FINN 20403 -Exam 1

Finance

Science and art of managing money; involves how individuals spend, save, and invest; in business, how firms raise, invest, and allocate profits.

Goal of the Firm

Maximize shareholder wealth, often through maximizing stock price.

Profit Maximization ≠ Wealth Maximization

Profit ignores timing, cash flows, and risk; wealth maximization focuses on long-term stock value.

Stakeholder Welfare

Considers interests of employees, suppliers, customers, and community, but shareholder wealth is priority.

Business Ethics

Standards of conduct; ethical practices can enhance firm value.

Financial Manager Decisions

Investment (capital budgeting), Financing (capital structure), Working Capital decisions.

Principal-Agent Problem

Conflict between owners (principals) and managers (agents) when managers act in self-interest.

Marginal Cost/Benefit Analysis

Only take actions if marginal benefits exceed marginal costs.

Cash Basis Accounting

Records revenue/expenses when cash is received/paid.

Accrual Basis Accounting

Records revenue when earned and expenses when incurred.

Sole Proprietorship

Business owned by one person; unlimited liability.

Partnership

Business owned by two+ people; unlimited liability.

Corporation

Separate legal entity; limited liability; double taxation.

LLC

Limited liability company; hybrid of corporation and partnership.

Corporate Governance

System of rules, processes, and laws by which companies are directed and controlled; includes SOX 2002 reforms.

Commercial Bank

Accepts deposits and provides loans; heavily regulated.

Investment Bank

Helps companies raise capital, IPOs, and mergers.

Shadow Banking System

Non-deposit financial institutions; less regulated.

Money Market

Market for short-term securities (<1 year) like T-Bills, commercial paper.

Capital Market

Market for long-term securities (>1 year) like stocks and bonds.

Primary Market

Market where new securities are issued; issuer involved.

Secondary Market

Market where existing securities are traded between investors.

Common Stock

Represents ownership and voting rights in a corporation.

Preferred Stock

Ownership with fixed dividends; no voting rights.

Broker Market

Buyer and seller brought together; broker earns commission; no risk.

Dealer Market

Dealers buy/sell securities; earn bid-ask spread; take risk.

Efficient Market Hypothesis

Securities are fairly priced; prices reflect all available info.

Glass-Steagall Act

Separated commercial and investment banks.

Gramm-Leach-Bliley Act

Repealed Glass-Steagall; allowed bank mergers.

Securities Act of 1933

Regulates sale of new securities; requires disclosure.

Securities Exchange Act of 1934

Created SEC; regulates secondary market.

FDIC

Federal Deposit Insurance Corporation; insures bank deposits.

Dodd-Frank Act

Reformed financial regulation after 2008 crisis.

IPO (Initial Public Offering)

First public sale of a company's stock.

Prospectus

Document with key details about a security issue.

Red Herring

Preliminary prospectus for investors.

Roadshow

Marketing presentations for potential investors before an IPO.

IPO Underpricing

Market price - offer price / offer price; common in IPOs.

Securitization

Pooling loans (like mortgages) into securities for investors.

Subprime Mortgages

High-risk loans to borrowers with low creditworthiness; contributed to 2008 crisis.

Nominal Interest Rate

Stated rate including inflation.

Real Interest Rate

Rate adjusted for inflation; measures purchasing power increase.

Risk-Free Rate

Real interest rate + inflation.

Yield Curve

Graph showing relationship between bond yields and maturities.

Normal Yield Curve

Upward slope; long-term rates higher than short-term.

Inverted Yield Curve

Downward slope; short-term rates higher than long-term.

Flat Yield Curve

No significant difference between short- and long-term rates.

Expectations Theory

Yield curve reflects interest rate expectations.

Liquidity Preference Theory

Investors prefer short-term securities; long-term requires premium.

Market Segmentation Theory

Interest rates determined by supply/demand within maturity segments.

Default Risk

Risk borrower won't meet payment obligations.

Central Bank Tools

Open Market Operations, Reserve Requirement, Discount Rate.

Currency Appreciation

Stronger currency; exports decrease, imports cheaper.

Currency Depreciation

Weaker currency; exports increase, imports more expensive.

Purchasing Power Parity (PPP)

Exchange rates adjust so goods cost the same across countries.

Trade Flows

Surplus/deficit affects currency supply/demand and value.