amount that stockholders paid the company when shares were purchased and the amount of earnings the company has retained since its origination

stockholders equity equation

paid in capital + retained earnings

total assets - total liabilities

retained earnings

they represent the cumulative total of all earnings kept by the company during its life

net working capital equation

current assets - current liabilities

book value per share equation

total common equity / shares outstanding

perferred stock

similar to debt as this paus a fixed amount each year, but is also like common stock because failure to pay this dividend doesn’t expose the firm to bankruptcy

net operating working capital (NOWC) equation

operating current assets - operating current liabilities

(current assets - excess cash) - (current liabilities - notes payable)

total liabilities equation

total debt + company’s free liabilities (noninterest bearing)

total debt + (accounts payable + accruals)

total debt equation

shortage and long term interest bearing liabilities

short term debt + long term debt