FIN 345 1st EditionExam # 1 Study Guide Lectures: 1 - 5Lecture 1 (January 13)1. Chapter 12. Learning Objectivesa. Explain why there are so many different types of financial instrumentsi. Major Financial Instruments1. Treasury bills, repurchase agreements, federal funds, bankers’ acceptances, commercial paper, negotiable CDs, Eurodollars, money market funds, treasury bonds, municipal bonds, term loans, mortgages, corporate bonds, and preferred or common stocks.a. Some are short-term and some are long-term. Long-term is anything over a yearii. Why so many?1. There are so many instruments to attract and appeal to the mostinvestors. What might be the most favorable this month might not be later, so with this many, a firm has options. iii. Why does a firm need these?1. Firms issue financial instruments so it can purchase the tangible assets necessary to produce income.b. Describe the types of debt that exist and their characteristicsi. Debt: a loan to an individual company or government1. Priority to assets and earnings compared to regular stockholders.These loans can always count on being paid back, but stockholders might not be paid dividends.2. Has principal value, face value, maturity value and par value, so they are all paid back the original value3. Interest payments4. Maturity date5. Control of the firm – bondholders do not have voting rights and have no say in the decisions of the firm6. Short-term debt: a year or lessa. Treasury bill, repurchase agreement (repo), federal funds,bankers acceptance, commercial paper, certificate of deposit, Eurodollar deposit, money market mutual fundb. Federal funds: banks have to keep a certain reserve basedon their assets. If they don’t have it after counted every night, they must borrow it, even if for one night7. Long-term debt: more than a yeara. Term loans: speed, flexibility, low issuance costsc. Explain what bond ratings are and why they are importanti. Bonds: more detailed, typically have an experienced attorney and is sometimes a better option3. Assets and Equitya. Assetsi. Real Asset: a physically observable, or touchable, itemii. Financial Asset: an asset that represents a promise to the stockholder that the firm will distribute cash flows some time in the futureb. Balance Sheet and Equityi. Equity demonstrates ownership, while a debt is an “I O U.” If you own stock, you have equity ownership.1. Common equity: Stockholder’s total investment in the firm2. Par Value: nominal or face value of a stock or bond3. Retained earnings: earnings the firms have not paid out as dividends during its life. These are used to facilitate growth, which is a good thing.4. Additional paid-in capital: difference between the market value of newly issued stock and its par value; any amount above par.5. Common Stock: represents ownership in coporation, has priority to assets and earnings except in event of default, dividends don’thave to be paid (holders get the leftovers), no maturity rate, control of the firm on policies, has preemptive right to buy more shares.a. Classified stockb. Founders’ shares: class A, total voting control and no dividends. Common with new companies6. Preferred stock: priority to assets and earnings, par value, has to be paid dividends before common stock gets theirs, can forego dividends but adds up cumulatively and must be paid to pay common stock, no maturity date, board of directors voting rights, call provisions, and participating, which means if the firmsincreases common stock earnings, they must also increase preferred.Lecture 2 (January 15) 1. Objective 3 of Ch. 1: Explain what bond ratings are and why they are important - Bondsa. Government bondsi. 2 types; deciding which is better depends on tax bracket1. Treasury notes or bond: issued by US government, are taxed, andare very safe because they are backed by the full face value and guarantee of the US government2. Municipal bonds: issued by state or local governments. Useful for schools, new construction like bridges/tunnels, etc. and are not taxed. Dividends are completely free of federal tax. Municipality doesn’t have to give as much to entice bond buyers if in high tax bracketsa. Revenue bonds: revenue from the project the bond was given for is used to pay the bond back with interest (ex: building a road and adding tolls)b. General obligation bondsb. Corporate bondsi. Mortgage bonds: secured by real estate. They have collateral for safety/securityii. Debenture: unsecured; basing safety on firm that issues itiii. Subordinated debenture: unsecure and gets money after debenture holder gets theirsiv. Other corporate bonds: income bond, putable bond, indexed bond, floating-rate bond, zero coupon bond, junk bondc. Bond contract featuresi. Coupon rate of interestii. Bond indenture: trustee, restrictive covenantiii. Call provision: you can call to take back the bond after a certain amount of time that was set in the contract, so the firm pays the bondholder and takes it elsewhere. Lowers cost to capital if the interest rates lower by the call time. Bondholder can get more interest and firm is protected.iv. Sinking fund: call for redemption by annual lottery; buy bonds on open marketv. Convertible featured. Bond ratingsi. Moody’s investors Serviceii. Standard and Poor’s Corporationiii. Investment grade bonds1. BBB rating or betteriv. Criteria for rating bondsv. Importance of bond ratings1. Spread out investment money to different bonds for diversification2. Higher rating increases quality of bond from a firm. The firm can offer lower interest rates. A firm with a low rating has to offer higher interest rates because of the higher risk the bondholder takes on.3. Not paying bonds will put firm in bankruptcyvi. Changes in ratingsLecture 3 (January 20)1. Debentures: Debt instrument not secured by assets or collateral. 2. 1 st mortgage: Secured debt instrument with claims on propertya. Cash flow impacts valuei. Example: Real estate is sold for $100,000 million and has to pay mortgage, then debentures…2 scenarios:1. Pay $75,000 mil 1st mortgage leaves $25,000 mil for debentures or2. Pay $50,000 mil 1st mortgage leaves $50,000 mil for debentures3. How does changing from A to B affect cost of debenture?a. Fewer claims on real estate if changed from scenario 1 to 2. That money goes to pay off more debentures. Less risk on debentures for scenario 2 because there is more leftover to pay back debentures.b. More money for debentures gives more value to cover