exam 1 - ch 1, 2, 3, and 5 Flashcards
(80 cards)
1
Q
what is the goal of the firm?
A
maximize shareholder value
2
Q
what are the 5 principles of finance?
A
- cash flow is what matters
- money has a time value
- meaning that a dollar received today is worth more than a dollar received in the future - risk requires a reward
- market prices are generally right
- conflicts of interest cause agency problems
3
Q
what are the 3 basic issues addressed by the study of finance?
A
- What long-term investments should the firm undertake? - capital budgeting decision
- How should the firm raise money to funny these investments? - capital structure decision
- How to manage cash flows arising from day-to-day operations - working capital decision
4
Q
sole proprietorship
A
- owned by an individual
- unlimited liability
- termination occurs on the owner’s death/choice
5
Q
general partnership
A
all partners are fully responsible for liabilities incurred by the partnership
6
Q
limited partnership
A
- limited liability
- restricted to the amount of capital invested in the partnership
- must be one general partner with unlimited liability
7
Q
corporation
A
- legally functions separate from its owners
- owners(shareholders) dictate the direction and policies of the corporation(through board of directors)
- Shareholder’s liability is restricted to the amount of investment in the company
- unlimited life
- double taxation
8
Q
S-type corporation
A
- limited liability
- taxed like a partnership(no double taxation)
- cannot be used for a joint venture between two corporations
9
Q
limited liability companies(LLC)
A
- limited liability
-taxed like a partnership(no double taxation) - cannot appear like a corporation(it will be taxed like one)
10
Q
public offering
A
both individuals and institutional investors have the opportunity to purchase securities
11
Q
private/direct placement
A
securities are offered and sold directly to a limited number of investors
12
Q
primary market
A
- new issues of securities are sold to initial buyers
- IPOs and SEOs
13
Q
initial public offering
A
the first time a company issues its stock to the public
14
Q
seasoned equity offering
A
sale of additional shares by a company whose shares are already publicly traded
15
Q
secondary market
A
that market in which previously issued securities are traded
16
Q
money market
A
for short-term debt instruments(maturity periods of 1 year or less
17
Q
capital market
A
for long-term financial securities(maturity greater than 1 year)
18
Q
spot market
A
market in which something sells immediately
19
Q
futures market
A
the market for buying and selling something at some future date
20
Q
organized securities exchange
A
tangible entities and financial instruments are traded on its premises and have an address
21
Q
over the counter market
A
- all securities markets except organized exchanges
- no specific geographic location
22
Q
why might a firm choose an over the counter market over and organized securities exchange?
A
- they do not meet the listing requirements of the exchange
- wish to avoid higher reporting requirements and fees
- may just choose to trade on OTC
23
Q
underwriters spread
A
- the difference between the price the corporation gets and the public offering price
- Money for securities is paid to the issuing firm before the securities are sold
24
Q
functions of an investment bank in an IPO
A
- underwriting: assuming the risk
- distributing: once securities are purchased from the issuing fir, distributed to investors
- advising: timing of sales, type of security, etc
25
floatation costs
transaction costs incurred when a firms raises funds by issuing securities
(underwriters spread and issuing costs)
26
negotiated purchase IPO
- mot prevalent method
- Issuing firms selected an IB to underwrite the issue
- the firm and IB negotiate the terms of the offer
27
competitive bid IPO
several Its bid for the right to underwrite the firm's issue
28
best efforts IPO
- The issue is not underwritten, no money is paid upfront
- Attempt to sell the shares in return for a commission
29
privileged subscription
Helps market the new issue to a select group of investors such as current stockholders, employees, or customers
30
direct sale IPO
- Issuing from selling the securities directly to the investing public
- No IB involved
31
dutch auction IPO
- Investors place bids indicating how many shares they are willing to buy and at what price
- The price the stock is sold for becomes the lowest price at which the issuing company can sell all the available shares
32
opportunity cost
ROR on the next best investment alternative
33
standard deviation
dispersion/variability around the mean ROR
34
nominal(quoted) interest rate
the interest rate paid on debt securities without an adjustment for any loss in purchasing power
35
real interest rate
- return earned with an adjustment for a loss in purchasing power
- nominal interest rate less any loss in purchasing power of the dollar during the time of the investment
36
inflation premium
a premium to compensate for anticipated inflation that is equal to the price change expected to occur bobber the life of the bond/investment
37
maturity risk premium
additional return required in long-term securities to compensate for a greater risk of price fluctuations cause by interest rate changes
38
default risk premium
additional return required to compensate for the risk of default
39
liquidity risk premium
additional return in securities that cannot be quickly converted into cash at a reasonably predictable price
40
nominal interest rate =
= inflation premium + real risk-free rate + default-risk premium + maturity-risk premium + liquidity-risk premium
41
(nominal) risk free interest rate =
= real risk-free rate + inflation premium
42
the fisher effect
Nominal interest rate = real interest rate + rate of inflation + (real interest rate) * (rate of inflation)
43
approximation approach for nominal interest rate
Nominal interest rate = real rate if interest + inflation risk premium
44
term structure of interest rate(yield curve)
the relationship between a debt security’s rate of return and the length of time until the debt matures
45
Unbiased expectations theory
term structure is determined by an investor’s expectations about future interest rates
46
Liquidity preference theory
investors require maturity-risk premiums to compensate them for buying securities that expose them to the risk of fluctuating interest rates
47
market segmentation theory
the rate of interest for a particular maturity is determined solely by demand and supply for a given maturity, and it is independent of the demand and supply for securities having different maturities
48
future value
the amount a sum will grow to in a certain number of years when compounded at a specific rate
49
present value
the value in today’s dollars of a future payment discounted back to the present at the required rate of return
50
annuities
- A series of equal dollar payments for a specified number of years
- Ordinary annuity payments occur at the end of each period
51
annuities due
- Ordinary annuities in which all payments have been shifted forward by one time period
- With annuity due, each annuity payment occurs at the beginning of the period rather than at the end of the period
52
(APR) annual percentage rate
The interest rate indicates the amount of interest paid or earned in one year without compounding(annually)
53
APR =
interest rate per period x compounding periods in a year(m)
54
(EAR) effective annual rate
- the annual compound rate that produces the same return as the nominal/quoted rate when money is compounded on a non-annual basis
- provides the true rate of return
55
EAR =
[1 + (APR / (m)compounding periods per year)]^m - 1
56
what adjustments do you have to make when finding FV or PV with non-annual periods?
- N = n x m
(number of payments per year
- I/Y = r / m
(rate per period)
57
perpetuity
an annuity that continues forever
58
what are common operating expenses?
- selling/marketing expenses
- general administrative expenses
- depreciation expense
59
overview of income statement
- sales(revenue) - cost of goods sold = gross profit
- Gross profit - operating expenses = operating income(EBIT)
- Operating income(EBIT) - interest expense= EBT
- EBT - income tax = net income
60
common sized income statement
Restates the income statement items as a percentage of sales
61
fundamental accounting equation
A = L + E
62
book value
- the value of an asset as shown on a firm's balance sheet
- Represents the historical cost of the asset rather than its current MV or replacement cost
63
current assets
- assets that are relatively liquid or expected to be converted into cash within 12 months
- Cash, accounts receivable, inventory, prepaid expenses
64
fixed assets
- property, plant, and equipment
- used for more than 1 year
65
net fixed assets =
Gross fixed assets(balance sheet) - Accumulated depreciation(balance sheet)
66
other fixed assets
neither current nor fixed, may include long-term investments and intangible assets such as patents, copyrights, and goodwill
67
what are common current debt items?
- accounts payable
- accrued expenses
- short term notes
68
preferred stock
preference(over common stock) with regard to payment of dividend and seniority at a settlement of bankruptcy claims
69
retained earnings
a cumulative total of all the net income over the life of the firm, less common stock dividends that have been paid out over the years
70
debt ratio
total liabilities / total assets
- percentage of assets that are financed by debt
71
new working capital
current assets - current liabilities
- measure of a firms ability to repay its debt
72
accrual basis
the principle of recording revenues when earned and expenses when incurred, rather than when cash in received or paid
73
what are sources of cash?
- decrease in an asset
- increase in a liability or equity
74
what are uses of cash
- increase in an asset
- decrease in a liability or equity
75
how to determine cash flows from operations?
1. Start with net income
2. Add back depreciation expenses
3. Consider other items(AR, inventory, other current assets, AP, other accrued expenses/liabilities)
76
how to determine cash flows from investing?
- changes in fixed assets
- increase in assets = outflow of cash
77
how to determine cash flows from financing?
Inflow: the firm borrows more money, an increase in stockholders’ equity
Outflow: firm repays debt, pays dividends, repurchases stock
78
ending cash =
beginning cash + change in cash
79
what are the items taken from the income statement for the cash flows statement?
net income and depreciation expenses
80
consider everything on the balance sheet for the cash flows statement except:
- accumulated depreciation
- net fixed assets
- changes in retained earnings
