Lecture notes before midterm Flashcards
1
Q
Three things that grow economies
A
- capital growth
- population growth
- productivity growth
2
Q
Asset (for the sake of this class)
A
Something that is expected to, directly or indirectly, generate cash
3
Q
types of shareholders
A
- retail investors (individuals)
- institutional (pensions, hedge funds, etc…)
(institutional investors tend to have a larger ownership share and more control of businesses)
4
Q
Corporate governance failure
A
stems from incentives for those running the business (CEO/ executive team) not aligning with the interests of the shareholders (creation of long-term value)
5
Q
purpose of auditors
A
specific to public companies
lend credibility to the statements of the mangement
6
Q
stakeholders within the marketplace
A
o Customers
o Shareholders
o Lenders
o Suppliers
o Regulators
o Auditors
o Institutions
7
Q
influence on business outside of the direct marketplace
A
regulations (government)
lobbying
8
Q
main business decisions
A
capital budget
capital raising
distribution of return
9
Q
“Most important” stakeholder
A
Shareholders, but only because they own the residual value of the company and theoretically are only paid after everyone else is taken care of
10
Q
Goal of a comapany
A
to maximize the shareholder’s wealth (which is about maximizing long-term value, not about maximizing short-term profit)
11
Q
Enterprise value
A
= company’s equity + it’s debt = value of the whole company (essentially cost to buy company)
market value of a company
12
Q
Market capitalization
A
Equity cost of a company. Shares outstanding * share price
13
Q
benefits of fintech
A
- access and inclusion
- efficiency
- lower startup costs for new business from cloud based resources
- force adaptations and growth from more traditional businesses
14
Q
segments of fintech
A
- payments
- marketplace lending
- wealthtech/ robo advisors
- insurtech
- reg tech
- crypto blockchain
- cybersecurity
15
Q
what is DEFI
A
Decentralized finance
peer to peer financial services
16
Q
shareholder vs bondholder conflict
A
Shareholders likely to be more interest in risk for potential gain vs lenders wanting fewer risk and higher certainty of repayment
17
Q
What is agency cost?
A
Gap between potential value (if all agent incentives were perfectly aligned) of a company and actual value driven by conflict of interest between management and shareholders
18
Q
Potential sources for conflict that creates agency cost
A
- excessive perks for executive not benchmarked to valuation
- differential information
- mismatched planning horizons
- managerial risk-aversion
19
Q
Internal controls for agency cost
A
- board of directors (composition, leadership structure)
- performance sensitive compensation
- ownership structure
- firm’s charter
20
Q
Composition of corporate board
A
public company’s board required by regulation to be 50% independent (no current or past affiliation with the company)
21
Q
types of performance sensitive compensation
A
- stock options
- cap bonuses (limits effects of short term gains in favor of long term)
22
Q
determining exercise price for stock options
A
designed with desired return to incentivize right company growth (what stock price should be after the given amount of time)
23
Q
External controls for agency costs
A
- market for corporate control
- managerial labor market
- shareholder activism
- regulation
24
Q
agency relationship
A
arises when one or more individuals (principals) hire other individuals or organizations (agents) to perform some service and delegates the decision making authority to that agent
25
Corporate governance
a set of mechanisms through which outside investors protect themselves against expropriation by insiders
26
Financial markets
exist to bring together economic agents who are saving (have cash now) an economic agents who provide opportunities to convert cash now into potentially more cash later
transfers may be direct or indirect (via investment bank or financial intermediaries)
27
Major types of financial instruments
From least to most risky
- U.S. Treasury bills
- commercial paper
- money market mutual funds
- commercial loans
- U.S. treasury notes and bonds
- mortgages
- municipal bonds
- corporate bonds
- preferred stocks
- common stocks
28
Treasury bonds
essentially risk free. loan of money to the government for a given period of time
29
Commercial paper
debt issued by very large companies wanting to borrow money in the short term
- low default risk
- interest rate slightly higher than treasury bills
- maturity up to 270 days
30
Money market mutual fund
mutual fund that invests money in short term securities
very safe, low return
31
US treasury and government bonds
one of the largest markets (debt market much bigger than equity)
32
Preferred stock
- usually comes with a guarantee that holder will get dividends before common stock holders
- claim only superseded by debt claim
- more risky than bonds, less risky than common stock
33
NYSE
New York Stock Exchange
has certain requirements for company's to be listed on it
34
What does it mean for a stock to be listed on an exchange
- members of the exchange can trade the stock
(broker contacted by investor, broker contacts member of exchange)
35
NASDAQ
Dealer's market
- Dealer posts bid price and ask price
- broker gets prices posted
- by regulation broker has to choose currently lowest ask price or highest bid price
- network connecting dealers: National Association of Security Dealer's Automated Quotation System
36
How interest rate drives currency value
- higher interest rate in US drives money flows into the US in pursuit of the higher return, increases demand for US currency so price of currency increases
- may cause decrease in exports (exports comparatively more expensive to other countries)
- may cause increase in imports as cost of imported raw materials drop
37
why companies may prefer to borrow money than fund via equity
because interest payments are deductible and dividends are not borrowing (and paying back the money) can result in lower taxes (overall decreasing the cost of borrowing)
38
types of markets
physical vs. financial
primary vs. secondary
money vs. capital
spot vs. future
39
ways banks evaluate loan applications
- look at source and uses of cash
to see where cash flows go and if they are appropriate (comparative balance sheets help with this - looking where cash is sitting (inventory? A/R?)
40
Bank reserve requirements and federal interest rates
banks want to lend out all deposits (to make money off all of them) but Fed requires that a certain percentage of the deposits must be held in the reserve
if bank lacks money to meet the reserve requirement can borrow overnight from a bank with excess funds
This overnight rate is the rate that the fed sets, becomes a benchmark for everything else
41
why will raising interest rates limit inflation
Idea is that demand for money is high so if cost of borrowing is higher demand will subside
42
Why is inflation an issue to be controlled
- potential wage-price spiral
- potential hording behaviors
- generally keeping control of economy
but risk increasing unemployment
43
How does the internet dampen inflation?
because it has allowed people to source everything from somewhere else if the price is lower elsewhere (including inflation)
44
how does interest going up affect the stock market?
- higher foreign demand for us securities
- people may leave equity investing for less risky bond investments if rates are similar
45
Trade credit
accounts and notes payable to other suppliers (rather than bank)
to evaluate rate paying for trade credit have to look at discount given up as % of what would have paid without discount and CONVERT IT TO AN ANNUAL RATE to compare to the bank rate
46
what do investors prefer to see as the predominant source of funds for the business?
Retained earnings
47
Evaluating if inventory level is appropriate
Use inventory turns = (accounts receivable + inventory)/ sales for the year
compared year to year
if percentage is same or decreases can assume comparatively okay, but if grows then there is more inventory than justified by sales
48
External funds needed by a company
= (expenses - revenue) * growth rate
requires forecasting next year's income statement (usually based on previous growth)
essentially solving for notes payable (bank) by estimating the rest of the balance sheet based on forecast
49
Bank's balance sheets
Assets = Loans receivable, market securities
Liabilities = deposits (are essentially accounts payable - interest-sensitive short-term)
50
Do banks prefer giving long-term or short term loans?
short term, since deposit accounts are essentially short term
51
Which is a better long-term source of funding debt or equity?
Equity, but it means potentially giving up control, especially if aiming for rapid rather than slow growth
52
Initial sources of capital
- FFF (friends, family, fools)
- Angels
- venture capitalists
- corporate partners (who may eventually want to consolidate)
- debt capital (unlikely at early stages)
- venture leasing
- internal financing
53
What is venture leasing?
Leasing assets and paying for them with stocks
54
Why might debt be a preferable funding source for a new business?
- allows retention of control
- offers a tax advantage (interest deduction)
- leverage
55
Estimating value of private company
base on some information publicized about a purchase that gives amount paid & % ownership
investment / ownership percentage = total implied value of company (after investment)
Pre-investment valuation = total implied value - investment
56
P/E ratio
stock price / earnings per share
57
What factors affect the P/E ratio
- expectations of growth (rapid growth --> high P/E)
- company risk
(high risk --> low P/E)
58
Bottom up valuation
a way to estimate the value of a private company
- take average P/E ratio for the given industry
- assuming that company has stabilized can assume it should have about the same P/E ratio so can use the ratio and solve for estimated stock price based on expected earnings
59
using bottom up valuation to find % ownership for given investment
- use average industry P/E ratio and estimated after tax profit after N years to get expected valuation in N years
- calculate future value of $1 after N years at required rate of return to get dollar return
- multiply required investment by dollar return to get required payoff in N years
- divide required payoff in N years by expected valuation in N years to get required % ownership at given investment amount and required return rate.
60
What country has the largest number of successful startups per capita?
US
61
Exit options for start up
IPO
getting company acquired
62
How to value financial assets
need to determine
- how many payments
- what are the payment
- what is the discount rate (is the desired) or market return
63
Discount bond
Market rate is higher than the coupon rate so investors are not willing to pay the face value of the bond
64
Premium bond
Mark rate sinks below coupon rate so investors are willing to pay more than the face value of the bond
65
Debt investment strategy if interest rates expected to rise
Since bond prices drop when interest rates rise bonds should be sold now before the prices drop
66
Debt investment strategy if interest rates expected to fall
Buy bonds now as can sell higher after interest rates falls
67
Valuing bonds paid semi annually
remember to adjust payments to that receiving half coupon rate twice a year!
(also adjust interest)
68
Yield to maturity
Also Promised yield
rate of return in bond is held to maturity (PV known)
use calculator to solve for I/Y given known:
- PMT (payments)
- FV (maturity)
- N (number of years
- PV (amount paid
69
Use of yield to maturity
in comparing different bonds
70
Bond rating agencies
Moody's
S&P
71
Bond sale regulations
to sell bonds to the public a company must get a rating from a rating agency in advance
(can sell to private investors no matter what, but they cannot later sell it to public)
72
Junk bonds
Ba/Bb and below
highly risky compared to higher rated bonds but still less risking than stocks
banks, insurance companies, other institutional investors are not allowed to invest in junk bonds
73
Constant growth stock price
price = Dividend period 1 / (required rate of return - growth rate)
constant dividend growth model
ONLY WORKS if growth rate is less than the required rate of return
74
P/E multiple
using P/E ratio to estimate stock price by finding average P/E ratio for industry or comparable firms and multiplying it by the expected earnings to get estimated stock price
75
Valuation of stock
Present value of all future dividends
if in constant growth phase can use constant growth model
if not can try P/E multiple
76
Valuation of preferred stock
risk between common stock and bonds
promises fixed dividend so can use value of a perpetuity to find the stock price
just need to know required return and the dollar amount of the dividend
77
Value of a perpetuity
= payment / rate
