Financial Management Terms – Flashcards
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Financial management/capital markets/investments
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The 3 areas of finance (separate with /)
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Valuation
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The integrating theme of finance; Maximizing this is a company's main financial goal
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Economics/Statistics/Accounting
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Finance grew out of these 3 areas (separate with /)
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Individuals/Firms/Financial markets and intermediaries
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The 3 elements to the world (in finance perspective) (separate with /)
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Financial management
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Focuses on decisions relating to how much and what types of assets to acquire, how to raise the capital needed to purchase assets, and how to run the firm so as to maximize its value (also called corporate finance)
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Capital markets
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The markets where interest rates, along with intermediate or long-term debt and corporate stocks are determined (i.e. NYSE)
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Federal Reserve System
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Regulates banks and controls the supply of money
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Securities and Exchange Commission
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Regulates the trading of stocks and bonds in public markets; enforces security regulations
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Security analysis/Portfolio theory/Market analysis
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The 3 activities of investments (separate with /)
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Security analysis
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Deals with finding the proper values of individual securities (i.e., stocks and bonds)
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Portfolio Theory
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Deals with the best way to structure portfolios, or "baskets," of stocks and bonds
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Market analysis
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Deals with the issue of whether stock and bond markets at any given time are "too high," "too low," or "about right" (includes behavioral finance)
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Behavioral finance
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Investor psychology is examined in an effort to determine whether stock prices have been bid up to unreasonable heights in a speculative bubble or driven down to unreasonable lows in a fit of irrational pessimism
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Board of directors
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Top governing body of a business
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Chief Operating Officer
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Directs the firm's operations, including marketing, manufacturing, sales, and other operating departments; often serves as a firm's president
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Chief Financial Officer
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Generally a senior vice president and the third-ranking officer, responsible for the investments, treasury, capital budgeting, accounting, credit, and legal departments; also investor relations
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Shareholders
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Owners of a corporation
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Long run
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The primary goal of the corporate management team is to maximize the shareholder's wealth by maximizing the company's intrinsic value (which maximizes the average price) over the ____
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Sarbanes-Oxley Act
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Act that requires CEO's and CFO's to certify that the firm's financial statements are accurate; passed by Congress in 2002
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Firm
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A collection of projects, financed by claims, such as stocks and bonds, and payables
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Sole proprietorship/Partnership/Corporation/Limited liability company
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The four basic forms of business organization in the US (separate with /) (ignore LLP)
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Sole proprietorship
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What most businesses are, owned by one person, if owner dies, firm dies Pros: Easy and inexpensive to form, subject to few government regulations, income taxed as personal income (avoid corporate income tax) Cons: Unlimited financial liability for owner, difficult to raise large amounts of capital
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Partnership
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A legal arrangement between two or more people who decide to do business together Pros: Inexpensive to form, income taxed as personal income (avoid corporate income tax) Cons: Unlimited financial liability for owners, difficult to raise large amounts of capital
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Corporation
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A legal entity created by a state, and it is separate and distinct from its owners and managers, unlimited life, does more than 80% of all business Pros: Limited owner liability, ownership is easily transferred, liquidity of stocks enhances value, *greater access to financial markets*, *easier to raise capital* *for public corporations Cons: Separation of ownership and management; income is taxed at the corporate rate, subject to double taxation: the earnings are taxed; and then when its after-tax earnings are paid out as dividends, those earnings are taxed again as personal income to the stockholders
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S corporations
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Corporations that are taxed as if they were proprietorships or partnerships; thus, they are exempt from the corporate income tax (can have no more than 100 stockholders, which limits their use to relatively small, privately owned firms)
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C corporations
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Larger corporations (small corporations elect S status and become these when they decide to sell stock to the public)
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Limited liability company
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Popular type of organization that is a hybrid between a partnership and a corporation, single owner, limited financial liability, income rate taxed as personal income, have votes in proportion to their ownership interest
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Limited liability partnership
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Similar to an LLC, used for professional firms in the fields of accounting, law, and architecture, multiple owners, limited financial liability, income rate taxed as personal income, have votes in proportion to their ownership interest
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Market value of equity
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(Price per share) x (# of shares outstanding)
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Intrinsic value
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An estimate of the stock's "true" value based on expected future cash flows and the risks involved, what security analysis is all about, distinguished successful and unsuccessful investors (also called fundamental value)
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Market price
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Actual price of a stock based on perceived but possibly incorrect information as seen by the marginal investor
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Marginal investor
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An investor who would buy more stock if the price fell slightly, sell more stock if the price rose slightly, and would maintain his/her current holding unless something were to change
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Equilibrium
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Market price = intrinsic value
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Undervalued
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Market price < intrinsic value; a good investment (even with badly run firms)
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Hostile takeover
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The acquisition of a company over the opposition of its management by corporate raiders; likely when a firm's market price < intrinsic value (managers should try to maximize their stock's intrinsic value and then communicate with stockholders, causing the intrinsic value to be high and the actual stock price to remain close)
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Institutional investors
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Concentrate and organize investors so they are better able to take action and directly intervene in the company's affairs (i.e. pension and mutual funds) (management less likely to heed concerns from individual investors)
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Primary market
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Type of market in which publicly owned companies raise new capital by selling additional shares
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NYSE/NASDAQ
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The 2 largest stock markets in the world (first is a physical location, second is a network of dealers—much of the trading goes through electronic systems in both)(separate with /)
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Secondary market
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Type of market in which investors trade outstanding shares of established publicly owned companies with each other (i.e. NYSE, NASDAQ)
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Dealer
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Buys and sells on his own account; makes money on the bid/ask spread
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Broker
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Brings together a buyer and a seller; charges a commission
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Bid/ask spread
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Ask price - Bid price
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Bid
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Price at which dealer will buy
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Ask
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Price at which dealer will sell
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Spot market
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Market for immediate delivery (within 3 days)
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Futures market
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Market for delivery some time in the future
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Money market
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Market where short-term, liquid, relatively safe debt securities are traded (i.e. bank CD's, commercial paper) (New York, London, and Tokyo are world's largest)
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Financial intermediaries
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Responsible for transferring cash across time, providing liquidity, facilitating risk transfer, and providing information (i.e. investment banks, commercial banks, insurance companies, hedge fund firms, venture capital firms)
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Agency conflict
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When managers may have incentives to act in ways that are not in the interest of shareholders from the separation of ownership and management in corporations
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Incentives
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Ways to align shareholders' and managers' ___: 1. Compensation packages 2. Active investors (institutional investors, activist hedge funds) 3. Threat of a takeover
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Compensation packages
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Should tie compensation of management to firm's performance over the long run (bonus tied to performance, award stocks or options phased over several years, links wealth of executive to wealth of shareholder)
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Business ethics
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A company's attitude and conduct toward its employees, customers, community, and stockholders
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Direct transfer/Primary market transaction/Financial intermediaries
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The 3 ways of transferring capital between savers and buyers (separate with /)
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Direct transfer
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Transfer that occurs when a business sells its stocks or bonds directly to savers, without going through any type of financial institution
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Primary market transaction
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Transfer that goes through an investment bank, which underwrites the issue (guarantees that the firm will raise the needed capital)
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Financial intermediary
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Transfer in which the intermediary obtains funds from savers in exchange for its securities; it uses this money to buy and hold businesses' securities, and the savers hold the intermediary's securities (i.e. banks, insurance companies, mutual funds)
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Private markets
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Markets in which transactions are negotiated directly between two parties
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Public markets
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Markets in which standardized contracts are traded on organized exchanges
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Physical asset markets
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Markets for products
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Financial asset markets
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Markets for stocks, bonds, notes, and mortgages
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Derivative securities
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Securities in which values are derived from changes in the prices of other assets in financial asset markets (i.e. options)
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Investment banks
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Help companies raise capital by helping design securities with features that are currently attractive to investors, buy these securities from the corporation, and resell them to savers (facilitates the issuance of securities)
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Commercial banks
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The traditional "department stores of finance" serving a variety of savers and borrowers
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Financial services corporation
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A firm that offers a wide range of financial services, including investment banking, brokerage operations, insurance, and commercial banking
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Credit unions
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Cooperative associations whose members are supposed to have a common bond, such as being employees of the same firm
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Pension funds
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Retirement plans funded by corporations or government agencies for their workers and administered primarily by the trust departments of commercial banks or by life insurance companies
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Life insurance companies
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Companies that take savings in the form of annual premiums; invest these funds in stocks, bonds, real estate, and mortgages; and make payments to the beneficiaries of the insured parties
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Mutual funds
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Organizations that pool investor funds to purchase financial instruments and thus reduce risks through diversification
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Money market funds
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Mutual funds that invest in short-term, low-risk securities and allow investors to write checks against their accounts
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Actively-managed funds
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Mutual funds that try to outperform the overall markets
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Index funds
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Mutual funds that are designed to simply replicate the performance of a specific market index
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Exchange traded funds
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Investment funds that buys a portfolio of stocks of a certain type and then sell their own shares to the public in a public market
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Hedge funds
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Private investment funds that markets itself exclusively to institutions and wealthy investors
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Private equity companies
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Organizations in which private equity players buy and then manage entire firms
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Over-the-counter market
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A large collection of brokers and dealers, connected electronically by telephones and computers, that provides for trading in unlisted securities
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Dealer markets
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Includes all facilities that are needed to conduct security transactions not conducted on the physical location exchanges
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Closely held corporation
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A corporation that is owned by a few individuals who are typically associated with the firm's management.
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Initial public offering market
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The market for stocks of companies that are in the process of going public
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Dutch auction
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Type of auction in which the actual transaction price is set at the highest price (the clearing price) that causes all of the offered shares to be sold
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Efficient market
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A market in which prices are close to intrinsic values and stocks seem to be in equilibrium
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Efficient markets hypothesis
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Theory that implies that on average, asset prices are about equal to their intrinsic values
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Initial public offering
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The first sale of stock by a private company to the public; also called "going public" (can be either/both a primary or secondary market transaction)
