Chapter 1, 2, 8, and 11 Finance Review

Comprehensive vocabulary flashcards covering basic financial principles, capital markets, risk and return (CAPM), portfolio management, stock valuation models, and cost of capital based on lecture review notes.

Sole Proprietorship Advantage

Easy Formation with few regulations

Primary Reason for IPO

To Raise funds beyond internal and private sources

Agency Problem

Managers may act in their own interest instead of shareholders' interest.

Shareholder Wealth Maximization

A decision-making framework where a manager rejects a project that increases short term profits but lowers the firms long-term stock value.

Market Price

The price observed in financial markets.

Intrinsic (Fundamental) Price

The price reflecting all relevant information about the firm.

Direct Transfer of Capital

Occurs when a corporation issues commercial paper directly to an insurance company.

Financial Intermediary Transfer

When households deposit money in a bank and the bank lends that money to a business.

Equity Security

A security that represents ownership in a company and has no maturity date, classified in the capital market.

Cost of Debt Capital

Interest rate

Cost of Equity

The return required by stockholders.

Country Risk

Primarily determined by a country’s economic, political, and social environment.

Commercial Banks

Financial institutions that primarily accept deposits and make loans to individuals and businesses.

Money Market

A market that deals with short term, high liquidity debt securities.

Secondary Market

A market where an investor sells shares of stock to another investor on the stock market exchange.

Limit Order

An order to buy a stock only if the price falls to a specific amount (e.g., $50$) or lower.

Registered Stock Exchanges

Trading venues that are most heavily regulated and must report both trades and pre-trade bid/ask information.

Securitization

The process of combining assets and turning them into tradable securities.

Market Equilibrium

A condition where the market price should be equal to the intrinsic value.

Market Risk

Risk caused by economic downturns, inflation, and rising interest rates.

Beta ($\beta$)

A measure in the CAPM framework of a stock's sensitivity to market movements.

Efficient Market Hypothesis (EMH)

A theory suggesting that beating the market is difficult, which makes index funds popular.

Risk Averse

A term describing investors who dislike uncertainty and prefer higher returns only if risk increases.

Standard Deviation

The best measure for stand-alone risk for a single asset held by itself, expressing risk in the same units as returns.

Diversification

The practice of holding portfolios instead of just one stock to reduce risk.

Correlation of $-1.0$

The correlation value that provides the greatest potential risk reduction in a two stock portfolio.

Systematic (Market) Risk

Risk caused by economy-wide factors affecting most firms; it is captured by beta in the CAPM and cannot be diversified away.

Semi-strong-firm Efficiency

A level of market efficiency implying that the stock price reflects all public information.

Fama-French Model

A model developed due to the CAPM's inability to explain size and value effects.

Behavioral Finance

A field focusing on decisions that are irrational but predictable, helping explain why market prices deviate from intrinsic value.

Maximum-risk Portfolio

According to the notes, the portfolio that: Minimizes variance.

Efficient Portfolio

A portfolio that offers the most return for a given level of risk.

Efficient Frontier

A collection of portfolios that offer the highest return for a given level of risk.

Indifference Curves

Graphical representations of an investor’s attitude toward risk and return.

Arbitrage Pricing Theory (APT)

A model that allows for multiple risk factors, unlike the single-factor CAPM.

Jensen's Alpha

A performance measure; a positive value implies the fund outperformed what CAPM predicts given its beta.

Capital Market Line (CML)

A straight line representing linear combinations of the risk-free asset and the market portfolio for efficient portfolios.

Sharpe Ratio

A measure of return earned per unit of total risk.

Treynor Ratio

A performance measure most appropriate when comparing well-diversified portfolios.

Proxy Fight

A struggle to gain control of a firm by collecting shareholder proxies to replace directors and management.

Class B Common Stock

A specific class of stock (often with voting rights) preferred by investors who want more influence over company decisions.

Tracking Stock

A type of stock issued to link dividends to the performance of a specific business segment.

Free Cash Flow (FCF)

Cash available to both shareholders and creditors.

Value of Operations

One of the two primary sources of a company’s value (the other being non-operating assets).

Intrinsic Value of Equity

The remaining value after subtracting debt and preferred stock from total intrinsic value.

Value Drivers

Inputs managers can affect through business decisions.

Horizon Value

A value used in nonconstant growth models to capture the value of the stock once growth becomes stable.

Market Multiple Analysis

Comparing a firm to similar companies using market-based ratios.

Return on Invested Capital (ROIC)

A metric suggesting a company is creating value if it is higher than the overall required return.

Additional Funds Needed (AFN) Method

A method to provide a quick estimate of how much extra financing a firm may need when sales grow.

Spontaneous Liabilities

Liabilities that increase automatically with sales, such as accounts payable and accruals.

Self-supporting Growth Rate

The growth rate that requires no external financing.

Target Capital Structure

The mix of debt, preferred stock, and common equity that minimizes WACC and maximizes firm value.

After-tax Cost of Borrowing

A rate lower than the before-tax interest rate because interest payments reduce taxable income.

Flotation Costs

The extra fees and expenses incurred when issuing new securities, which are generally higher for equity than for debt.

Retention Ratio

The percent of profits kept and reinvested by the firm.

Weighted Average Cost of Capital (WACC)

The average cost of the firm's financing weighted by how much of each source is used.