Finance 330 midterm

the science and art of managing money

Finance level on Personal Level
concerned with…
-how much earnings they spend
-how much they save
-how much they invest in their savings

Finance in Business Context
-how firms raise money from investors
-how firms decide to reinvest profits in the business or distribute them to investors

financial services
concerned with the design and delivery of advice and financial products to individuals, business, government

sole proprietorship
business owned by 1 person and operated for his or her own profit

business owned by 2 or more people and operated for profit

entity created by law, has legal powers of an individual,
-can sue and be sued
-make and be party to contracts
-acquire property in its own name

decision rule for managers
only take actions that are expected to increase share price

groups such as employees, customers, supplies, creditors, owners and others who have a direct economic link to the firm

business ethics
the standards of conduct or moral judgment that apply to persons engaged in commerce

marginal cost-benefit analysis
economic principle that states that financial decisions should be made and actions taken only when added benefits are greater than added costs

corporate governance
refers to rules, processes, and laws by which companies are operated, controlled, and regulated
-defines rights and responsibilities of corporate participants

principal-agent relationship
an arrangement in which an agent acts on behalf of a principal
-shareholders of a company (principals) elect management (agents) to act on their behalf

agency problems
arise when managers place personal goals ahead of the goals of shareholders

agency costs
arise from agency problems that are borne by shareholders and represent a loss of shareholder wealth

incentive plans
management compensation plans that tie management compensation to some price
-granting stock options

performance plans
tie management compensation to measures such as EPS or growth in EPS

financial institutions
intermediaries that channel the savings of individuals businesses and governments into loans or investments

commercial banks
provide savers with secure place to invest their funds and that offer loans to individual and business borrowers

investment banks
assist companies in raising capital, advise firms on major transactions, engage in trading and market making activities.

Glass-Steagall Act
1933 congress act that created the federal deposit insurance corporation and separated the activities of commercial and investment banks
-Established the FDIC

shadow banking system
group of institutions that engage in lending activities, but do not accept deposits
-therefore, not subject to regulations as traditional banks

financial markets
forums in which suppliers of funds and demanders of funds can transact business directly

primary market
financial market in which securities are initially issued, only market in which the issuer is directly involved in the transaction

the process of pooling mortgages or other types of loans and than selling claims or securities against that pool in the secondary market

a tradable financial asset of any kind

secondary market
financial markets in which pre-owned securities (those that are not new issuers) are traded

money market
created by a financial relationship between suppliers and demanders of short term funds
-transactions are made in marketable securities

capital market
market that enables suppliers and demanders of long-term funds to make transactions
securities are; Bonds, Common Stock, Preferred Stock

long-term debt used by businesses and government to raise large sums of money

common stock
units of ownership interest or equity in a corporation
-typically comes with voting rights

preferred stock
a special form of ownership that has features of both a bond and common stock

broker markets
securities exchanges on which the 2 sides of a transaction, buyer and seller, are brought together to trade securities
-NYSE, American Stock Exchange

dealer markets
market in which buyer and seller are not brought together directly but have orders executed by securities dealers that “make markets” in the given security *on the over-the-counter market

role of capital market (firms perspective)
to be a liquid market where firms can interact with investors in order to obtain valuable external financing resources

role of capital market (investor’s perspective)
to be an efficient market that allocates funds to their most productive uses

mortgage-backed securities
represent claims on the cash flows generated by a pool of mortgages

risk associated with mortgaged-backed securities
homeowners may not be able to, or may choose not to, repay their loans

Federal Deposit Insurance Corporation (FDIC)
provides insurance for deposits at banks and monitors banks to ensure their safety and soundness

Generally Accepted Accounting Principles (GAAP)
the practice and procedure guidelines used to prepare and maintain financial records and reports

income statement
provides a financial summary of a company’s operating results during a specific period

balance sheet
presents a summary of a firms financial position at any given point in time

statement of retained earnings
reconciles the net income earned during a given year, and any cash dividends paid

statement of cash flows
provides summary of the firm’s operating, investment, and financing cash flows and reconciles them with changes in its cash and marketable securities during the period

agency theory
the study of issues arising from the separation of ownership and management

ratio analysis
involves methods of calculating and interpreting financial ratios to analyze and monitor the firms performance

cross-sectional analysis
the comparison of different firms financial ratios at the same point in time

time-series analysis
evaluation of the firms financial performance over time using financial ratio analysis
-assesses a firms progress

most informative analysis approach
combine cross sectional and time series analysis

type of cross-sectional analysis in which the firm’s ratio values are compared to those of a key competitor that it wishes to emulate

problems with using ratio analysis
-large deviations from norms mean POSSIBILITY of problem
-single ratios don’t provide enough info for overall performance
-results can be distorted by inflation

current ratio
measures the firms ability to meet short term obligations

total asset turnover
indicates the efficiency with which the firm uses its assets to generate sales

debt ratio
measures proportion of total assets financed by firm’s creditors

gross profit margin
measures % of each sales dollar remaining after the firm has paid for its goods

net profit margin
% of each sales dollar remaining after all costs and expenses have been deducted

market ratios
relate to a firm’s market value, as measured by its current share price, to certain accounting values

cash flow
the primary ingredient in any financial evaluation model

cash flow (accounting perspective)
cash flow is summarized in a firm’s statement of cash flows

cash flow (financial perspective)
firms focus on both operating and freeing cash flow

the portion of the costs of fixed assets charged against annual revenues over time

Modified Accelerated Cost Recovery System (MARCRS)
used to determine deprecation of assets for tax purposes
-the depreciable value of an asset is its full amount
-depreciable life of an asset is determined by its MARCRS recovery pre determined period

operating cash flow
cash flow a firm generates from normal operations

free cash flow
amount of cash flow available to investors after the firm has met all operating needs and paid investments in fixed current assets

future value
value at a given future date of an amount placed on deposit today and earning interest at a specified date

compound interest
interest that is earned on a given deposit and has become part of the principal at the end of a specified period

compounding interest more than annually
multiply n by number of compounds
divide interest by number of compounds

amount of money on which interest is paid

present value
current dollar value of a future amount- the amount of money that would have to be invested today at a given interest rate over a specified period to equal the future amount

discounting cash flows
process of finding present values;
the inverse of compounding interest

stream of equal periodic cash flows, over a specified time period. These cash flows can be inflows of return of outflows of return

ordinary (deferred) annuity
an annuity for which the cash flow occurs at the end of each period

annuity due
annuity for which the cash flow occurs at the beginning of each period

an annuity with an infinite life
-providing continual annual cash flow

loan amortization
the determination of the equal periodic loan payments necessary to provide a lender with a specified interest return and to repay the loan principal over a specified period

sole proprietorship and partnership (liabilities)
unlimited liability
– creditors can claim against personal assets

corporation (liabilities)
limited liability
-guarantees owner can lose more than what they invested

chief executive officer (CEO)
-appointed by board of directors
-official responsible for managing the firm’s day-to-day operations
-carries out policies established by board of directors

board of directors
-elected by firm’s stockholders
-responsible for approving strategic goals and plans

nominal (stated) annual rate
contracted annual rate of interest charged by a lender or promised by a borrower

effective (true) annual rate
the annual rate of interest actually paid or earned