BUS 301

Finance
The ways people and organizations raise and allocate capital, use monetary resources, and account for the risks involved.
Financial management
The process for and the analysis of making financial decisions in the business context
Corporate Governance
The set of laws, policies, incentives, and monitors designed to handle the issues arising from the separation of ownership and control
2 great things financing provides?
1. Economy will be more productive 2. Individuals wealth will grow
2 dimensions of people:
1. Those that have the money 2. Those that have the ideas
2 sources of friction:
1. Retained earnings 2. Taxes
Main subareas of financing:
1. Investments, financial management, financial institutions and markets, international finance.
Investments
The analysis and process of choosing securities and other assets to purchase
Financial Management
The process for and the analysis of making financial decisions in the business context
FI’s and Markets
The organization that facilitate the flow of capital between investors and companies
International Finance
The use of finance theory in a global business environment
Time Value of Money (TVM)
The theory and application of valuing cash flows at various points in time
Risk
A potential future negative impact to value and/or cash flows.
Sole Proprietorship
A business entity that is not legally separate from its owner (Single individual, unlimited liability, very limited capital, taxes paid by owner)
Partnership
(Owned by multiple people, unlimited liability, limited access to capital, taxes paid by partners)
Corporation
(Owned by public investors, company managers control, stockholders can only lose their investments, easy capital, corp. pays income tax, stockholders pay taxes on dividends)
Hybrids: S-Corp, LLP, LLC…
(Partners or shareholders own, control is shared, mostly limited risk, capital limited by size, taxes paid by partners)
Angel Investors
Exchange capital for ownership in a business
Venture Capitalists
Organized as groups of investors and can provide larger amounts of capital
Owner’s only appropriate goal is to?
Maximize shareholder’s wealth
Agency Problem
The difficulties that arise when a principle hires an agent and cannot fully monitor the agent’s actions
Auditors
A person who performs an independent assessment of the fairness of a firm’s financial statements
Most common retirement plan?
Defined Contribution Plan (401k)
Minimize conflict
1. Ignore it 2. Mitigate it to another manager 3. Offer managers an equity stake
Board of Directors
The group of directors elected by stockholders to oversee management in a corporation
Investment Analysts
A person who analyzes a company’s business prospects and gives opinions about its future success
Investment banks:
Banks that help companies and governments raise capital
Credit analysts
A person who analyzes a company’s ability to repay its debts and reports the findings as a grade
Balance Sheet
The financial statement that reports a firm’s assets, liabilities, and equity at a particular point in time
Annual Report contains 4 parts
1. Balance sheet 2. Income Statement 3. Statement of Cash Flows 4. Statement of R.E.
Current Assets
Assets that will normally convert to cash within one year (Cash and marketable securities, AR, Inventory)
Fixed Assets
Assets with a useful life exceeding one year (Physical assets, long-term assets)
Current liabilities
Obligations of the firm that are due within one year (Accrued wages and taxes, accounts payable, notes payable)
Long-term debt
Obligations of the firm that are due in more than one year (
Stockholder’s Equity
Funds provided by the firm’s preferred and common stock owners (Preferred stock, common stock, and paid-in surplus)
Income Statement
Financial statement that reports the total revenues and expense over a specific period of time
Statement of Cash Flows
Financial statement that shows the firm’s cash flows over a period of time
Statement of Retained Earnings
Financial statement that reconciles net income earned uring a given period and any cash dividends paid with the change in retained earnings over the period
To record depreciation involves which two methods
1. Straight-line-used when reporting income 2. Modified Accelerated Cost Recovery System (MACRS)-used when computing taxes
Financial leverage
The extent to which debt securities are used by a firm
Earnings Management
The process of controlling a firm’s earnings
Cash flows from operations
Cash flows that are the direct result of the production and sale of the firm’s products
Cash flows from investing activities
Cash flows associated with the purchase or sale of fixed or other long-term assets
Cash flows from financing activities
Cash flows that result from debt and equity financing transactions
Free Cash Flows
Cash flows available for payments to stockholders and debt holders of a firm after the firm has made investments in assets necessary to sustain the ongoing operations of the firm (EX: Issuing stock, debt, etc.)
Investments in Operating Capital (IOC)
Buy physical assets for eventual equipment replacement to sustain firm’s operation
Capital Structure
THe amount of debt versus equity financing to hold on the balance sheet
Book (historical value)
Assets are listed on the balance sheet at the amount the firm paid for them
Market Value
Assets are listed at the amount the firm would get if it sold them
Interest on state and local bonds are
EXEMPT from federal taxes; Only have to pay 30% of dividends from another company
Equity financed firm
Very little interest expense to deduct but will have HIGHER taxable income and pay more taxes; Stockholders prefer debt financing as they profit
5 most common ratio groups
1. Liquidity ratios 2. Asset management ratios 3. Debt management ratios 4. Profitability ratios 5. Market value ratios
Ratio Analysis
The process of calculating and analyzing financial ratios to assess the firm’s performance and to identify actions needed to improve firm performance
Liquidity Ratios
Measure the relation between a firm’s liquid (or current) assets and its current liabilities
Asset Management Ratios
Measure how efficiently a firm uses its assets (inventory, AR, and fixed assets) as well as it accounts payable
Debt Management Ratio
Measure the extent to which the firm uses debt (or financial leverage) versus equity to finance its assets
Capital structure
The amount of debt versus equity to hold on the balance sheet
Profitability ratios
Ratios that show the combined affect of liquidity, asset management, and debt management on the firm’s overall operating results
Market Value Ratios
Ratios that relate a firm’s stock price to its earnings and book value
Common size financial statements
Dividing all balance sheet amounts by total assets and all income statement amounts by net sales (USED TO IDENTIFY TRENDS/CHANGES)
2 Benchmarks
1. Performance of the firm over time (Time series analysis) 2. Performance of the firm against one or more companies in the same industry (cross-sectional analysis)
Primary Markets
provide a forum in which demanders of funds raise funds by issuing new financial instruments (stocks and bonds)
Investment Banks
Financial institutions that arrange primary market transactions for businesses
Public Offerings (IPOs)
Primary market financial instruments include stock issues from firms initially going public
Secondary Markets
Markets that trade financial instruments once they are issued
Financial Markets
The arenas through which funds flow
Trading Volume
The number of shares of a security that are simultaneously bought and sold during a period
Money Markets (Over-the-counter)
Markets that trade debt securities or instruments with maturities of less than one year (Fluctuations small and less risky)
Money markets securities:
reasury Bills-short term U.S. gov. obligation -Federal funds and repurchase agreements-short term fund transferred between FI -Commercial paper-(paper) short term unsecured promissory note issue to raise short term cash -Negotiable certificates of deposit-bank issued time deposits that specify an interest rate and maturity date negotiable -Banker’s acceptances-bank guaranteed time drafts payable to a vendor of goods
Capital Markets
Markets that trade debt (bonds) and equity (stock) instruments with maturities of more than one year
Capital Market securities:
-US Treasury notes and bonds-US treasury long term obligation to finance the national debt and pay for other government expenditures -State and local government bonds-debt securities issued by state and local gov. cover capital improvements -US government agency bonds- -Mortgages and mortgage backed securities-long term loans to individuals or businesses to purchase home, pieces of land (SECURITIES: long term debt securities that offer expected principal and interest payments as collateral -Corporate bonds-long term bonds issued by corporations -Corporate stocks-long term equity securities issued by public corporations; stock shares represent fundamental corporate ownership claims
Foreign Exchange Markets
Markets in which foreign currency is traded for immediate (spot) or future delivery
Foreign Exchange Risk
Risk arising from the unknown value at which foreign currency cash flows can be converted into US dollars
Derivative Security
A security formalizing an agreement between two parties to exchange a standard quantity of an asset at a predetermined price on a specified date in the future
Financial Institutions
Institutions that perform the essential function of channeling funds from those with surplus funds to those with shortages of funds
Major types of financial institutions:
Commercial Banks: depository institutions whose major assets are loans and whose major liabilities are deposits Thrifts: Depository institutions including savings associations, savings banks and credit unions, that generally perform services similar to commercial banks but tend to concentrate their loans in one segment such as real estate loans or consumer loans Insurance Companies: protect individuals and corporations (policyholders) from financially adverse events, such as untimely death, illness, retirement, and personal injury and liability due to accidents, theft, fire and so on Securities Firms and Investment Banks: underwrite securities and engage in related activities such as securities brokerage, securities trading, and making markets in which securities trade Finance Companies: make loans to both individuals and businesses. The loans are funded by short and long term debt, and many are collateralized with some kind of durable goods, such as washer/dryers, furniture, carpets, and the like Mutual funds: pool many individuals and companies financial resources and invest those resources in diversified asset portfolios Pension Funds: offer savings plans through which fund participants accumulate savings during their working years
Direct Transfers
The process used when a corporation sells its stock or debt directly to investors without going through a financial institution
Without FIs:
1. Monitoring Costs 2. Liquidity Costs 3. Price risk-Investors lose money from transactions/other costs
Liquidity
The ease with which an asset can be converted into cash
Price Risk
The risk that an asset’s sale price will be lower than its purchase price
Delegated Monitor
An economic agent appointed to act on behalf of smaller investors in collecting information and or investing funds on their behalf
Asset Transformers
Service provided by financial institutions in which financial claims issued by an FI are more attractive to investors than are the claims directly issued by corporations
Secondary Securities
Packages or pools of primary claims
Nominal Interest Rates
The interest rates actually observed in financial markets
Factors affecting Nominal Interest Rates
Inflation-The continual increase in the price level of a basket of goods and services, Real Interest Rate: The interest rate that would exist on a default free security if no inflation were expected, Default risk-The risk that a security issuer will default on that security by being late on or missing an interest or principal payment, Liquidity risk-The risk that a security can be sold at a predictable price with low transaction costs on short notice
Special Provisions
provisions (taxability, convertibility, and callability) that impact a security holder beneficially or adversely and as such are reflected in the interest rates on securities that contain such provisions (Ex: TAXABILITY- investors pay no federal taxes on interest payments such as a Treasury bond-taxable on federal level but not state/local ) or corporate bond (interest is taxable on all levels).CONVERTABILITY-exchange the bond for another type of the issuers security (preferred or common) at a set price)
Time to maturity
length of time until a security is repaid, used in debt securities as the date upon which the security holders get their principal back LONGER time to mature, the HIGHER the required interest rate buyers will demand
Maturity Premium (MP)
difference between the required yield on long-versus short-term securities of the same characteristics can be positive negative, or zero
Fisher effect
An additional premium above the expected rate of inflation for forgoing present consumption (which reflects the real interest rate issued discussed above).
3 Theories that explain the shape of the yield curve:
1. The unbiased expectations theory-At any given point in time, the yield curve reflects the market’s current expectations of future short-term rates 2. The liquidity premium theory-long-term rates are equal to geometric averages of current and expected short-term rates 3. The market segmentation theory-Individual investors and FIs have specific maturity preferences, and convincing them to hold securities with maturities other than their most preferred requires a higher interest rate (maturity premium)
Forward Rate
This is the expected or “implied” rate on a short-term security that will originate at some point in the future.
common-size financial statements
hese can be used by interested parties to identify changes in corporate performance.
Average Collection Period
This measures the number of days accounts receivable are held before the firm collects cash from the sale.