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Howcan “Finance” be defined” generally?
Finance is the management of money invested inassets that are expected
to produce at least a fair return forthe Owner by the appreciation of the asset’s
market value and/or future cash flowsto be received.
BusinessFinance is the management of money invested in business
assets/projects that are expected toproduce at least a fair return for the
Owner by the appreciation of the asset’smarket value and/or future cash flows
to be received.
Accounting isabout recording and reporting accurately according to
Generally Accepted Accounting Principlesthe financial impact of an entity’s
historical business transactions.
Financeis about investing in an asset(s) with a reasonable expectation of
receiving at least a fair return (in cashvalue terms) in the future (plus the original
cash value of the amount invested).
Howcan “Finance” be defined by the kinds of professions its equips?
-Corporate Finance (Treasury: CashManagement, Treasury: Finance, Financial Planning)
- Commercial Banking
- Money Management (i.e., ProfessionalInvesting)
- Investment Banking
Whatis the primary goal of Business Finance?
. To maximize the market value of theshareholders equity investment (by working
to produce enough Free Cash Flowprofitability to at least cover the company’s Weighted
Average Cost of Capital). The focus ison making the market value of the business’ assets
increase in value, and this will leadto an increase in the value of the Business Owner’s
What “formula”summarizes what management needs to do in order to achieve the primary goal?
FreeCash Flow > Weighted Average Cost of Capital
Whyis “profit maximization” not strong enough to be theprimary goal of business financial management?-
-Becauseit only addresses Accounting Net Income (and not Free Cash Flow).
-Because Accounting Net Income ignoresmanaging a company’slevel of riskiness.
-Because Accounting Net Income ignoresthe company’sWeighted Average Cost of Capital (“WACC”).
-Because focusing only on Free Cash Flowwould also ignore risk and WACC.
. What is the difference between “intrinsicvalue” and “market price” with respect to the valuation of common stocks?
Intrinsic value” is an estimate of a stock’stheoretical “true”value based on accurate risk and
“Marketprice” is the current price being paid inthe market for a stock based on perceivedbut possible incorrect information
Withregard to current trends in business, what is “corporate governance” andwhat are some examples of changes taking place?
Corporategovernance refers to the ways the management of a publicly-held corporation
is organized and incentivized toensure the common stockholders’ interests (i.e., receiving
at least a fair return on their equityinvestment, corporate reputation, etc.).
Whatcan be the relationship between ethical problems in business and shareholdervalue?
If a publicly-held corporation has managementand employees who violate generally
accepted standards of ethicalbehavior, then this could lead to common stockholders losing
confidence in management’sability to serve their interests, and this could lead to a lower
demand for the stock, and thereby, alower value/price for the stock.
. Agency Problem: When Management fails to achieve the PrimaryGoal; Conflicts between
theBusiness Owner’sgoals and Management’sGoals.
Agency Costs: The various costs of theAgency Problem.
Howcan Stockholders manage/minimize the Agency problem?
-Aligning Management compensation to the Primary Goal
- Sell the company to another company (soManagement may lose their jobs)
- Incurring monitoring and bonding costs
- Have more independent (outside) directors onthe board
Howcan Stockholders manage/minimize the Agency problem? Continued
-Separate the role of Chairman of the BOD from the CEO position
- Require Management (i.e., corporate officersand BOD members) to purchase a substantial
amountof the company’scommon stock.
.What are the two basic legal categories of Business Organization
Unincorporated and Incorporated.
What are the advantages and disadvantages to abusiness of being unincorporated? What two forms of unincorporated businesseswere described in the text?
. Adv:simple to form; subject to only the Individual Income Tax Code
Disadv:Personal Assets at risk; harder to finance and to sell (must sell assetsseparately).
Forms: Sole Proprietorships and Partnerships
What are the basic forms of beingincorporated?
- Limited Partnerships
-Corporations (“Inc.” or “Corp.”)
-“S”Corporations (Income Tax Code designation
-Limited Liability Companies (“LLCs”)
What are the advantages of Incorporation?
- Lower risk to Owners, Managementand Employees because an incorporated
business (in all of itsforms) is a legally separate Person
- Easier to sell the company (i.e., justsell the stock to sell all assets)
-Easier to obtain external financing
- More complicated to form andmaintain
- Subject to the Corporate Income Tax Code- “DoubleTaxation”
Business’ NetEarnings are subject to Corporate Income Tax
and any distributed Net Earnings toshareholders (dividends)
are subject to either the Personal orCorporate Income Tax Code
What are the three basic ways financial capital is channeled from “Net Savers” to “Productive Project Investors”?
Direct Transfers: Net Saverspurchase financial securities (aka financial instruments) directly
from Productive Project Investors.
-Indirectly through FinancialIntermediary: Net Savers purchase securities issued by F.I.s, and
F.I.s purchase securities issued byProductive Project Investors.
-Investment Banks purchase/underwritesecurities issued by Productive Project Investors,
then sell those securities to F.I.sand/or Net Savers.
. 1. Spot Markets and FuturesMarkets; 2. Money Markets and Capital Markets;
3. Primary Markets and SecondaryMarkets; 4. Private Markets and PublicMarkets.
What is the difference between a “spot” market versus a “futures” market?
A “spot”market is for current “on-the-spot”transactions (i.e., “today”);a “futures”market is for transactions to
occur in the future.
A4. A “money”market is places of exchange for debt instruments with an original maturity ofless than one year.
A “capital”market is places of exchange for debt instruments with an original maturity ofmore than one year and also the market for equity securities(common stocks and preferred stocks).
. What is the difference between a “primary market” versus a “secondary market”?
A “primary”market is the market where securities are sold by the issuing ProductiveProject Investor and the P.P.I receives cash.
A “secondary”market is the market for securities which have been previously sold in thePrimary Market can be bought and sold multipletimes.
What is the difference between a “private market” and a “public market”?
“Private”means a total dollar amount below (about) $5 million raised from no more than(about)
40 or 50 investors.
“Public”means permission has been obtained from the U.S. Securities and ExchangeCommission
(“S.E.C.)to raise more than (about) $5 million from more than (about) 40 or 50investors.
How did the instructor categorize the six (6)largest kinds of financial institutions?
4. Investment Banks (as advisors,underwriters and brokers); 5. Financial Service Corporations (combinations ofall of the above under one holding corporation, like JP Morgan Chase; Bank ofAmerica, Wells Fargo Corp.); 6. Central Banks (e.g., Federal Reserve System).
. What is the difference between a Commercial Bank and an Investment Bank?
A Commercial Bank essentiallymakes loans to businesses and owns a portfolio of government securitiesfinanced with deposit liabilities and other capital.
An Investment Bank essentiallyadvises corporations and governments about what kind of securities to sell;acts as an underwriter to purchase and re-sell the offerings of securities bycorporations and governments; and operates wholesale and/or retail brokerageoperations. [Bank of Oklahoma and Goldman Sachs].
What is the difference between aCommercial Bank and a Financial Service Corporation? Examples?
Commercial Banks (see above); aFinancial Service Corporation is a holding corporation which owns severaldifferent types of financial intermediaries (commercial bank, mutual funds,investment bank, insurance+).
What are the major kinds ofInvestment Companies?
Mutual Funds, Private EquityFunds, Hedge Funds, Exchange Traded Funds.
Which financial institution isowned by all U.S. national commercial banks but is controlled by a board thatis appointed by the President of the United States?
The U.S. central bank the Federal ReserveSystem: its 12 Independent District Banks and their boards of directors(elected by district-based Commercial Banks as stockholders and by the Board ofGovernors), and its Board of Governors (comprised of 7 members appointed by thePOTUS).
Loans from Commercial Banks.
A stock exchange with a physicallocation is essentially a wholesale market for large value blocks of securitiestransactions by the members-only. The members are investment companies andinvestment banks trading large blocks of securities.
The “Over-TheCounter”Market is places of exchange where security brokers and dealers (brokers whichcarry inventories of securities) trade securities in large or small blocks onboth a wholesale and retail basis, and usually are transacting business overtelephone lines (i.e., by phone) or the internet.
What is the difference between acommon stock traded in the secondary market versus the IPO market?
An “IPO”is an “initialpublic offering”of securities by a corporation (usually common stock) wherein it is the firsttime the corporation is selling its stock on a “public”versus “private”basis, in the Primary Market.
How does an investor in a commonstock receive a return on their equity investment?
An investor in common stock pays aprice as agreed between that investor and whomever is selling the stock inhopes of receiving in the future (a) cash dividend payments per share (i.e.,dividend income), plus
(b) an increase in the marketprice of the common stock which the investor can realize in cash in the futureby selling the common stock (i.e., capital gains income).
What are the S&P 500 Index, theDow Jones Industrial Average (“DJIA”), and the NASDAQ Composite Index? What is one important way these indices are used?
S&P 500 Index: an industry-broad portfolio of500 of the largest, widely-held, U.S. corporations the common stock of which ispublicly-traded. Managed by Standard & Poor’sCorporation. This Index reflects the average stock price performance for allcompanies in the Index.
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