Allocation of funds between those with extra to those who need it
Finance
exchanges, brokerages- match borrowers with lenders
Market intermediary
Banks
Finanacial Intermediary
negotiable financial instrument that is evidence of indebtedness
Security
short term, less than one year
money market security
long term, more than one year
capital market security
represents ownership of a company
Equity
Issues new securities, IPOs
Primary market
buying and selling existing securities
Secondary market
number of shares*share price
Market price
one owner
business income taxed once
unlimited liability
Sole proprietorship
two owners
business income taxed once
unlimited liability
Partnership
separate legal entity
limited liability
double taxation
Corporation
separate legal entity
income taxed once
LLC
limited to 100 shareholders
taxed as a partnership
S corporation
maximize the market value of the equity interest or, alternatively, maximize owners' value
Primary goal of financial mangement
conflict of interest between management and owners
Principal-agent problem
summary of a company's transactions in a way that outsiders can understand
accounting
Unqualified-good
Qualified-some errors
Adverse- major issues
Disclaimer of opinion-unable to complete audit
GAAP opinions
shows company's financial position at a given time
Balance sheet
Liquidity (most first)
Asset order on the balance sheet
current assets-current liabilities
Net working capital
non-cash expense
Depreciation
cash flow from day to day operations
Cash flow from operations
cash flow from buying/selling long term assets
Cash flow from investing
cash flow from obtaining funding from external sources as well as repaying claimholders
Cash flow from financing
money that can be withdrawn without harming firm's ability to operate
Free cash flow
tax paid on the final dollar earned
Marginal tax rate
received and fully deductible when paid
Interest is fully taxable when
no
Are dividends tax deductible
lowers the tax expense
What does higher depreciation do to tax expense
length of time between investment of cash in inventory and when money is returned in the form of cash from customers
operating cycle
return provided to sharholders
return on equity
contract between two parties; a lender (the investor) and a borrower (the company or the government)
bond
money paid when bond matures ( usually 1000)
face value
regular interest payment (coupon*face)
Coupon
No coupon, only payment is when bond matures
Zero coupon bond
bond value is greater than face value
coupon rate is greater than discount
premium bond
bond value is less than face value
coupon rate is less than discount
discount bond
inverses
discount rate and present value changes are
default risk
what does a bond rating represent
past returns
ex post returns
expected returns
ex ante returns
probability that the actual return from an investment is less than the expected return
risk
degree to which two securities move together (correlation coefficient is essentially the same thing)
covariance
set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a given level of expected return
efficient frontier
greater
required return must be___________than the dividend growth rate
mix of debt sources for a company
capital structure
cost of raising one more dollar
marginal cost of capital
common stock
retained earnings have the same cost as
process of planning and evaluating expenditures on assets whose cash flows are expected to extend beyond one year
capital budgeting
one change of signs
-----++++++
normal cash flow stream
two or more changes of signs
--+++++---
non normal cash stream
npv(interest rate, initial investment, {CF1,CF2,...,CFn})
NPV in calculator
discount rate that will yield a NPV of 0
internal rate of return
irr(initial investment, {CF1,CF2,...,CFn})
irr in calculator
where IRR=NPV
crossover point
USE NPV
If there is a conflict between NPV and IRR
similar to IRR but uses a reinvestment rate determined by the evaluator
MIRR
measures the benefit per unit cost of a project
profitability index
no
are sunk costs a relevant cash flow
total initial cost - accumulated depreciation
book value
one variable is changed at a time
sensitivity analysis
multiple variables are changes to create specific scenario
scenario analysis
nonsense
monte carlo simulation
tax deductibility
benefits of using debt
affect many or all assets
also called non diversifiable
systematic risk
limited to a number of assets
also called asset specific
unsystematic risk
shows how an asset moves with the overall market
1=same risk as market
<1=less systematic risk
>1=more systematic risk
0=risk free asset
beta coefficient
market where prices of all assets accurately reflect all relevant and available information about the assets
efficient market
weak
semi-strong
strong
forms of market efficiency