Finance 3000 Midterm 1

Structure of financial markets

- Primary Market vs. Secondary Market -Exchange market vs. Over The Counter Market -Money Market vs. Capital Market -Physical Asset Markets vs. Financial Asset Market -Spot Market vs. Future Market -Private Market vs. Public Market

Future value of the investment in n years

(FVn)

Time money remains invested

(N)

Periodic Equal Payment (Or deposit)

(PMT)

secondary market

the market in which previously issued securities are traded among investors

Future Markets

the markets in which participants agree today to buy or sell an asset at some future date

Adverse Selection

the problem of incomplete information - of choosing alternatives without fully knowing the details of available options Potential borrowers most likely to produce adverse outcome are ones most likely to seek loan and be selected -Before transaction occurs

Classical Goal of Financial Management

Maximize shareholder profits - Price of common stock -Value of the firm

Liquidity Ratios

Measure the ability of the firm to meet its short-term financial obligations.

Profitability Ratios

Measure the overall effectiveness of the firm's management Two Types: Profit in Relation to Sales Profit in Relation to Investment

What is the difference between a primary market and a secondary market?

Primary market is where securities are issued for the first time. Secondary means they previously issued or exchanged securities

primary market

market for selling financial assets that can only be redeemed by the original holder

spot market

market in which a transaction is made immediately at the prevailing price

Financial Management 3 main areas

-Capital Budgeting -Capital Structure -Working Capital Management

financial system (4 areas)

-Capital allocation Process -Financial Markets -Financial Institutions -Regulations on the financial System

Four basic areas of finance

-Corporate finance -Investements -Financial MArkets and instituions -International Finance

How is capital transferred between savers and borrowers?

-Direct Finance: Borrow directly from lenders in financial markets (Bond markets, Stock markets, etc) -Indirect Finance: Borrow indirectly from lenders via financial intermediaries (insurance Co, Banks, etc)

Evaluating Financial Performance

-Evaluate the success of an ongoing business -Determine weaknesses of an ongoing business -Compare current performance with past performance -Compare current performance with industry standards

Capital Allocation Process

-In a well-functioning economy, capital flows efficiently from those who supply capital to those who demand it. -Suppliers of capital - individuals and institutions with "excess funds". These groups are saving money and looking for a rate of return on their investment. -Demanders or users of capital - individuals and institutions who need to raise funds to finance their investment opportunities. These groups are willing to pay a rate of return on the capital they borrow. ●

Transactions costs

-Reduce transactions costs by developing expertise and taking advantage of economies of scale -Banks provide depositors with checking accounts that enable them to pay their bills easily -Depositors can earn interest on checking and savings accounts and yet still convert them into goods and services whenever necessary

Limited liability Partnership

-one or more partners have limited liability -limited partners do no participate in the management -Limited partners are merely investors - one general partner must exist

3 step analysis

1. Calculation 2. Interpretation 3. Evaluation

asymmetric information

a situation in which one party to an economic transaction has less information than the other party

Financial Institution

A business that provides money-related services. -Engages in indirect finance -More important source of finance than security Markets -Needed because of transaction costs, the reduction of risk, and asymmetric information.

Sole Proprietorship

Advantages: - Easily established - Minimal Organizational Costs -Keep all generated profits Disadvantages: Unlimited liability -Losses absorbed by owner -Limited capital Limited life

Corporation

Advantages: -Liability Limited to Investment -Ease in Raising Capital -Continues after death of owner(s) Disadvantages: -Tax Treatment of earnings (Double Taxation) -Time and Cost of Incorporation -Separation of ownership and management

Present Value (PV)

Amount that is invested

Stock options

An option to buy stock at a stated price within a specified time period that is granted to an executive as part of his or her compensation package.

Balance sheet

Assets=Liabilities+OE

What is an exchange market

Auction market

What is future market?

Brands try to lock in brand loyalty at an early age

Issue Approach

Calculate, Interpert, Evaluate

Business Ethics (How management deals with its stakeholders)

Can be defend as a company's attitude and conduct toward it's employees, customers, community, and stockholder.

Statement of cash flow

Cash inflow-cash outflow=change in cash

General Partnership

Each partner is fully responsible for liabilities Advantages: -minimal organizational requirements - Negligible government regulations Disadvantages: - All partners have unlimited liability -Losses absorbed by owners - Difficulty of transferring ownership - Limited life-terminates at death or decision of one partner

financial markets

Financial assets are created, exchanged bought, sold: 1.) main channel market facilitator of direct finance 2.)provide economic growth 3.) Strong financial market will lead strong economy 4.) Provides some social

Compound value

Future value of a lump sum (one time payment) Value at some time in the future of an investment Interest compounds: earn interest on interest in later years. Future value in one year is present value plus the interest that is earned over the year.

Simple interest

Interest earned only on the original principal amount invested

Who uses ratio analysis?

Internal Users: - Performance evaluation -Planning for the future External Users: -Creditors -Suppliers -Customers -Stockholders

Efficiency Ratios

Provide basis for assessing how effectively the firm is using it's resources to generate sales

Income Statement

Revenues-Expenses=Net Income

What is a money market?

Short term securities are traded

What are the major forms of business organization?

Sole prop, General Partnership, Limited Liability Partnership, Corporation

What is over the counter Market

The market where securities that are not listed on exchanges are traded. Dealer/Broker

Capital Structure (High paying Job) Where will you get the long-term financing to pay for your investment?

The mixture of debt and equity maintained by a firm

Working Capital Management. How will you manage your everyday financial activities such as collecting from customers and paying suppliers?

The process of managing a firm's short-term assets and liabilites

Capital Budgeting (Defense Team) What long term investments should a firm take on?

The process of planning and managing a firm's long-term investments

Interest Rate (i)

The text uses as R in notation

Leverage Ratios

Used to measure the extent to which non-owner supplied funds have been used to finance the firm's assets Two Types: ● Balance Sheet Leverage Ratios ● Coverage Ratios

Functions of Financial Markets

Well-functioning financial markets facilitate the flow of capital from investors to the users of capital.: -Markets provide savers with returns on their money saved/invested, which provides them money in the future. -Markets provide users of capital with the necessary funds to finance their investment projects. -Well-functioning markets promote economic growth. -Economies with well-developed markets perform better than economies with poorly-functioning markets. -Financial Market is also beneficial for purposes other than increasing production in a business.

Moral Hazard

When the act of insuring an event increases the likelihood that the event will happen After transaction occurs Hazard that borrower has incentives to engage in undesirable (immoral) activities making it more likely that won't pay loan back

Agency Problem

Will managers work in the shareholder's best interests? -Managerial compensation: 1.) Given opportunities to buy stocks for barging prices 2.) Better performers within firm will tend to get promoted 3.)The threat of a takeover may result in better management 4.)Proxy rights: The authority to vote for some one else.