What is the goal of the firm or financial managers?
Maximize shareholder (firm owner) wealth, or equivalently, the stock price or market value of firm.
Should the firm or financial managers set the goal to maximize profit?
No. Maximization of accounting profit (earnings or EPS) does not lead to highest possible share price. It ignores at least three important factors: 1. Timing 2. Cash Flows 3. Risk
Should the firm or financial managers maximize stakeholder's (employees, customers, suppliers, creditors, and communities) welfare?
No. Stakeholders are difficult to be ranked, therefore their welfare cannot be maximized simultaneously. In a competitive market environment, if the firm maximizes shareholder's wealth it must take care stakeholder's benefits. And provided a healthy legal
What are financial managers' key decisions?
There are four types:
a) Financing Decisions- how to raise funds, both short term and long term.
b) Investment Decisions- how to allocate fund/capital in long term projects.
c) Capital Budgeting Decisions- how to select the projects that create the most v
What are principles of managerial decisions?
a) The time value of money- timing matters
b) Risk return tradeoff- high risk with high return and low risk with low return
c) Cash is king- focus on cash flows
d) Competitive financial market- follow the market supply/demand, respond to market signal
e)
What is the primary principle that Finance adopted from Economics, and how to apply it to financial decisions?
It is marginal cost- marginal benefit analysis. All wise financial decisions must achieve the results of MB>MC
What is the difference between finance and accounting in terms of business transactions?
Financial managers emphasis on actual cash flows (inflows, outflows, net flows); while accountants prepare financial statements that recognize revenue at the time of sale (whether payment has been received or not) and recognize expenses when incurred; tha
What is Principle-Agent problem, and associated agent costs? How to solve the problem?
a) Owners (principle) of a firm and its managers (agent) are not the same people and the agent does NOT act in the interests of the owners of the firm; therefore may increase the firm's managerial costs so-called agent costs.
b) the firm's owners (stockho
What are job duties/business functions of top positions of a corporate?
a) Board of directors- make strategic decisions
b) President/CEO- fully in charge of overall business operations
c) CFO- under CEO, in charge of overall financial management
d) Treasurer- under CFO, manages cash, pension plans, as well as key risks
e) Con
What are three organizational forms? And what are major differences in their features?
a) Sole Proprietorship- unlimited liability, taxed on proprietor's personal tax return
b) Partnership- unlimited liability for owners and may have to cover debts of other partners, taxed on partner's personal tax returns
c) Corporation- limited liability,
Do ethics of the firm affect its share prices?
Yes, definitely, Sarbanes-Oakley Act of 2002 set up several ethical guidelines to firms.
What are financial institutions?
They are fund demanders and fund suppliers of the economy. In general, individuals are net fund suppliers, and firms are net fund demanders. Financial institution are intermediary that channels the savings of individuals, businesses, and governments into
The three types of financial institutions
a) commercial Banks: receive deposits and make commercial loans
b) investment banks: assist companies in raising capital, advise firms on major transactions and business issues, and engage in security trading and market-making activities
c) shadow banking
What are the differences between money market and capital market? What securities are traded in each market?
a) money market is a long-term financial market, in which traded securities with one year or less being traded. Those typical financial securities are:
1) treasury bills
2) commercial paper
3) negotiable certificates of deposit
While capital market is a l
What is the difference between primary market and secondary market?
Primary market is for a firm to issue or sell its stocks in order to raise equity financing. The stocks are purchased bu investors at the first time in the market. The process is so called initial public offering. While secondary market is a financial mar
What are major forms of firm owners' income?
a) ordinary income, the income coming form business operations, such as wages, salaries, and dividends distributions
b) capital gain, the income coming form proceeds of selling the firm's assets, including physical assets and financial securities.
What are the differences between broker market and dealer market?
Both broker and dealer markets are secondary markets because they trade for pre owned securities. The differences are:
a) Broker market has a trading floor. Brokers bring sellers and buyers together to make a transactions but brokers do not buy or sell se
What is the Over-the-counter (OTC) market?
A financial market where smaller, unlisted securities are traded. The total trading volumes in this market are small.
What does the theory of Efficient Market Hypothesis claim? And what implications does it suggest?
The EMH claims:
a) at any point in time security prices fully reflect all information available about the firms and its securities
b) securities are typically in equilibrium; they are fairly priced
c) because market quickly reach equilibrium and securitie
What is a different view of the school of behavioral finance opposing the efficient market hypothesis?
Stock prices can deviate from their true values for extended periods; these deviations may lead to predictable patterns in stock prices. In particular, some evidences indicate that stocks performed poorly in the past displayed a predictable tendency to re
What were major measures of Floss-Steagall Act of 1933?
a) prohibited institutions that took deposits from engaging in activities of high risk business such as underwriting and trading, thereby effectively separating commercial banks from investment banks
b) established Federal Deposit Insurance Corporation (F
What was the purpose of Gramm-Leach-Bliley Act of 1999, and what did it do?
In order to promote competitions in US banking industry, this Act allows business combinations between commercial banks, investment banks, and insurance companies and thus permits these institutions to compete in markets in a wider range of activities.
What are two major ways for a firm to raise capital?
(a) Private placement - raise fund by selling the firm's new securities directly to an investor or a group of investors through its own business network. (b) Public offering - sale of either bonds or stocks to the general public conducted by financial ins
What are venture capital and venture capitalists (VCs)? And what are deal structure and pricing with VCs?
Venture capital is an equity financing provided by a firm that specialized in financing young, rapidly growing firms. Venture capitalists are formal business entities that take in private equity capital from many individual and institutional investors, an
What is so-call IPO? And what major procedures, institutions, concepts, results are involved with IPO?
IPO stands for Initial Public Offering, a private firm goes public by issuing its common stock to public investors in a primary capital market. After the IPO, the firm's stocks become outstanding, listed in stock exchange(s), and will be traded in seconda
What are so-called securitization of mortgage loans and mortgage-backed securities?
It is a process of pooling mortgages of other types of loans to be a financial package or product and then selling claims or securities against that pool in the secondary market. This kind of securities are mortgage-backed securities that represent claims
What are subprime mortgages?
Mortgage loans made to borrowers with lower incomes and poorer credit histories as compared to "prime" borrowers, therefore having much higher delinquency or default risks.
What is an equilibrium rate of interest? And how the equilibrium rate is determined?
Equilibrium rate of interest (or equilibrium interest rate) is general market interest rate. It is determined by the interaction of total supply and total demand of funds in financial markets.
What is the relationship among nominal interest rates, real interest rates and expected inflation rates?
(a) Nominal rate of interest (r) - the actual rate of interest charged by the supplier of funds and paid by the demander of funds. (c) Real rate of interest (r
) - the rate of return on an investment measured not in dollars but in the purchasing power tha
What are risk-free securities? And what are risk-free rates?
Risk-free securities refer to those securities with No default risk. The interest rates offered by those securities is a benchmark of rate return in the absence of risk. In US, government securities are regard as 6 risk-free; therefore, the nominal intere
What is risk-premium for an underline non-government security?
Corporate issued securities (bonds and stocks) are Not risk-free; they all have certain degree of delinquency or default risk. For investors, in order to compensate the risk for an underline security j, a risk premium (RP_j) should be added to a benchmark
What kinds of the firm's risks should be examined? And how to measure risk-premium of a security issued by a specific firm?
(a) All kinds of risks with a firm should be examined, including business risk, financial risk, interest rate risk, liquidity risk, and tax risk, as well the purely debt-specific risks - default risk and contractual provision risk. (b) There are three mai
What are yield to maturity (YTM), term structure of interest rates, and yield curve?
(a) YTM is compound annual rate of return earned on a debt security purchased on a given day and held to maturity, and it is an estimate of the market's required return on a particular bond. (b) Term structure of interest rates is the relationship between
What are typical shapes of yield curves? And what theories explain the term structure of interest rates (YTM)?
(a) There are three types of yield curves: normal (upward sloping), flat, and inverted (downward sloping). (b) There are three theories to explain the shapes of yield curves. Expectations theory, expectation could cause any shape of a yield curve; Liqui
Why do financial professions and economists want to study yield curve?
(a) For financial managers, in comparison of costs for long-term funds or short-term funds, yield curve may affect the firm's financing decisions. 7 (b) Yield curve is a good predictor for future economy. A positive slope predicts an economic growth or bo
What economic activities require foreign currencies and foreign exchanges? And how many forms of foreign exchange rates?
International trade and international investment are major driving forces for demand and supply of foreign currencies, then the markets and activities of foreign exchanges. (a) Direct rate: USD/JPY, the domestic currency (USD) is in the numerator; (b) Ind
What is the Bretton-Woods International Monetary System?
In 1944, top leaders of several major allied countries held a conference and then signed an agreement in Bretton-Woods, NH, which established a Pegged Exchange Rate system for all member countries. Under the Bretton-Woods International Monetary System, in
What is Purchasing Power Parity (PPP)?
PPP is an economic theory explaining the fundamental determination of foreign exchange rates. It states that exchange rates will make the prices of goods and services the same in all countries according to currencies' real purchasing power to goods and se
Who are winners, and who are losers due to changes on exchange rates?
(a) Buyer or seller of a currency? If you want to buy a currency, you want a "cheap" (or weak) currency If you want to sell a currency, you want an "expensive" (or strong currency) (b) Strong USD or weak USD? A Japanese airline ordering new aircraft fr
What are major factors that influence foreign exchange rates and how?
(a) Trade flows If Country A has trade deficit with Country B, i.e., imports exceed exports; then the Country A's currency should be depreciated relative to Country B's currency, the Country B's currency should be appreciated, and vice-versa. (b) Inflatio