TIM 305 Exam #1

What are the limitations of ratio analysis?

* Limitations of financial ratio analysis' 1. Many ratios are calculated on the basis of the balance-sheet figures. These figures are as on the balance-sheet date only and may not be indicative of the year-round position. 2. Comparing the ratios with past trends and with competitors may not give a correct picture as the figures may not be easily comparable due to the difference in accounting policies, accounting period etc. 3. It gives current and past trends, but not future trends. 4. Impact of inflation is not properly reflected, as many figures are taken at historical numbers, several years old. 5. There are differences in approach among financial analysts on how to treat certain items, how to interpret ratios etc. 6. The ratios are only as good or bad as the underlying information used to calculate them.

Describe the Uniform System of Accounts for Hotels

* Uniform System of Accounts for hotels: a standardized income statement that provides hospitality industry with numerous advantages • Understand proper format of income statements • Allows easier comparison between properties - Normally for internal use (property level) • Used for different size properties • Time tested • Unique to the hotel industry • Allows management to focus on different functional areas of a full-service hotel • E.G. labor expense can be attributed to an individual department to help determine that department's profitability.

Define Subchapter S Corporation

- Avoids separate federal taxation. Firms must meet certain requirements, including a maximum of 75 owners, each of whom must be a resident/citizen of the U.S.

To raise equity capital through public markets, the corporation must meet certain requirements of whom?

- Securities and Exchange Commission (SEC)

Define corporation. What are the advantages and disadvantages?

- A corporation is a legal "person" separate from its owners. Separation of ownership and management allows the ease of transferring ownership, unlimited life of the business, and limited liabilities for business debts. Advantages: - Unlimited life - Limited liability for its owners - Lack of dependency on any one individual - Relative ease in raising capital Disadvantages: - Relatively difficult to form - Increased regulation - Double taxation of dividends (corporate profits are taxed twice)

How do you calculate current yield?

- Amount of annual interest earned/current price • This yield is not the return an investor will receive if she holds the bond until maturity

Define depreciation

- Businesses recognize the expense of an asset as it is used. - The cost is prorated over the useful life of the asset. - When a company purchases an asset that benefit the company more than one year, the asset should not be expensed, but capitalized, meaning that particular purchase is added to the company asset. - Over the periods, the asset will be used and depreciated according to the usage. - Amortization is for intangible assets - patents or copyrights.

Define capital structure

- Financing mix - How much to borrow? What are the least expensive sources?

Define hedging

- Hedge is an investment position intended to offset potential losses that may be incurred by a companion investment. - Reduce any substantial losses - Agreement to deliver a certain amount to a specified buyer on a certain date in the future for a certain fixed price.

When do projects create value?

- If a project's benefits exceed its costs, value is created for the owners.

How are the financial statements interrelated?

- Income Statement provides "Net Income" or "Net Loss." - Statement of Retained Earnings uses "Net Income" or "Net Loss" to calculate "Ending Balance of Retained Earnings." - Balance Sheet can be completed by using "Ending Balance of Retained Earnings" for its "Stockholders' Equity" section.

What is the relationship between interest rate and bond price?

- Interest rate goes up (or down), price goes down (or up)

Define capital budgeting

- Long term - Identify investment opportunities that are worth more than they cost to acquire.

What are the most important pieces of information about a bond?

- Maturity date: the date the bond becomes due. - Par (face) value: amount to be repaid at maturity (=$1,000). - Coupon rate: predetermined rate of interest. - Priced on an index relative to 100.

What is the goal of financial management?

- Maximize profits. (e.g. the current value per share of the existing stock). • When a firm has publicly traded common stock, it is maximizing the stock price • Focus on profits

Define risk.

- Potential for outcomes to be different from our expectations. The greater the outcome is from our expectations, the greater the risk (for better or worse).

What are the different credit ratings?

- S&P/Moody - AAA/Aaa - Investment, Risk is almost zero - AA/Aa - Investment, Low risk - A/A - Investment, Risk if economy declines - BBB/Baa - Investment, some risk; more if economy declines - BB/Ba - Speculative, Risky - B/B - Speculative, risky; expected to get worse - CCC/Caa - Speculative, probable bankruptcy - CC/Ca - Speculative, probable bankruptcy - C/C - Speculative, In bankruptcy or default - D - Speculative, in bankruptcy or default

Define working capital management

- Short term - Working capital = short-term assets and liabilities - How much to borrow? What are the least expensive sources?

What is the difference between a sole proprietorship and a partnership?

- Sole proprietorship: business owned by one person; most common type of business in the U.S. - Partnership: two or more owners; limited partnership

How assets, liabilities, and owner's equity affect cash.

- When an asset increases, the Cash account decreases. - When an asset decreases, the Cash account increases. - When a liability increases, the Cash account increases. - When a liability decreases, the Cash account decreases. - When owner's equity increases, the Cash account increases. - When owner's equity decreases, the Cash account decreases.

Define yield to maturity

- Yield to maturity - Total return when holding it till maturity - ASSUMPTION: you reinvest the coupons at the same rate in compounding effect.

What are the two main methods of financing?

1) Equity financing (Stock) 2) Debt financing (bond) - Priority over stockholders - Limited influence

What are the three key elements in the financial management process?

1) Financial planning Enough funding is available. 2) Financial control Business is meeting its objectives. 3) Financial decision-making

What are the purposes of the various ratios?

1) Liquidity: ability to meet current debts using current assets; ability to meet short-term obligations 2) Turnover: management's effectiveness regarding the management of assets; efficiency of operations 3) Solvency: ability to meet long-term debts; how much risk the company has taken on 4) Profitability: how profitable the operation is; how good a company is good at converting revenue/assets/equity into profits. 5) Investor: the ratios of special significance to outside investors 6) Activity: key measures of operating performance

What key questions would you ask yourself if you were to start your own business?

1) What investments should you take on? - What types of assets will you need? 2) Where will you get the financing to pay for your investment? - Will you bring in other owners or borrow the money? 3) How will you manage your everyday financial activities? - Collecting from customers and paying suppliers.

What are the three liquidity ratios?

1. Current ratio • Keep in mind: • Many hospitality firms have very few receivables. • Hospitality firms are fixed-asset intensive; the owners wants mangemetn to invest in assets that will produce cash flows (e.g. land, buildings, and equipment) • Not unusual for hotels to have lower current ratios than other industries. 2. Quick (acid-test) ratio: "less liquid" assets such as inventories and prepaid expenses are included from the numerator because these current assets are often difficult to convert into cash. • Typically always lower than the current ratio, assuming the company has inventory and prepaid expenses 3. Working capital: not a shareholder's equity account; related to the current and quick ratios • Working capital = current assets minus current liabilities • Most businesses need to obtain working capital to become established as this means they have an excess of items such as cash and inventory above what they owe.

What are the three types of solvency ratios?

1. Debt-to-assets ratio includes both short-term and long-term debt • Managers may borrow less to maintain some "unused debt capacity" in case of a good investment opportunity • Managers may also use debt because of the type of assets they have. They often attempt to match the term of the loan with the life of the asset. • Given the long-term nature of hotel assets, managers may want to calculate ratios that use long-term debt instead. 2. Debt-to-equity ratio: if a firm is successful in generating and retaining earnings, then the proportion of debt decreases, thereby reducing the risk to existing lenders. • Not unusual for the debt-to-equity ratio to be very high in hotel industry. • In the hotel industry, a significant amount of the debt is guaranteed by real estate. If they go bankrupt, lenders an take the hotel as collateral. 3. Interest coverage ratio (times interest earned ratio): All parties are concerned with the firm's ability to make periodic interest ratio • Interest coverage may be lower in hotel industry because of the extensive use of financial leverage to finance operations.

How do stockholders make money?

1. Receiving a stream of dividend payments (current income) 2. Capital gain: eventually selling their stock at a higher price than what they paid • Shareholders pay income taxes on dividends, but taxes on capital gains can be deferred until the share of stock is actually sold. Capital gains are currently taxed at a lower rate than dividends are. - Holding period return

What are the four main types of financial statements?

1. Income statement: indicates performance of an operation over a period of time 2. Balance sheet: indicates the financial position of the operation at a particular point in time 3. Statement of retained earnings: shows the changes of the owner's position during an operating cycle 4. Statement of cash flows: explains changes in the cash account for an operating cycle

What are the three types of turnover ratios?

1. Inventory turnover: average taken involves calculating the average of the inventory values shown on the beginning and end-of-year balance sheets • Improve the accuracy of this ratio by taking more periods into account • Compare to previous periods or industry averages for comparable hotels • Too-low may indicate unpopular menu items or an investment policy that purchases too much inventory. Must manage inventory carefully because of the expense of receiving and storing it. • High ratio may be facing stockouts of certain desired items. 2. Asset turnover ratio: presents the amount of sales that are generated by the assets • Averages can be used, but a single figure is often used because assets often do not change as rapidly as inventory 3. Fixed asset turnover: we often use this in the hotel industry because hotels are so fixed-asset intensive, and may want to know the productivity of our fixed assets alone • There is a significant amount of accumulated depreciation on the balance sheet. Over time, the net value of the fixed asset will decline, which improves this ratio. In the long run, the hotel would deteriorate, affecting occupancy and rates.

What are the three major decisions of the firm?

1. Investment: What investments should the firm take on? 2. Financing: Where will the firm get financing to pay for the investments? 3. Distribution: What should the firm do with the earnings generated by the investments?

What are the three types of profitability ratios?

1. Net profit margin 2. Return on investment (a.k.a. return on assets): compares the profits of the firm to the investment in assets made by the firm. • Assess management's effectiveness in using the assets to generate earnings • If assets are going to change significantly during the year, it may be appropriate to use an average asset figure • A large amount of depreciated assets will lower the denominator and make the ratio appear larger. A significant new investment in assets could push the ratio much lower. * DuPont ratio: breaks down the return on investment into: profit margin and asset turnover. • Interaction between the profit margin and the ability of assets to generate sales. • Ratio reveals trade-off 3. Return on stockholder equity ratio: key ratio examined by investors when considering an investment; affected by the amount of financial leverage used to finance the operations. • As more financial leverage is used, expected return for shareholders will increase, along with risk associated with the investment

What are four activity ratios?

1. Occupancy percentage 2. Average daily rate: be careful when comparing average room rates. It is more appropriate to budget a rate or compare to an average room rate for an earlier period. 3. REVPAR: revenue per available room • Provides the most comprehensive picture of property performance. • Trade-off between occupancy and ADR 4. Average food check: Gross profit margins on food items are normally much lower, so many operations focus on increasing the average check (food revenue/# of customers) • Used in budgeting 5. Food and beverage cost of sale ratios are important indicators of potential profitability of F&B operations • Cost of food sold: subtract items such as employee and complimentary meals and distributing those expenses to the appropriate departments

What are three types of investor ratios?

1. Price-to-earnings ratio: investors use this ratio to help them make decisions about buying or selling stocks. • Firms with very high P/E ratios are considered companies with good prospects for strong growth in future earnings • Companies with lower P/E ratios are considered to have lower prospects for future earnings growth • Value is based on future cash flows, not accrual basis earnings 2. Dividend payout ratio: measures the percentage of earnings that is paid to the owners in the form of dividends • More stable and well-established firms will pay out a larger proportion of their earnings as dividends • High-growth companies tend to retain their earnings to reinvest in assets. • Once firms begin to pay a dividend, they do not want to decrease it because of the potential impact on stock price 3. Dividend yield: inversely related to the firm's prospects for future growth. A relatively low dividend yield implies high growth prospects • A relatively low dividend yield implies high growth prospects • Dividend yield is not a true rate of return for holding the stock, which would be based on the dividends received plus any increase in the stock price.

What is the purpose of turnover ratios?

• Turnover ratios: help measure management's effectiveness when employing the resources at their disposal

What are the three decisions financial managers must make?

1. The investment decision: the selection of which assets to hold • Fixed assets typically produce the greatest amount of revenue for the firm. • Resources are limited, which assets will be the best for us to own? 2. The financing decision: how should we pay for the assets that we decide to acquire? • Current liabilities: debts owed to others • Long-term liabilities: debts that will take longer than a year to pay (i.e. bonds) • Owner's equity: includes preferred stock, common stock, and retained earnings • Both lenders and owners have claims on the assets, but lenders have a priority claim • Proportion of debt used versus equity will vary 3. The dividend decision: firms have a choice to pay dividends or retain these earnings and use them to finance new assets (or a combination) • Stockholders hope price of their stock will increase and also pay dividends • All three financial decisions should create or maximize the value of the owners' investment

What are the three major factors that affect the value of these dividends?

1. The size of the dividends. Larger dividends will yield a higher stock price. 2. The timing of the dividends. The sooner the dividends are received, the higher the stock price. 3. The risk associated with the dividends. Lower the risk, the higher the stock price.

Explain the process of financial management

A. Firm issues securities to raise cash B. Firm invests in assets C. Firm's operations generate cash flow D. Cash is paid to government as taxes. Other stakeholders may receive cash. E. Reinvested cash flows are plowed back into firm. F. Cash is paid out to investors in the form of interest and dividends.

What are the advantages and disadvantages of a sole proprietorship and a partnership?

Advantages: - Ease of formation - Greater control - Single taxation (income taxed as personal income) Disadvantages: - Unlimited liabilities - Relative difficulty in raising capital - Limited life of the business

Describe agency problems.

Agents? • Agency: corporations delegating decision making to their hired agents (management), who act in the best interest of principals (outside financiers) - Owners vs. managers - Franchisors vs. franchisees - Owners vs. lenders: ability to raise debt capital is important, but the primary task of managers is to maximize the wealth of the shareholders, not necessarily increase the price of the company bonds. - Agency problems arise when an agent does not act in the best interest of the principal. • Agency problems: caused by conflicting interests among stakeholders: management, owners, creditors, employees, suppliers, and government. • Shirking: manager receives a high, fixed salary with no positive incentive to increase profits, the manager may work as few hours as possible. A solution might be to offer the manager stock to align incentives with owners. • Excessive consumption of perquisites: Including corporate jet, fancy offices, or threat of termination and/or takeover of the company. Solution is increased monitoring and hiring auditors. • Problems between bondholders (lenders) and shareholders: If project pays off, benefits will go to the shareholders, but if the project fails, the loss will be greater to the bondholders. • Design of contract is crucial to success

What are REITs?

Real Estate Investment Trusts (REITs) • REITs manage real estate portfolios for shareholders • Stock of the REIT is traded on one of the stock markets • Equity REITs: actually own real estate and pass income from the real estate on to the owners. • Mortage REITs: lend money to the industry and provide interest income to the owners. • REITs are exempt from corporate income taxes if they distribute at least 95% of their earnings to shareholders • Popular method of financing hotels over the past decade, but this can be affected if there are changes in tax laws

What are the two indices that track stock market performance?

Dow Jones Industrial Average • "The Dow": A price-weighted index of the common stock of 30 large companies that are considered industry leaders • Oldest sock market index • Index is a weighted average of the stock pries, based on the value of each stock. • Dow Jones Composite Average: Three indices combined, which also includes tracking an index of 20 transportation companies and 15 utility companies Standard & Poor's 500 • Financial services corporation that rates stocks, bonds, and commercial paper • S&P 500: Tracks the performance of the stock market and creates an index of 500 stocks, primarily those listed on the NYSE • Calculated using a weighted average based on the value of the 500 individual stocks • Stock market is considered risky because you are unable to obtain a return on a consistent basis • Variance: way of quantifying the differences between the actual returns in any given year and the overall average • Standard deviation: square root of the variance, also quantifies differences • Correlation coefficient: measure of how returns move together over time • Returns that move together are +1.0, move in exact opposite directions are -1.0 • Most assets have returns between 0 and +1.0 • Important when calculating the risk of groups of assets called portfolios

How do you maximize the wealth of the owners?

For a corporation, this means increasing the stock price. How? - Increase revenues - Control expenses

What's the difference between preferred stock and common stock?

Preferred stock: - Not issued as often - No voting rights - Priority position for dividends based on the par value of the stock - Similar to a bond Common stock: - Most prevalent type of stock issued - Voting rights - Right to dividends - Right to residual claim on assets - Bear the most risk

What two contracts can be used to hedge risk?

Forward and Futures Contracts • Prices of commodities can change over time, which creates uncertainty for both the buyer and the seller of the market. This created the need for forward and futures contracts. • Forward contract: an agreement about a sale of an asset that will be delivered in the future. • Forward price: price agreed on for future delivery • Cash payment is not required until delivery is made • Details and price are negotiated • Both parties are locked and must trust the other to perform • Very difficult to sell to third party • Future contract: involves a future delivery of an asset at a price (called the forward price). Features of a futures contract are largely standardized as opposed to being negotiated between the two parties. • Contract is between a trader and a clearinghouse that guarantees contract performance and the solvency of the two parties. • Contract sizes and delivery rates are standardized, making them easier to sell to a third party. • Value of the contract changes each day • "Marking to market": process of settling the value of the contract between the parties • Can either sell their contract or take an opposite position (instead of buying wheat on a certain day, you sell it on a certain day). • Taking a second and opposite position is quite common. Only 5% of futures contracts are actually fulfilled. • Forward and future contracts can be used with foreign currencies and commodities

What's the difference between the two financial markets?

Money markets - Short-term - Over the counter - Interbank lending Capital markets - Long-term - Equity - Ownership - Bonds - Interest

What's the difference between New York Stock Exchange and NASDAQ?

New York Stock Exchange • Oldest stock market, founded in 1792. Designated as a national securities exchange by the Securities and Exchange Commission (SEC) in 1934) • NYSE: physical location in which buyers and sellers conduct secondary trading of financial instruments, including bonds • Companies must meet certain standards to be listed on the NYSE • Not only for American companies • NYSE offers membership to securities dealers and brokerage firms in the form of "seats" on the trading floor • Only member firms are allowed to deal in securities offered on the exchange • Each seat carries a price and can be bought and sold between competing firms NASDAQ • NASDAQ: National Association of Security Dealers and Automated Quotation • Growth of the economy and interest by investors in smaller companies contributed to the growth of NASDAQ • NASDAQ serves an important function by allowing companies too small to be listed on the NYSE access to financial capital (also home to large companies, such as Microsoft) • Known as an over-the-counter (OTC) market because it is not a physical location like the NYSE • NASDAQ is the fastest-growing securities market and surpassed the NYSE in the number of shares traded • Comprised of two separate markets: a National market, and the Small Cap market • Key element in the system: dealers who act as "market makers" and compete with each other for business • Market makers: stabilize prices by helping to guarantee trades between buyers and sellers. If buyers or sellers cannot be found, market makers utilize securities from their own personal inventory to help ensure the liquidity of stock issues.

What's the difference between a preferred stock and a bond?

Preferred stock - Payment: fixed dividend - Taxation: non-deductible -Repayment: No Bond: - Payment: fixed interest - Taxation: deductible - Repayment: Yes

Define financial management

The management of the finances of a business to achieve financial objectives. - Create wealth/value - Generate cash - Provide an adequate return on investment (ROI)

Define yield. What is the relationship between yield and bond price?

Yield: the percentage return at any given price Current yield = coupon / market price Yield goes up (down), price goes down (up).

Describe the bond market

• Bond market is not really separate from the stock market • Many bonds are traded on the NYSE, like stocks • Majority of corporate and U.S. Treasury bonds are traded on OTC markets • Bonds represent a contractual agreement between lender and borrower, most bonds (with the exception of government bonds) are not guaranteed • Investment services firms rate the "safety" of bonds in terms of the probability of company payments of interest and principal • Default: companies that don't make interest payments on their bond issues on time • The lower the letter in the alphabet, the greater quality of bond (A>B) • Standard & Poor's rates bonds using all capital letters (AAA>AA) • Moody's rates bond with a capital letter followed by lowercase letters (Aaa>Aa>>C); C is the lowest rate.

Define bond

• Bonds: a form of debt capital issued by a corporation. Corporations issue bonds to investors, who receive interest payments and a repayment of their loan at the end of the term. • Corporate bonds can be trade on exchanges. • Bonds: represent a method of debt financing and a promise to repay investors over a period of time • Have a fixed-income security - Provides a series of cash flows over time: 1) semi-annual interest payments 2) principal at maturity • Bondholders do not have a true ownership claim on the assets, but they do receive a return on their investment in the form of semiannual payments and the return of the face value of the bond (called the principal) at the end of the term. • Like dividends, this represents a series of cash payments that can be valued • Bonds can be traded like stocks (although not in the same value)

When can ratio analysis be misleading?

• Can be misleading if not used properly • Most meaningful when used as the beginning of a detailed investigation into a particular portion of a hospitality operation • Compare ratios to industry standards, as industry comparisons are primarily used by lenders and investors • Be careful in consideration of the benchmark used • Potential pitfalls in utilizing industry averages • Large firms can dominate a sample of an industry and distort the overall picture • Not all firms use the same accounting methods (e.g. in regards to period of time) • Changes such as renovations and revised advertising strategies can make comparison difficult for even the same property • Managers often compare common hotel operation ratios, such as ADR, occupancy rate, and REVPAR to a prior period or goal.

Define capital markets and give examples.

• Capital markets: markets in which debt and equity issues are traded • Stock market (equity financing), bond market (debt financing), mortgage, futures market

How do commercial banks loan to the hospitality industry?

• Commercial banks, who have traditionally been the largest lender to the hospitality industry, take in capital from depositors to whom they provide a return on their money in the form of interest. To be able to pay this interest, banks will lend the money to businesses and individuals. Banks earn the spread (the difference between the interest rate charged on loans and the interest rate paid to depositors). • Interest = Principal x Rate x Time • Fully amortized loan: each payment contains a portion that is interest and a portion that is principal • Principal: amount originally borrowed • Most home mortgage loans are fully amortized, and the interest portion is tax deductible • Balloon payment: commercial loans are interest only, with the principal being repaid only at the end of the loan term. • Banks have also become more involved in investments for individuals. • Banks are still not allowed to sell insurance.

What is the advantages of debt financing over equity financing?

• Federal taxes: debt financing has an inherent advantage over equity financing because interest payments on bonds are tax-deductible expenses for the issuing firms, and the interest expense is included on the income statement. Dividend payments to stockholders are not considered operating expenses and do not appear on the income statement. This is one of the reasons firms finance their assets with debt instead of equity. • Most hospitality firms use a combination of debt and equity.

Define financial markets.

• Financial markets: where suppliers of financial instruments (firms) meet buyers of these instruments (investors) through financial intermediaries (such as brokers) and transfer funds. • There are a variety of financial instruments for investors to choose from. - Individuals and organizations need access to financial resources to invest, meet payroll, and develop new products.

What's the difference between direct quote and indirect quote in currency?

• For companies based in the U.S., a direct quote would indicate the cost of one unit of foreign currency in U.S. dollars • Indirect quote: the inverse of the direct quote (how much it would cost to obtain $1) • SEC requires profits from overseas to be "repatriated" and converted to U.S. dollars before they are reported to investors. • Primary factor affecting exchange rates is the difference between the expected rate of inflation. • Hedge risk by using a forward or futures contract to sell euros for U.S. dollars at an agreed rate of exchange.

Describe the statement of cash flows. Where do hospitality firms derive their cash inflows/outflows from?

• Important because cash is considered the lifeblood of the business: suppliers are paid in cash, lenders are paid in cash, and dividends are paid in cash. • Earnings from the income statement are accrual based and do not represent cash flows into the business • Recent scandals revolved around the ability of the average investor to assess current and future cash flows of the company, and that cash flows are more readily observable. • Hospitality firm may derive cash inflows (or outflows) from three basic sources: 1. Operating activities: those for which the firm is primarily in business (selling rooms/food) 2. Investing activities: securities and equipment 3. Financing activities: loans and dividend payments • Difficulties is the conversion of accrual-based figures to cash flows • Add depreciation back to net income because we never spent the cash to begin with • Adjust accrual items: increases in current assets (e.g. inventory) represent decreases to cash flows and must be subtracted • Liabilities are in an opposite fashion with cash (an increase in accounts payable means an increase to cash) • Most investors are concerned with the statement of cash flows from operating activities • Rough estimate can be found by taking net income from the income statement and adding back depreciation, as many accrual items will balance out.

Define limited liability company

• Limited liability company (LLC): uses the limited liability features of a corporation while being taxed in a manner similar to a partnership (avoiding double taxation) - Operated and be taxed as a partnership but retain limited liabilities for owners. • Must specify a date of dissolution • One cannot join without approval from the other members

Define limited liability partnership

• Limited liability partnership (LLP): typically legal and accounting professions, the personal liability of the partners is limited.

What is the purpose of liquidity ratios?

• Liquidity ratios: measure a firm's ability to pay its short-term debts • Used by lenders to determine if there are enough current assets to pay off short-term debts

Describe money market

• Money market: market for debt instruments that are short term (will mature in one year or less)

Describe mortgage market.

• Mortgage market: the pooling of home mortgages by government-sponsored agencies. • Government agencies purchase mortgages from lenders and resell them to investors in the form of securities • Investors receive income from mortgage payment makers • Mortgage-backed securities (passthroughs): Securities are sold to institutional investors such as insurance companies and pension funds and can be traded like bonds. • They are not actually issued by the federal government, so return is not guaranteed. • Very low risk and earn lower returns than commercial paper

What are the different types of money market instruments?

• Most common money market instruments: certificates of deposit (CDs), commercial paper, and treasury bills. • OTC and interbank lending • CDs: debt securities issued through commercial banks. Available to institutional investors in large denominations as well as to small investors in denominations of $100. Maturities and interest rates will vary. Secured time deposit. Restricts holders from withdrawing funds on demand. • Commercial paper: short-term debt instrument with maturities ranging up to 270 days (9 months). Issued by well-known quality companies to investors who are looking for safety yet want a return on their investment. Rated much like corporate bonds. Only large firms. Unsecured promissory note. • Treasury bills: used by the Federal Reserve to help fund the operations of the U.S. government (government debt). • Most common maturities are three, six, and twelve months, with the smallest denomination being $10,000 • Auctioned weekly or monthly by Federal Reserve, although investors an also buy them directly from brokers and certain banks • Actually zero coupon securities: investors buy bonds at a discount and the bonds gain value as they near maturity; no interest payments are made. • Treasury notes: have longer maturities than bills (no longer issues 30-year) • Backed by credit of the U.S. government, so return is essentially guaranteed • Sold rather easily • Risk-free rate of return • Return is often quite low for short maturities

Describe the statement of retained earnings.

• Often included in a consolidated statement of stockholder's equity • Beginning balance + net income - dividends = ending balance of retained earnings • Adjustments would include errors made or a change in an accounting principle • Retained earnings is only a small portion of the stockholder equity account • Items that affect equity include issuance or repurchase of stock, unrealized gains or losses on investments, and foreign exchange contracts. - Two major components are "Net Income" and "Dividend Declared" "Net Income" increases retained earnings. "Dividends Declared" decreases retained earnings.

What affects the price of the bond?

• Price of the bond is affected by the: 1. Size and timing of payments 2. Current assessment of the risk of those payments (the higher the risk, the lower the value/price)

What are the two markets stocks can be sold in?

• Primary market: the initial sale of the stock on an open market for the very first time. • Initial public offering (IPO): a new common stock issue by a firm. • Firm establishes a relationship with an investment banker, who provides consulting services to the firm regarding the price of the new issues and completes the necessary legal work required by the SEC. • Investment bankers often work with bankers in other firms to help sell the new issue to the public. • Investment banker will purchase the issue from the firm and then reissue the stock to the public through brokers. • Investment banking firms make a significant amount of fees when they help with an IPO • Secondary market: represents investors trading among themselves through brokers; where most trading of stocks occurs. • Although firm is usually concerned about the share price, no new funds are raised in this process. • Each company listed on the stock exchange is assigned a specialist, who maintains a balance in supply and demand or the stock and prevents large swings in prices. They either match your order with someone who wants to sell, or sells you stock from their own inventory. Stock certificates are kept by the brokers for the customers. • Pricing of stocks is based on a "bid" and an "ask" price. • Bid: what a prospective buyer is willing to pay for a share. • Ask: amount for which a broker will sell it to you • Bid-ask spread: difference between the two and represents a small profit for the broker. • Buying and selling process of stocks moves quite quickly.

What is the purpose of profitability ratios?

• Profits: the same as net income from the income statement. • Profit margins: used to assess management's ability to produce a return for the owners. • Varies widely in the hospitality industry • Net income: often compared to total revenue, total assets (investment), and shareholder equity.

Describe the income statement

• Provides details on the revenues and expenses • Used to assess management's capabilities • Can be compiled for internal or external use • Largest expense in hotels is labor cost, where in F&B it's cost of goods sold (labor next) *Hotel income statement: • Focus is on the operated departments - primarily rooms, F&B, and telephone. • Contribution margin: total operated income for the property • Undistributed operating expenses: not directly attributable to any one department (e.g. marketing) • Fixed expenses (e.g. taxes, insurance, interest, depreciation, management fees, rent) • Income taxes *Restaurant Income Statement • Major difference from hotels is the lack of segmentation of payroll costs across departments • Other income is either shown as a minor revenue or as a reduction of uncontrollable expenses • All items are expressed as a percentage of total revenue, with the exception of F&B cost of sales, which are shown as a percentage of F&B revenue.

What is the purpose of ratios?

• Ratios help evaluate the financial position or performance of a firm - measure a company's productivity; how good a job a company's doing in using its assets, turning over inventory, and generating profits from each dollar of sales. - To show broad trends and to help you with your decision-making.

What is the purpose of investor ratios?

• Related to common stock and involve earnings and the stock price • Ratios previously discussed affect investor ratios

Describe the balance sheet

• Represents the financial position of the firm for a specific point in time • No significant differences in the balance sheets used by management, compared to external users • No Uniform System • Balance sheet is comprised of three major sections: assets, liabilities, and owners equity • Assets: owned by the firm • Liabilities: claims on the assets by creditors or lenders to the firm • Owner's equity: claims to the assets by the owners • All assets must be claimed by someone: assets = liabilities + owner's equity • Assets of a firm are listed in order of liquidity, with the most liquid assets listed first • Subtotal for current assets is presented to analyze the position of the firm. • First: cash and cash equivalents • Accounts receivable: presented net of allowance for doubtful accounts • Inventories: current asset and recorded at the lower of cost or market value • Deferred income taxes: result from differences in reporting to investors against reporting to IRS (tax payable vs. tax expenses). • Federal government allows firms with an operating loss to use either a tax carryback against previous years or a tax carryforward for future years. This would represent an asset to the firm. • Investments are items such as stocks and bonds that the firm intends to hold for more than a year. • Property and equipment are shown at cost less accumulated depreciation • Goodwill: intangible asset obtained when the price paid for an asset exceeds the value of the assets. • Patents and franchise fees • Liabilities: divided between "current" (due within one year) and long term • Current maturities of long-term debt is the portion due within one year of the balance sheet date • Owner's equity: shows common stock, additional paid-in-capital and retained earnings • Retained earnings: the account that is reduced when dividends are declared. IT does not represent cash, but rather the accumulation of net income earned by the firm in previous periods less any dividends. • Treasury stock: representing the repurchase of the firm's stock and shown as a reduction in owner's equity • All assets and liabilities must be presented in an average of exchange rates • Any gains or losses from translations are reported in the owner's equity section as "Other comprehensive income (loss)." This line can be significant.

What is the purpose of solvency ratios?

• Solvency ratios: indicates the degree of financial leverage (when a firm borrows money to finance its assets) used by the company • Examined by lenders to obtain a clear picture of the risk they may be taking if they lend money to the firm • Owners are also concerned because they want the firm to borrow money to help increase the rate of return they can obtain from the investment of their capital. If the firm can earn a return higher than the cost of the borrowed funds, then financial leverage makes sense. • Another advantage of debt is that interest expense is tax deductible, whereas dividend payments are not. • More debt that is used, risk and the chance for bankruptcy increase.

What does it mean if a bond is callable?

• Some bonds are callable: issuer has the right to repurchase the bonds at a certain price within a certain period of time. • Used by the issuing company to protect themselves in case interest rates drop. • Call price has to be high enough to entice investors to want to purchase the bond despite this feature.

How are stock prices determined?

• The price of a share of stock is the sum of all cash flows received from the ownership in the stock • Price is largely dependent on the current and future prospective cash flows of the company • Supply and demand plays a role • Three factors affecting the present value of these cash flows: timing, magnitude, and risk.

What are the two large institutional investors that receive monthly cash flows?

• These two large institutional investors both receive monthly cash flows (i.e. premiums). • Life insurance companies invest these premiums to meet the needs of the insured when it is time to collect • Pension funds receive money from company payroll accounts and meet the needs of individuals after they retire • Insurance companies are regulated by the individual states, whereas many pension funds are regulated by the Pension Benefit Guaranty Corporation • Still lend funds to hospitality firms, but the frequency and magnitude have declined.