Corporate Finance

Savings and Turn

Savings and loans' primary purpose is to take in deposits from households and to lend funds for home mortgages Backed by SAIF

What is social responsibility? how does it influence the decisions made by financial managers

Social responsibility is doing what is right by society/ sometimes it can be expensive

Financial instituitons

assist surplus economic units and deficit economic units and analyze and absorb credit risk

common stock

is riskier than preferred stock to the investor

If the real rate of interest is 3%, then:

the expected inflation rate is 3% and the nominal risk-free rate is 6%

[IRP+RR]+[DRP+MRP+IRP-SSP]=

Nominal Rate

Operating Profit Margin

Operating profit / sales - on income stmt

Today's workers who are given retirement benefits are most likely to be offered

a defined contribution plan

With respect to spreads, a dealer

has a spread that generates income for the dealer

non-depository institutions

Finance Companies Insurance Companies Pension Funds

How is finance related to accounting and economics

Financial managers use accounting information Financial managers use economic principles to make decisions based on financial information

What are the 3 career paths/ opportunities in the field of finance?

Financial managers: analyze finances, assessing risk, evaluate opportunities, and find financing sources Financial markets and institutions: focus on the flow of money through the economy Investments: manage income/ producing assets

Gross Profit Margin

Gross Profit/Sales - on Income stmt

financial intermediaries

Help facilitate the flow of funds in the financial marketplace

What are 3 financial factors that influence a company's value

Importance of cash flow Timing of cash flow Influence of risk

property and casualty insurance

Insure against damage to person and property (health, autos, homes, theft, earthquake, etc.)

Life insurance

Insure against financial hardship caused by death (purchase long-term securities)

All of the following could be considered a financial security except:

Inventory

Pension Funds

Workers and/or employers contribute funds. Defined Benefit Plans (DBP) versus Defined Contribution Plans (DCP)

current ratio

current a

current ratio

current assets / current liabilities - balance sheet

Which of the following best describes the nominal risk-free interest rate

the inflation premium plus the real rate

Financial managers

CFO CEO

What is the annual interest payment on a bond with a 7% coupon rate and a $1,000 par value?

70.00

The expected inflation is 4% and the nominal risk-free rate is 6%; the real rate of interest is

2%

Legal and Ethical Issues

Interest of stakeholders

Traded in money markets

banker's acceptances

Assume that Goodfellows National Bank pays 5% interest on depositors' passbook savings accounts, which make up 50% of all funds on hand, and pays 7% interest on depositors' Certificates of Deposit, which make up the other 50% of funds received. Next, assume that Goodfellows charges 10% interest on short-term loans, which make up the other 50% of all loans outstanding, and charges 12% interest on long-term loans, which make up the other 50% of all loans outstanding. Now what is Goodfellows' interest rate spread?

(.05*.50) + (.07*.50) = 6% (.10*.50) + (.12*.50) = 11% 11-6= 5%

quick ratio

(Current Assets - Inventory) / Current Liabilities - balance sheet

Maturity Matching

-Household and business savers generally want to lend for only a short time. Savings and checking accounts are usually available for immediate withdrawal. -Borrowers often want long-term financing. Institutions can give 30-year mortgages and long-term loans to businesses and government entities

Denomination

-Households generally have small amounts of surplus funds to invest. They can put small amounts into savings at a time. -Those who need loans usually require larger amounts of funds. They can borrow for business purposes, or to buy a home or automobile.

Absorbing Credit Risk

-Individual lenders cannot easily evaluate the credit risk of borrowers. They also cannot generally afford to take the risk of losing their limited savings. -Institutions have the necessary expertise and also are in a better position to absorb an occasional loss.

Arrange the following markets in order from most efficient to least efficient. 1. The real estate market 2. The money market 3. The secondary market 4. The over-the-counter market

1) Money Market 2) Secondary Market 3) OTC 4) Real estate Market

The Federal Reserve has how many district banks

12

If the nominal interest rate is 13%, inflation is expected to be 2.5%, default risk premium, illiquidity risk premium, and maturity risk premium are all 1% each, what is the real rate of interest?

7.5%

If the real rate of interest is 2%, inflation is expected to be 3%, the default risk is 1%, and the illiquidity risk premium maturity risk premium are both 1.5%, what would the yield be on this bond?

9%

Goodfellows National Bank has decided to compete with savings and loan associations by offering 30-year fixed-rate mortgage loans at 8% annual interest. It plans to obtain money for the loans by selling one-year 6% CDs to its depositors. During the first year of operation, Goodfellows sells its depositors $1,000,000 worth of 7% one-year CDs, and homebuyers take out $1,000,000 worth of 8% 30-year fixed-rate mortgages. a. Considering only the information above, what is Goodfellows' gross profit for the first year of operation? In Goodfellows' second year of operation, it must sell $1,000,000 worth of new CDs to replace the ones that mature. However, interest rates have gone up during the year, and now the rate the bank must pay to get people to buy new CDs is 9%. b. Assuming Goodfellows' does sell $1,000,000 worth of new CDs at 9% interest in the second year, and assuming the $1,000,000 worth of 8% mortgage loans are still outstanding, what is Goodfellows' gross profit during the second year?

A) (1,000,000 * 8%)= 80,000 (1,000,000 * 7%)= 70,000 80,000-70,000 = 10,000 B) (1,000,000 * 8%)= 80,000 (1,000,000 * 9%) = 90,000 80,000- 90,000 = 10,000

What is an agent? What are their responsibilities?

Agent represents the principal/ has the legal and ethical responsibility to make decisions that further the interest of the principal

Sales finance companies

Allow people to pay for items on a payment plan

What is meant by the terms "flight to liquidity" and "flight to quality"? What role did the 2008 Financial Crisis play in this flight to quality and liquidity?

As stock market goes down, investors sell their stuff and buy safer securities: bonds, Cds, and T-bills: A flight-to-liquidity is a financial market phenomenon occurring when investors sell what they perceive to be less liquid or higher risk investments, and purchase more liquid investments instead/ flight-to-quality is moving capital away from risky investments

What are some types of financial intermediaries/facilitators? What role do they play in financial markets?

Broker- brings buyer and seller together makes money off commission: Ex. relator Dealer- buy securities at bid price and sells them at ask price makes money from spread between bid and ask price Investment Banks- underwriting (purchase all securities available then sells them to the public)

Financial Institutes

Commercial banks, savings and loans, credit unions, finance companies, insurance companies, pension funds

Credit Unions

Credit unions are owned by depositors (actually share owners) who are individuals, not businesses. Credit unions take in funds and primarily make personal loans

Which of the following risk premiums might be included in a corporation's bonds

Default risk, inflation risk, and liquidity risk

Services provided by financial intermediaries

Denomination matching, Maturity matching, and Absorb credit risk

Assume that the Goodfellows National Bank pays 5% interest on depositors' accounts and charges 10% interest on loans it makes to businesses. What is Goodfellows' interest rate spread?

Loan rate = 10%; this is the interest that banks receive from loans made to businesses and individuals Deposit rate = 5%; this is the interest banks must pay to their depositors. Interest rate spread = 10% - 5% = 5%

Two securities of equal risk are available for investment - a money market security and a capital market security. Assuming a normal yield curve, which security should be purchased to achieve the highest yield? Why?

Money market-short-termed Capital market- long-termed Purchase capital because it's % return is higher

Return on Equity

Net Income/Common Equity - balance & income

Net Profit Margin

Net Income/Sales - on income stmt

What are some different types of markets? Describe each market.

Primary Market- direct market/ directly from deficit units to surplus units Secondary Market- Stock market, bond market/ OTC, NASDAQ, NYSE Money Markets- Short-termed: T-bills, commercial paper, CDs Capital Markets- long-termed: stock, bonds, T-bonds

How are profits and cash flows different

Profit is simply sales minus expenses Value (stock price) depends on future cash flow, timing, and risk

What is a proprietorship? Partnership? Corporation?

Proprietorship: one owner; unlimited liability; very easy to start up Partnership: two or more owners; partners are liable as a whole; split between partners Corporation: limited liability; separate legal entity from the owners; double taxation

Insurance companies

Receive premiums for insurance policies. This pool of funds is used to reimburse policyholders who incur losses that are covered under the policy

What can a financial institution often do for a deficit economic unit (DEU) that it would have difficulty doing for itself if the DEU were to deal directly with a surplus economic unit (SEU)?

Surplus economic units do not usually have the expertise to determine whether deficit economic units can and will make good on their obligations, so it is difficult for them to predict when a would-be DEU will fail to pay what it owes (credit and default risk). Such a failure is likely to be devastating to an SEU that has lent a proportionately large amount of money. In contrast, a financial institution is in a better position to predict who will pay and who won't (credit risk). It is also in a better position, having greater financial resources, to occasionally absorb a loss when someone fails to pay (default risk)

Assume that you are attending a meeting of the Federal Reserve's Open Market Committee (FOMC). There is great concern among the members present that the economy is in a recessionary trend. a. What would you recommend that the FOMC do to stimulate the economy? b. Explain the chain of events that occurs when the FOMC takes the action that you recommended in part a

The FOMC should stimulate the economy by lowering the federal funds rate The Fed could lower reserve requirements at commercial banks. ii. The Fed may lower the federal funds rate by purchasing Treasury securities. iii. Both scenarios increase the reserves in the monetary system. iv. When the money supply increases, banks have more funds to lend to businesses, governments, and households. v. A lower federal funds rate also decreases the interest rate banks charge on loans. vi. When interest rates decrease, borrowing becomes more affordable for businesses and individuals

Commercial Banks

The primary purpose of commercial banks is to take in business deposits and to lend funds to businesses A specified percentage of deposits must be held as reserves (vault cash and deposits at the Fed). The Fed pays interest on deposits of banks.

Assume that Goodfellows National Bank has $60 million in transaction accounts, $20 million in nonpersonal time deposits, and $10 million in Eurocurrency liabilities. Given the reserve requirements listed below, how much must Goodfellows keep on hand in reserve funds?

Total deposits: Transaction accounts = $60,000,000 Nonpersonal time deposits = $20,000,000 Eurocurrency liabilities = $10,000,000 Reserve requirements: Transaction accounts - above $16 million = 3% (60,000,000 - 16,000,000) X 0.03 = $1,320,000 Total reserve requirements: ((60,000,000 - 16,000,000) X 0.03) + (20,000,000 X 0.0) + (10,000,000 X 0.0) = $1,320,000

The economy is suffering from a recession, explain what will happen to the yield spread between a Treasury bond and a BBB rated corporate bond.

Yield spread increases: Difference between bid price and ask price. Treasury- government Corporate- backed by corp.

The economy is experiencing a severe recession. The Fed will most likely

buy Treasury securities

Depository Institutions

commercial banks, savings & firms, and credit union

The risk that the issuer of a security may fail to make promised payments to the investor at the specified times is

default risk

Primary reserves

include vault cash and deposits held at the Federal Reserve

The flow of excess funds surplus economic units to financial institutions is called

intermediation

Commercial paper is

is a money market instrument

A zero-coupon bond

makes no periodic interest payments

What is the main goal of a business

maximize shareholder wealth-VALUE

Return on assets

net income/total assets - balance & income

Real interest rate inflation

nominal risk free interest rate

Finance companies

non-bank firms that borrow funds to make short and medium term loans to higher risk borrowers

commercial finance companies

organizations that make short-term loans to borrowers who offer tangible assets as collateral

Returned earnings

residual earnings of a company

default risk, maturity risk, illiquidity, and safe storage premium

risk premium

investments

security analyst & mutual fund managers

consumer finance company

small lend to people with low credit score and demand high interest

Financial markets

stock market & federal reserve

When bond investors have a strong desire for keeping their money safe:

they may accept a lower interest rate, perhaps even a negative rate, if the promise of safety is there in the bond