Financial Management Terms

Financial management/capital markets/investments
The 3 areas of finance (separate with /)
Valuation
The integrating theme of finance; Maximizing this is a company’s main financial goal
Economics/Statistics/Accounting
Finance grew out of these 3 areas (separate with /)
Individuals/Firms/Financial markets and intermediaries
The 3 elements to the world (in finance perspective) (separate with /)
Financial management
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)
Capital markets
The markets where interest rates, along with intermediate or long-term debt and corporate stocks are determined (i.e. NYSE)
Federal Reserve System
Regulates banks and controls the supply of money
Securities and Exchange Commission
Regulates the trading of stocks and bonds in public markets; enforces security regulations
Security analysis/Portfolio theory/Market analysis
The 3 activities of investments (separate with /)
Security analysis
Deals with finding the proper values of individual securities (i.e., stocks and bonds)
Portfolio Theory
Deals with the best way to structure portfolios, or “baskets,” of stocks and bonds
Market analysis
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)
Behavioral finance
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
Board of directors
Top governing body of a business
Chief Operating Officer
Directs the firm’s operations, including marketing, manufacturing, sales, and other operating departments; often serves as a firm’s president
Chief Financial Officer
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
Shareholders
Owners of a corporation
Long run
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 ____
Sarbanes-Oxley Act
Act that requires CEO’s and CFO’s to certify that the firm’s financial statements are accurate; passed by Congress in 2002
Firm
A collection of projects, financed by claims, such as stocks and bonds, and payables
Sole proprietorship/Partnership/Corporation/Limited liability company
The four basic forms of business organization in the US (separate with /) (ignore LLP)
Sole proprietorship
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
Partnership
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
Corporation
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
S corporations
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)
C corporations
Larger corporations (small corporations elect S status and become these when they decide to sell stock to the public)
Limited liability company
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
Limited liability partnership
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
Market value of equity
(Price per share) x (# of shares outstanding)
Intrinsic value
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)
Market price
Actual price of a stock based on perceived but possibly incorrect information as seen by the marginal investor
Marginal investor
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
Equilibrium
Market price = intrinsic value
Undervalued
Market price < intrinsic value; a good investment (even with badly run firms)
Hostile takeover
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)
Institutional investors
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)
Primary market
Type of market in which publicly owned companies raise new capital by selling additional shares
NYSE/NASDAQ
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 /)
Secondary market
Type of market in which investors trade outstanding shares of established publicly owned companies with each other (i.e. NYSE, NASDAQ)
Dealer
Buys and sells on his own account; makes money on the bid/ask spread
Broker
Brings together a buyer and a seller; charges a commission
Bid/ask spread
Ask price – Bid price
Bid
Price at which dealer will buy
Ask
Price at which dealer will sell
Spot market
Market for immediate delivery (within 3 days)
Futures market
Market for delivery some time in the future
Money market
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)
Financial intermediaries
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)
Agency conflict
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
Incentives
Ways to align shareholders’ and managers’ ___:
1. Compensation packages
2. Active investors (institutional investors, activist hedge funds)
3. Threat of a takeover
Compensation packages
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)
Business ethics
A company’s attitude and conduct toward its employees, customers, community, and stockholders
Direct transfer/Primary market transaction/Financial intermediaries
The 3 ways of transferring capital between savers and buyers (separate with /)
Direct transfer
Transfer that occurs when a business sells its stocks or bonds directly to savers, without going through any type of financial institution
Primary market transaction
Transfer that goes through an investment bank, which underwrites the issue (guarantees that the firm will raise the needed capital)
Financial intermediary
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)
Private markets
Markets in which transactions are negotiated directly between two parties
Public markets
Markets in which standardized contracts are traded on organized exchanges
Physical asset markets
Markets for products
Financial asset markets
Markets for stocks, bonds, notes, and mortgages
Derivative securities
Securities in which values are derived from changes in the prices of other assets in financial asset markets (i.e. options)
Investment banks
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)
Commercial banks
The traditional “department stores of finance” serving a variety of savers and borrowers
Financial services corporation
A firm that offers a wide range of financial services, including investment banking, brokerage operations, insurance, and commercial banking
Credit unions
Cooperative associations whose members are supposed to have a common bond, such as being employees of the same firm
Pension funds
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
Life insurance companies
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
Mutual funds
Organizations that pool investor funds to purchase financial instruments and thus reduce risks through diversification
Money market funds
Mutual funds that invest in short-term, low-risk securities and allow investors to write checks against their accounts
Actively-managed funds
Mutual funds that try to outperform the overall markets
Index funds
Mutual funds that are designed to simply replicate the performance of a specific market index
Exchange traded funds
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
Hedge funds
Private investment funds that markets itself exclusively to institutions and wealthy investors
Private equity companies
Organizations in which private equity players buy and then manage entire firms
Over-the-counter market
A large collection of brokers and dealers, connected electronically by telephones and computers, that provides for trading in unlisted securities
Dealer markets
Includes all facilities that are needed to conduct security transactions not conducted on the physical location exchanges
Closely held corporation
A corporation that is owned by a few individuals who are typically associated with the firm’s management.
Initial public offering market
The market for stocks of companies that are in the process of going public
Dutch auction
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
Efficient market
A market in which prices are close to intrinsic values and stocks seem to be in equilibrium
Efficient markets hypothesis
Theory that implies that on average, asset prices are about equal to their intrinsic values
Initial public offering
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)