FIN111
What is a financial claim? How can a financial claim be both an asset and a liability at the same time?
-A financial claim or a security, is one's claim against another's wealth. -To its holder, it's a financial asset, so its issuer, a liability. -It may be debt (contract promising repayment with interest on a certain schedule) or equity (part ownership rewarded by participation in profits). -DSUs issue claims in return for funds, SSUs exchange funds for claims.
Outline the potential financial risks to a loan guarantor
-A loan guarantor agrees that in the event that a borrower is unable to reply a debt owing to a lender, the guarantor will reply the amount, providing an extra degree of security to the lender. -The financial risk to the guarantor is the likelihood that the borrower will default on their debt repayments to the lender -Where a mortgage is provided, the lender has the right to realise this security to the extent of any outstanding debt owing by the borrower.
What are advantages of operating as a public company?
-Access to the public securities market, easier to raise large capital -Ease of transfer of ownership -Because public companies usually have a lot of shares outstanding, large blocks of securities can be bought or sold without an appreciable impact on the price of the shares.
What is an agency relationship and what is an agency conflict? How can agency conflicts be reduced in a company?
-Agency relationships develop when a principal hires an agent to perform a service. -Agency conflict arises when the agent's interest and behaviour oppose the principal's -Agency conflicts can be reduced by three mechanisms: management compensation, control of the firm and the board of directors.
Discuss three forms of financial market efficiency. Why is it important that financial markets be efficient?
-Allocational: form of economic efficiency that implies funds will be invested to their highest valued use (promotes investments in projects that have the highest risk-adjusted rate of return) -Informational: ability of investors to obtain accurate information about the relative values of different financial claims (allows investors to determine which investments are the most valuable and enables households and firms to get information to make smart investment decisions) -Operational: when the costs of conducting transactions are as low as possible (if costs are high, fewer financial transactions will occur, and more investment project will be passed up, therefore society becomes worse off)
What are the three fundamental decisions the financial management team is concerned with and how do they affect the firm's balance sheet?
-Capital budgeting decision; which productive assets to buy. -Financing decisions; focus on raising money the firm needs to buy productive assets (selling long term debt and equity). -Working capital management decisions; how firms manage their current assets and liabilities. The focus is to see if the firm has enough money to pay its bills and that any spare money is invested to earn interest.
What are the major risks faced by financial institutions and why is it important that each is carefully managed?
-Credit risk: the possibility that a borrower may not pay as agreed. -Interest rate risk: the likelihood that interest rate fluctuations will change a security's price and reinvestment income. This can harm profit, cash flows, and the stability of the institution. -Liquidity risk: inability to meet its short-term obligations because of inadequate liquidity -Foreign exchange risk: possibility of loss on fluctuations in exchange rates. Can cause gains or losses. -Political risk: possibility that government action will harm an institution's interest. Includes changes in regulation, appropriation of assets, changes to foreign investment and currency transfer and trading rules, all of which can influence earnings and value. -Reputational risk: potential for negative publicity to cause loss through decline in customer base, increased litigation and revenue reductions. -Environmental risk:
Why are capital budgeting decisions among the most important decision in the life of a firm?
-Determine which productive assets the firm purchases -Productive assets generate most of the cash flow -Long term decisions, so risky
What are some problems with direct financing that make indirect financing more attractive?
-Direct financing requires exact match between the characteristics of the financial claims DSUs wish to sell and those the SSUs want to buy. -Therefore direct financing involves a costly search. -Intermediaries transform direct claims sold by DSUs and make them more attractive to SSUs, helping DSUs find financing and SSUs find appropriate investments
Explain the concept of financial intermediation. How does the possibility of financial intermediation increase the efficiency of the financial system?
-Financial intermediation is where financial institutions mediate unmatched preferences of ultimate borrowers (DSUs) and ultimate lenders (SSUs), and then issue their own liabilities with different characteristics to SSUs. -Therefore, financial intermediaries transform claims to make them more attractive to both DSUs and SSUs. -This increases the amount and regularity of participation in the financial system, therefore promoting the three forms of efficiency, allocational, informational, and operational.
What type of person is better suited to a credit card?
-People who are disciplined in tracking how much they are spending on their credit card. Most credit card providers have online facilities that allow cardholders to do this. -Exposed to fraud up to your credit card limit. -Have a range of fees and charges which apply in addition to the interest which accrues on the outstanding balance. -Fees tend to be higher than debit cards. -Wealthy graduate. -High spenders: in order to avail the reward schemes.
What type of person is better suited to a debit card?
-Poor students who easily succumbs to impulse purchases. -Depends on current circumstances and attitudes
What is the difference between primary and secondary markets?
-Primary markets are where financial claims are initially sold by DSUs. All financial claims have primary markets. -Secondary financial markets allow people to exchange previously issued financial claims for cash at will, therefore provide liquidity. -The Australian stock exchange (ASX) is an example of a secondary market.
Explain why profit maximisation is the the best goal for a company? What is an appropriate goal?
-Profit is subjective -Accounting profits don't equal cash flows -Profit maximisation does not account for timing and ignore risk -Appropriate goal is to maximise the value of the firm's current share prices, to do this, financial decisions must make the total value of cash inflows exceed the total value of cash outflows
Why are many business operated as sole proprietorships or partnerships?
-Small operating scale and capital base of the firm -Easy to start and have few regulations on the owners
What are the disadvantages of operating as a public company?
-The company pays taxes on its income but the owners' income gets taxed again when dividends are paid (double taxation)
Why are direct financing transactions more costly and/or inconvenient than intermediated transactions?
-The parties to direct finance have to find each other and negotiate an exact match of preference as to amount, maturity, and risk. -Intermediaries provide all parties choices about financial activity, and drive costs down through competition, diversification, and economies of scale.
Briefly discuss why there is likely to be a different interest rate charged on a secured loan compared to an unsecured loan?
-There is likely a lower interest rate for secured loans, reflecting the relatively lower risk exposure for the lender when there is security provided. -When a security interest is held by a lender, the lender is able to recover the asset provided as security to offset any amounts outstanding by the borrower. -In the event of bankruptcy to th
What is a partnership and what is the biggest disadvantage of this business organization? How can it be avoided?
-Two or more owners legally joined together. -Major disadvantage is all partners have unlimited liability for the firm's debt -To avoid this, form a limited partnership in which only general partners have unlimited liability, and limited partners are only responsible for business obligations up to the amount of capital they contributed to the partnership.
Why is denomination divisibility an important intermediation service from the perspective of the typical household?
-Typical households don't have the minimum investment of $1 million into direct credit markets. -Financial intermediaries facilitate indirect investment by households by offering financial claims with smaller denominations. -Otherwise, households would need to save for a long time, earning no interest income, a substantial opportunity cost and a disincentive to save and invest.
Which of the following assets is tangible? a) Exxon-Mobil's corporate headquarters building b) Apple Computer's trademark c) Hewlett-Packard's most recent printer patent d) Microsoft's technical expertise
Exxon-Mobil's corporate headquarters building
Explain the key roles of the financial system. Why is it so important to the broader economy to have an efficient and effective financial system?
Financial markets have five primary functions: -facilitating flow of funds -providing the mechanism for the settlement of transactions -generating and disseminating information that assists decision making -providing means for the transfer and management of risk -provide ways of dealing with the incentive problems that arise in financial contracting Having an efficient system is critical as it facilitates commercial, retail, and government transactions in a timely, low cost and reliable way. -Will also produce actual and timely information, enabling effective financial decision making.
What are the major uses of funds for a bank?
Lending and investing
Shareholders of a corporation may be, among others: a) individuals b) pension funds c) insurance companies
a, b, and c
Costs associated with the conflicts of interest between the managers and the shareholders of a corporation are called: a) legal costs b) bankruptcy costs c) administrative costs d) agency costs
agency costs
Which of the following is not a financial asset? a) common stock b) bank loans c) preferred stock d) buildings
buildings
A firm's investment decisions is also called its: a) financing decision b) liquidity decision c) capital budgeting decision d) leasing decision
capital budgeting decision
Limited Liability is an important feature of a) sole proprietorship b) partnerships c) corporations d) both partnerships and corporations
corporations
A corporation, potentially, has infinite life because it: a) is a legal entity b) has the same ownership and management c) has limited liability d) is closely regulated
is a legal entity
Generally, a corporation is owned by its: a) managers b) board of directors c) shareholders
shareholders
In the principal-agent framework a) shareholders are the principals b) managers are the principals c) managers are the agents d) a and c
shareholders are the principals and managers are the agents
Which is the following types of assets are intangible? a) production machinery b) factories c) trademarks d) office equipment
trademarks
As a legal entity a corporation can perform the following functions EXCEPT: a) borrow money b) lend money c) sue and be sued d) vote
vote
