Finance chapter 1-5

interest rate factor

(1+r) - is the rate of exchange between dollars today and dollars in the future

What are some ways that managers are naturally inclined to act in their own best interests

- being conservative on risk taking - perquisite consumption - effort level

types of financial institutions/intermediaries

- commercial banks and credit unions - investment banks - financial service corporations - pension funds - life insurance companies - mutual funds - exchange traded funds - hedge funds - venture capital and private equity companies

How is capital transferred between savers and borrowers?

- direct transfers - financial intermediaries

How to create value for investors

- managers (agents) work on behalf of the shareholders (principals) - maximizing the share price is generally the best metric for maximizing shareholder value - in equilibrium, a stock's price should equal its "true" or intrinsic value

Present value

- today's value of money you expect to receive in the future - discount future cash flows (using the discount factor) to calculate the present value PV=FV/(1+r)^t

perquisite consumption

- using some of the company $ for things like golf membership - helps managers but not the business

Future value

- value of today's money at some point in the future - compound present cash flows (using the interest rate factor) to calculate the future value FV=PV(1+r)^t

Financial management (aka corporate finance)

- what assets to buy (capital budgeting) - how to raise the capital to buy them (capital structure) - how to run the firm to maximize its value

discount factor

1/(1+r)

Which of the following compensation proposals is most likely to be in the best interest of the company's shareholders? - A base salary of $500,000 plus perquisites worth $250,000 - A base salary of $500,000 plus a stock option package for 250,000 shares, with 20% of shares maturing at the end of each of the next five years - A base salary of $500,000 plus a stock option package for 250,000 shares that mature in six months

A base salary of $500,000 plus a stock option package for 250,000 shares, with 20% of shares maturing at the end of each of the next five years

Which of the following factors tend to encourage management to act in their stockholders' best interests? - A reasonable compensation package sufficient to attract and retain able managers. - Direct intervention by shareholders. - Firing managers who do not perform well. - Threat of a hostile takeover. - All of these factors encourage management to act in shareholders' best interests.

All of these factors encourage management to act in shareholders' best interests.

intrinsic value

An estimate of a stock's "true" value based on accurate risk and return data. The intrinsic value can be estimated but not measured precisely.

Corporate finance, Capital markets , or investments? Brandon, a trader at the New York Stock Exchange (NYSE), executes the decisions made by investors and takes action based on requests by different buyers and sellers in the market.

Capital Markets

Corporate finance, Capital markets , or investments? Managers at a bank need to decide on the interest rate that they must charge for the loans that they make to their prime customers.

Capital Markets

Type of market: Long-term mortgage-backed securities are traded between investors and issuers.

Capital market

Corporate finance, Capital markets , or investments? Richard, the chief executive officer (CEO) of ABC Corp., must make decisions that help achieve the primary goal of the corporation: maximize shareholders' wealth.

Corporate Finance

Corporate finance, Capital markets , or investments? Matthew must make a decision on how to cut costs so that his company can generate extra cash flow to acquire assets.

Corporate finance

Bethany is planning to start a business. Why might she choose to operate her business as a corporation rather than as a proprietorship or a partnership? - A smaller amount of a corporation's income is generally subject to federal taxes. - Corporations generally face fewer regulations. - Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation. - Corporations generally find it easier to raise large amounts of capital. - Corporate investors are exposed to unlimited liability.

Corporations generally find it easier to raise large amounts of capital.

direct costs

Costs that can be specifically identified with a particular project or activity. - fines, lawsuits from externalities

Cooperative associations whose members are supposed to have a common bond are known as

Credit Unions

the use of additional ____ increases stockholder- debtholder conflicts. Consequently, bondholders attempt to protect themselves by including _____ in bond agreements that limit firms' use of additional ______ and ______ actions.

Debt; covenants, debts, managers

A financial instrument whose value is derived from the value of an underlying asset is called a

Derivative

Direct Transfers, Indirect transfers through Investment Banks, or Indirect Transfers through Financial Intermediaries: Based in Grass Valley, California, L & M Seeds Co. is a small company that manufactures organic seeds. To raise capital, the company sells stocks directly to savers in Grass Valley without involving any bank or financial intermediary.

Direct Transfers

Direct Transfers, Indirect transfers through Investment Banks, or Indirect Transfers through Financial Intermediaries: Erin borrows money from her uncle to buy a new laptop.

Direct Transfers

Future Value Equation

FV=PV(1+r)^n

Future Value of Annuity equation

FVA= PMT[((1+I)^N-1)/I]

The acronym IPO stands for "independent public offering." True/False?

False (stands for "initial public offering")

Finance grew out of economics and accounting, and it is generally divided into three areas. _________ also called corporate finance, focuses on decisions about acquiring assets, raising capital, and running the firm so as to maximize its value. ______ relate to the markets where interest rates and stock and bond prices are determined. ______ involve decisions concerning stocks and bonds and include security analysis, portfolio theory, and market analysis. These areas are closely interconnected.

Financial Management, Capital markets, investments

Type of market: Helen buys 1,000 shares of Microsoft stock through her online brokerage account.

Financial asset markets

Large conglomerates that combine many different financial institutions within a single corporation are known as

Financial services corporations

One of the following statements about issuing and owning securities is incorrect. Which statement is NOT CORRECT? - When stock in a closely held corporation is offered to the public for the first time, the transaction is called going public, or an IPO, and the market for such stock is called the new issue, or IPO, market. - The stock of publicly owned companies must generally be registered with and reported to a regulatory agency such as the SEC. - When a corporation's shares are owned by a few individuals, we say that the firm is closely, or privately, held. It is possible for a firm to go public and yet not raise any additional new capital for the firm itself. - Going public establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares.

Going public establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares.

Which of the following statements about hedge funds is CORRECT? - Hedge funds have more in common with commercial banks than with any other type of financial institution. - Hedge funds are extremely popular in Europe and Asia, but they are rarely used or made available in the United States. - Hedge funds are legal in the United States, but they are not permitted to operate in Europe or Asia. - Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only the wealthiest investors invest in hedge funds, and they understand the risks. - Hedge funds have more in common with investment banks than with any other type of financial institution.

Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only the wealthiest investors invest in hedge funds, and they understand the risks.

Direct Transfers, Indirect transfers through Investment Banks, or Indirect Transfers through Financial Intermediaries: California Public Employees' Retirement System (CalPERS) manages pension and health benefits of California public employees and retirees. CalPERS collects money from its participants and creates a pool of assets. It manages these assets by making investments across domestic and international markets.

Indirect Transfers through Financial Intermediaries

Direct Transfers, Indirect transfers through Investment Banks, or Indirect Transfers through Financial Intermediaries: W2 Corp. needs capital to finance a new product line. It borrows money in the form of long-term bonds underwritten by an investment bank.

Indirect Transfers through Investment Banks

Market equilibrium

Intrinsic Value = Stock Price

Corporate finance, Capital markets , or investments? As a technical trader, you will be analyzing investor psychology and making investment decisions based on how investors behave during certain situations.

Investments

Corporate finance, Capital markets , or investments? Chris works for a financial advising firm. He must create a financial plan and come up with a list of securities in which his client can invest. Chris must make decisions regarding the investments that he should recommend to his clients to include in their portfolio.

Investments

balancing shareholders interests and society interests

Managers recognize that being socially responsible is not consistent with maximizing shareholder value

Present Value Equation

PV = FV/(1+r)^t

Retirement plans funded by corporations or government agencies for their workers and administered primarily by the trust departments of commercial banks are known as

Pension Funds

Both the CEO and the CFO are required to certify the accuracy of information contained in financial statements, reports, press releases, and any other form of public announcement made by a company. This requirement was instituted in 2002 as a part of the

Sarbanes-oxley Act

Which of the following is an example of securities traded in money markets? - Short-term debt securities such as Treasury bills and commercial paper. - Consumer automobile loans. - Common stocks. - Foreign currencies. - Long-term bonds.

Short-term debt securities such as Treasury bills and commercial paper.

A hedge fund purchased credit default swaps on securities it did not own because it believed that the securities were likely to default. In this example, the hedge fund is....

Speculating

A company is nearly bankrupt. The CEO wants to take the last cash and buy lottery tickets. Who would be in favor of this?

Stockholders

Weak, strong, or semi-strong form efficiency: Current market prices reflect all relevant information, whether it is known publicly or privately.

Strong form efficiency

Of the following policy changes, which would be the most likely to REDUCE potential conflicts of interest between stockholders and managers? - The company changes the way executive stock options are handled, with all options vesting after one year rather than having 20% of the options awarded vest every two years over a 10-year period. - Congress passes a law that severely restricts hostile takeovers. The company's outside marketing firm is given a lucrative year-by-year consulting contract with the company. - The composition of the board of directors is changed from all inside directors to all outside directors, and the directors are compensated with stock rather than cash. - A firm's compensation system is changed so that managers receive larger cash salaries and no long-term options to buy stock.

The composition of the board of directors is changed from all inside directors to all outside directors, and the directors are compensated with stock rather than cash.

The bid-ask spread in a dealer market represents the profit that a dealer would make on a transaction involving a security. Which of the following statements best describes the bid-ask spread? - The difference between the closing price of the security and the opening price of the security on the day of the transaction. - The difference between the price at which a dealer is willing to buy a security and the price at which a dealer is willing to sell it. - The sum of the price at which a dealer is willing to buy a security and the price at which a dealer is willing to sell it.

The difference between the price at which a dealer is willing to buy a security and the price at which a dealer is willing to sell it.

A stock's return can be broken out into its dividend yield (which might be zero) plus a capital gains yield (which could be positive, negative, or zero). These returns can be calculated for all of the stocks in the S&P 500. You can find an indicator of the "return on the market" by calculating the weighted average of those returns, using each stock's total market value. True/False?

True

Data from the Dow Jones Industrial Average, the S&P 500 Index, and the NASDAQ Composite Index give information about past stock returns. True/False?

True

The equation used to find the annual rate of return on any given stock is the stock's dividend for the year plus the change in the stock's price during the year, divided by its beginning-of-year price. When applied to a large portfolio of stocks, like those in the S&P 500, the average of the returns on each stock can be used to find stock market returns for the year in question. True/False?

True

To find the annual rate of return on any given stock, add the stock's dividend for the year plus the change in the stock's price during the year, then divide by its beginning-of-year price. True/False?

True

Weak, strong, or semi-strong form efficiency: Current market prices reflect all information contained in past price movements.

Weak form efficiency

Which of the following statements about financial markets is CORRECT? - If an investor sells shares of stock through a broker, then it would be a primary market transaction. - While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. - The New York Stock Exchange is an auction market, and it has a physical location. - Capital markets deal only with common stocks and other equity securities. - Home mortgage loans are traded in the money market.

While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties.

Annuity

cash flows are all the same amount, and spread out equally over a finite period of time

perpetuity

cash flows are same amount over regular intervals, but forever

The traditional department stores of finance serving a variety of savers and borrowers are known as

commercial banks

interest rate is what allows us to do what?

convert cash across time

indirect costs

costs that are the result of a firm's general operations and are not directly tied to any specific cost object - inability to attract talent, boycotts

The US Securities and Change Commission (SEC), a US federal agency, is considered to be an investor's advocate. Its purpose is to protect investors, maintain market integrity, and facilitate capital formation. Under the Sarbanes-Oxley Act of 2002, the SEC requires CFOs to certify that the firm's:

earning numbers are accurate

Maximizing the stock price on a specific target date will maximize shareholder value. True/False?

false

The primary financial objective of the firm is to maximize EPS. True/False?

false

What is Finance?

finance is the study of how we allocate our assets over time in a risky world

capital markets

financial institutions or intermediaries (middlemen and women who find investors for people who need them)

direct transfers

from savers direct to individuals businesses - small amounts less common in developed markets, more common in less-developed markets

The process in which derivatives are used to reduce risk exposure is called

hedging

Financial intermediaries

help move funds from parties with excess capital to parties needing capital - more common in developed economies - intermediaries help elevate the risk of investments, provide funding, provide liquidity to the economy

Capital structure

how to finance/fund to make asset purchases

Most managers recognize that being socially responsible is

important and generally (but not always consistent) with achieving their financial goals.

The goal of the managers of a publicly owned company should be to maximize the firm's _______

intrinsic value

Organizations that underwrite and distribute new investment securities and help businesses obtain financing are known as

investment banks

Vision Tech's stock price is currently trading at $41 per share. The consensus among analysts is that the intrinsic value of Vision Tech's stock is $33 per share. Is Vision Tech more or less likely to receive a hostile takeover bid?

less likely

How should managers use intrinsic value

managers should avoid actions that reduce intrinsic value, even if those decisions increase the stock price in the short run (intrinsic value is a long-run concept)

What's the goal of the financial manager?

maximize shareholder value

Corporate finance is concerned with the different aspects of a business's financial management. The chief financial officer (CFO) is the top financial position in the organization and oversees several tasks. The CFO is not responsible for which of the following departments? - investor relations - human resources - marketing - research and development - production

only responsible for investor relations

An analyst with a leading investment bank tracks the stock of Mandalays Inc. According to her estimations, the value of Mandalays Inc.'s stock should be $28.95 per share, but Mandalays Inc.'s stock is trading at $33.58 per share on the New York Stock Exchange (NYSE). Considering the analyst's expectations, the stock is currently: - Overvalued - Undervalued - In equilibrium

overvalued

financial market

place where individuals and organizations needing capital are brought together with those having a surplus of capital

APR is the ______

quoted rate

investments

security analysis, portfolio theory, mkt analysis, behavioral finance

Weak, strong, or semi-strong form efficiency: Current market prices reflect all relevant publicly available information.

semi strong form efficiency

type of market: You need gasoline now, so you drive to the gas station and purchase 10 gallons of gasoline.

spot market

What happens to stock prices when there is a financial crisis

stock prices can drop tremendously (happens from behavioral aspects)

What are some ways stockholders and debt holders have conflicts

stockholders want riskier projects because they receive more from the pay off but bondholders receive fixed payments so they are more interested in limiting risk

The owners of a corporation are __________ of the company . The primary goal of the corporate management team is to ______ the shareholders' wealth by ________ the_______ over the long run.

the shareholders; maximize; maximizing; company's stock price

importance of financial markets

they help match those two groups together so that capital moved efficiently - need variety of intermediaries willing to handle capital transfers of varying risk and time-horizon - increase investment and economic growth - greater economic flexibility - ability to withstand changes/crises in the economy

What is the main goal of financial management

to add value for the investor(shareholders)

There are factors that influence stock price over which managers have virtually no control. True/False?

true

In equilibrium a stock's price should equal it's _____ or _____

true; intrinsic value

law of one price

two assets with the same cash flows must sell for the same price; no arbitrage

capital budgeting

what assets to buy

Why do we focus on shareholder value ?

what someone is willing to pay for a share in a company encompasses maximizing revenues, earnings per share (EPS), market shares, and minimizing costs